What is LTCG Tax on Mutual Funds?

Mutual funds are a popular investment instrument among investors who prefer not to invest in the stock market directly. They are managed by an expert fund manager, have a diversified portfolio, are cost-effective, and come with tax benefits.

That said, when you invest in mutual funds, you have to bear capital gains tax. Therefore, it's essential to understand how taxes on mutual funds work if you're looking to maximize your returns while minimizing your tax liability.

In this blog, we'll look closer at the long-term capital gain tax on mutual funds and how you can minimize its impact on your investment returns. 

What is LTCG tax on mutual funds?

If you sell your mutual funds after holding the units for more than one year, you must pay a long-term capital gains (LTCG) tax if the profits earned from the sale exceed Rs. 1 lakh. The tax rate depends on the type of mutual funds you own.

If you've invested in equity mutual funds, you will be taxed at 10%. For non-equity mutual funds, the LTCG tax rate is 20% after indexation. Indexation is a technique that adjusts the price of mutual fund units for inflation, reducing your capital gains tax liability.

Tax situation on long-term capital gains

Here's a quick guide to help you understand the long-term tax rates on mutual funds-

You can easily calculate your potential LTCG taxes by using an online long-term capital gains tax calculator. Select the type of mutual fund you've invested in, the holding period, and the sale and purchase value, and click on 'Calculate'. The long-term capital gains tax calculator will generate the result instantly.

You can also calculate the tax manually using the following method.

*Note: The LTCG rates are applicable only for investments made before 31st March 2023. Irrespective of the holding period, Capital gains from debt mutual funds will be taxed as per the investor’s income tax slab rate starting from 1 April 2023.

How is LTCG tax calculated on mutual funds?

Before diving into the manual calculation, you must understand two important terms- cost of acquisition and full value of consideration.

The cost of acquisition is the amount at which you bought the mutual fund units. It includes the purchase price, as well as other charges like transaction fees, brokerage, stamp duty, etc.

The full value of consideration is the amount you received for selling your units.

Now, let's understand LTCG tax calculation with the help of an example. Suppose you purchased mutual fund units worth Rs. 1 lakh in 2016. You sold all units for Rs. 5 lakh in 2018. Since you held the units for more than 12 months, here's how you can calculate your LTCG tax-

Full value of consideration- Rs. 5 lakh

Cost inflation index- 280

Indexed cost of acquisition- 1 lakh X (280/100) = Rs. 2,80,000

Total taxable gain= Rs. 5,00,000 - Rs. 2,80,000= Rs. 2,20,000

Since your profit exceeds Rs. 1 lakh, you'll be taxed at 10%.

2,20,000 X 10% = Rs. 22,000

Hence, your LTCG tax is Rs. 22,000.

How to minimize LTCG tax on mutual funds?

While LTCG tax is mandatory in mutual funds, you can take a few steps to minimize your tax liability-

-Invest in tax-saving mutual funds like ELSS to claim a deduction of up to Rs. 1.5 lakh under section 80C of the IT Act.

-Opt for systematic withdrawal plans (SWPs) that allow you to redeem your mutual fund units at regular intervals. This way, you can ensure that your profits are below Rs. 1 lakh in a financial year.

-Consult a tax professional to optimize your investments and reduce your tax liability.

To Wrap Up

Mutual funds are an excellent way to invest in the stock market without spending hours monitoring it. They're also an excellent way to save taxes. But at the same time, the gains you make when selling your units attract capital gains taxes. Therefore, you must stay updated with the latest tax developments to make the most of your investments.

If you haven't invested in mutual funds yet, start today with Tata Capital Moneyfy. Our experts will evaluate your financial goals, budget, and risk appetite to determine the best fund for you. Visit the Moneyfy Website or download the Moneyfy App to know more.