Short Term Capital Gain – STCG Tax on Mutual Fund

As an investor in mutual funds, you may be aware of the various benefits they offer, such as diversification, professional management, and liquidity. But do you also know about the tax implications of your mutual fund investments? Depending on the type and duration of your investment, you may have to pay different types of taxes on your mutual fund gains. One of these taxes is the short term capital gain tax (STCG).

STCG tax is the tax that you have to pay when you sell your mutual fund units within a short period of time and make a profit. The period of time that determines whether your gain is short term or long term depends on the type of mutual fund you invest in. There are three main types of mutual funds based on their asset allocation: equity funds, debt funds, and hybrid funds. Each of these funds has a different STCG tax rate and holding period.

Understanding Short-Term Capital Gains Tax on Mutual Funds

Short Term Capital Gain (STCG) tax is the financial guest that arrives when you decide to part ways with your mutual fund units a bit too soon, turning a profit in the process. For adrenaline-driven investors dabbling in equity funds, selling within a year invites a 15% tax on the gains. However, if you’re more of a marathon investor, holding beyond a year, the tax shifts to a more lenient 10% on profits exceeding Rs. 1 lakh annually. Debt fund enthusiasts face a different timer; selling within three years means your gains get taxed as per your income slab. But wait, there’s a silver lining! Hold on for longer, and you enjoy a reduced tax rate of 20% on your gains, sweetened further by indexation benefits that adjust your purchase cost for inflation, effectively reducing your taxable income.

Navigating the STCG tax labyrinth becomes easier with a few clever strategies. For one, balancing your investment portfolio to offset any short-term losses against gains can lower your tax bill. Moreover, embracing the systematic investment plan (SIP) method not only disciplines your investment journey but also cleverly positions you for more long-term gains, thereby skirting the higher STCG tax rates. Remember, each mutual fund type—equity, debt, and hybrid—plays by its own tax rules, so a tailored approach, possibly under the guidance of a tax advisor, can help optimise your tax outcomes while keeping your investment goals on track.

How to Calculate Short-Term Capital Gains: Formula and Steps

When you sell an asset within a year of purchase and make a profit, you’ve entered the world of short-term capital gains, which are taxed differently than their long-term counterparts. Here’s how you can figure out what you owe to the taxman without breaking a sweat:

• Kick things off with the total amount you pocketed from the sale. This includes everything from cash to property, or any service received in the asset’s exchange.
• From this total, subtract any costs directly related to the sale (think brokerage fees, commission, or stamp duty), the initial purchase price (including related charges), and any money you’ve poured into improving the asset (like renovations or repairs).
• The figure you’re left with is your short-term capital gain (or loss if the number’s in the red). A positive number means it’s time to celebrate your profits, but with a slice of caution for the taxes due.
• The tax rate on your gain depends on the asset’s nature and your tax bracket. Equity shares and mutual funds that lean towards equity get taxed at a flat 15% rate, whereas debt funds and other assets are taxed based on your income.

Here’s a Quick Example to Put Theory Into Practice

Imagine you snagged 100 shares of XYZ Corp. at Rs. 200 each on January 1, 2023, and sold them off at Rs. 250 per share by June 1, 2023. Let’s say the buying and selling process cost you Rs. 500 in brokerage fees, and there were no improvements made to the shares.

• Your total sale value clocks in at Rs. 25,000 (100 shares at Rs. 250 each).
• After deducting Rs. 20,500 for expenses (including the Rs. 500 brokerage and the Rs. 20,000 original purchase cost), there’s no improvement cost to worry about.
• You’re looking at a short-term capital gain of Rs. 4,500 (Rs. 25,000 minus Rs. 20,500).
• Given the 15% tax rate for equity shares with securities transaction tax (STT) applied, your tax liability stands at Rs. 675 (15% of Rs. 4,500).

What is STCG Tax for Equity Mutual Funds?

Short Term Capital Gains the profit earned from selling or transferring mutual fund units that are held for a short period of time. The duration of the holding period and the tax rate for STCG depend on the type of mutual fund.

For equity mutual funds, which invest at least 65% of their assets in equity and related instruments, the holding period for STCG is less than 12 months. The STCG tax rate for equity mutual funds is 15%, plus applicable surcharge and cess.

Only when mutual fund units are sold or transferred through an accredited stock exchange and are liable to securities transaction tax (STT) is STCG tax applicable. However, transactions undertaken in an International Financial Service Centre (IFSC) are exempt from STT but still taxable at 15%.

If the total income of the investor is less than the basic exemption limit, STCG tax can be decreased by adjusting the gains against the limit. For example, if an investor has a taxable income of Rs. 2 lakhs and a STCG of Rs. 1 lakh from equity mutual funds, then the tax liability will be only on Rs. 50,000 (Rs. 1 lakh – Rs. 50,000), which is the amount exceeding the basic exemption limit of Rs. 2.5 lakhs.

Given its impact on post-tax returns, the STCG tax is a crucial consideration when making mutual fund investments. Investors should be aware of the holding period and the tax rate for different types of mutual funds and plan their investments accordingly.

Tax Implications for Short-Term Gains from Debt Mutual Funds

Debt mutual funds are those investment instruments that predominantly invest their funds in fixed-income securities like bonds, debentures, and other debt instruments. These securities usually generate returns in the form of interest or capital appreciation, which makes them a preferred investment choice for conservative investors.

The taxation of debt mutual funds is governed by the holding period rule: Short-Term Capital Gains: If the debt mutual fund unit is sold within 36 months (three years) of purchase, the gains are termed short-term capital gains (STCG). These short-term capital gains are added to your other income and taxed at slab rates. Long-Term Capital Gain: However, if they were sold after 36 months, then the gains were termed long-term capital gains (LTCG). These long-term capital gains were taxed at 20% with an indexation benefit. The benefit of indexation is that investor gains are adjusted for inflation.

However, as per the amendments made in the Union Budget 2020, debt mutual funds will no longer receive indexation benefits and are deemed to be short-term capital gains. Therefore, the gains from debt mutual funds will now be added to your taxable income and taxed at the slab rate. Earlier, the long-term capital gains from debt mutual funds were taxed at 20% with an indexation benefit.

The change may impact the attractiveness of these mutual funds as an investment option, as the tax burden on the profits may increase. Investors should compare the post-tax returns of debt mutual funds with other fixed-income instruments like fixed deposits, bonds, etc. and choose the one that suits their risk-return profile and tax efficiency.

Tax Treatment for Short-Term Profits from Hybrid or Balanced Mutual Funds

Hybrid or balanced mutual funds are investment instruments that invest in a mix of equity and debt securities, aiming to provide both capital appreciation and regular income. The proportion of equity and debt allocation may vary depending on the fund’s objectives and strategy.

The taxation of hybrid or balanced mutual funds depends on the equity exposure of the fund. If the fund has more than 65% of its assets invested in equity or equity-related instruments, then it is treated as an equity-oriented fund for taxation purposes. In this case, the short-term capital gains (STCG) are taxed at 15%, and the long-term capital gains (LTCG) are taxed at 10% (without indexation) on gains exceeding Rs. 1 lakh in a financial year.

However, if the fund has less than 65% of its assets invested in equity or equity-related instruments, then it is treated as a debt-oriented fund for taxation purposes. In this case, the short-term capital gains (STCG) are taxed as per the investor’s income tax slab, and the long-term capital gains (LTCG) are taxed at 20% (with indexation).

Investors should check the equity-debt ratio of the hybrid or balanced fund before investing, as it affects the tax liability and the post-tax returns. They should also consider the fund’s performance, risk profile, and suitability for their financial goals.

Tax Considerations for Short-Term Gains from SIPs

SIPs or Systematic Investment Plans are a popular investment choice offered by mutual fund companies. They enable investors to regularly invest a fixed amount in a mutual fund scheme, providing the advantage of rupee-cost averaging and helping mitigate market volatility.

The taxation of SIPs is similar to that of lump sum investments in mutual funds, except that the holding period is calculated for each installment of the SIP. For example, if an investor starts a SIP of Rs. 10,000 per month in an equity fund in January 2020 and redeems the entire investment in January 2021, then the gains from the first instalment will be considered long-term, as they were held for more than 12 months. However, the gains from the subsequent instalments will be considered short-term, as they were held for less than 12 months.

The tax rate for the short-term gains from SIPs depends on the type of mutual fund scheme. For equity-oriented funds, the STCG tax rate is 15%, and for debt-oriented funds, the STCG tax rate is as per the investor’s income tax slab. The tax rate for the long-term gains from SIPs also varies based on the type of mutual fund scheme. For equity-oriented funds, the LTCG tax rate is 10% (without indexation) on gains exceeding Rs. 1 lakh in a financial year. For debt-oriented funds, the LTCG tax rate is 20% (with indexation).

Investors should keep track of the holding period and the tax rate for each installment of the SIP, as it affects the tax liability and the post-tax returns. They should also choose a mutual fund scheme that matches their risk appetite, return expectations, and investment horizon.

In Conclusion

For investors hoping to maximise their post-tax earnings, understanding the nuances of the mutual fund industry’s Short Term Capital Gains (STCG) tax is essential. Knowing the precise tax ramifications of your investments is important because equity, debt, and hybrid funds are subject to varied rates and regulations.

Whether you’re a cautious investor who prefers debt funds or an ambitious one who leans towards equity funds, the type of fund and the length of time you keep it for will have a big impact on your tax bill. Ultimately, informed decision-making, aligned with your financial goals and tax planning, is key to achieving financial success in the complex world of mutual fund investments.