Difference Between Short-Term and Long-Term Capital Gains Tax

Understand the contrasting tax implications of short-term and long-term capital gains to optimise your investment strategies.
Short-Term vs Long-Term Capital Gains Tax
3 min
13 March 2024

When you sell mutual funds, you might need to pay capital gains tax on the profit. This tax depends on the difference between the buying price and selling price of the investment. Also, how long you held the investment determines the tax rate. This article will explain short-term and long-term capital gains tax differences and share tips on reducing your tax liability.

What are capital gains?

Capital gains refer to profits generated from the sale of capital assets like property, mutual funds, stocks, bonds, etc., and are subject to government taxation. The tax on these profits, known as capital gains tax, varies based on the duration for which the investment is held.

Types of capital gains

  1. Short-Term Capital Gains Tax
    Short-term capital gains tax is levied on the profit earned from the sale of Mutual Funds within one year of purchase for equity schemes and three years for other than equity-oriented schemes. The tax rate on short-term capital gains is typically higher than long-term capital gains. It varies depending on the investor's tax bracket.
    Short term capital gains tax (LTCG) in India is charged at a rate of 15% equity mutual funds held for less than a year. While on debt funds, short term capital gains are 20%.
    The distinction in tax rates between short-term and long-term capital gains is designed to incentivise long-term investing. By imposing a higher tax rate on short-term gains, the tax system encourages investors to hold onto their investments for a more extended period, promoting stability and potentially more favorable returns. This approach aims to discourage short-term, speculative trading while rewarding those who commit to long-term investment strategies.

  2. Long-Term Capital Gains Tax
    Long-Term capital gains tax is levied on the profit earned from the sale of Mutual Funds or equity after one year of purchase. It is a tax levied on the gains made on an investment held for a longer period.
    Long term capital gains tax (LTCG) in India is charged at a rate of 10% on stocks and equity mutual funds held for over a year. While on debt funds LTCG is levied at a rate of 20% on units held for more than 36 months, also allowing the benefit of indexation to reduce the tax liability.

Difference Between Short-term and Long-Term Capital Gains Tax

Parameters

Short-term gains

Long-term gains

Holding Period for Equity Mutual Funds

Tax is applicable if the holding period is less than or equal to 1 year

Tax is applicable if the holding period is more than 1 year

Applicable Tax Rate for Equity Mutual Funds

15%

10% over and above Rs. 1 lakh without indexation

Holding Period for Debt Mutual funds

Tax is applicable if the holding period is less than or equal to 36 months

Tax is applicable if the holding period is more than 36 months

Applicable Tax Rate for Debt Mutual funds

As per the income tax slab

20% after indexation


Capital Gains Tax Strategies to Reduce the Tax Burden

  1. Holding an equity investment for a Longer Period: Holding an equity investment for over a year can help get long-term capital gains tax benefits, which is usually lower than the short-term capital gains tax.
    For debt mutual funds it is different, you must hold it for at least 36 months (about 3 years) to qualify as a long-term capital gain tax.
  2. Tax Loss Harvesting: Selling an unprofitable asset at a loss and buying another profitable asset can help offset capital gains from profitable trades, which reduces the overall tax liability.
  3. Opting for Dividend Re-investment Scheme: Instead of taking the dividend payout, investors can reinvest dividends to purchase additional shares, which may reduce the tax liability.
  4. Careful Selection of Mutual Funds: Choosing mutual funds that have longer durations, higher credit risks, or credit opportunities can lead to higher tax-adjusted returns than those with shorter durations.
  5. Indexation for Long-term Debt Mutual Fund Investments: Indexation is a method for calculating the cost of an asset after adjusting for inflation to reduce the tax liability on long-term debts.

Common Misconceptions about Capital Gains Tax in Mutual Funds

  • Myth: Switching between schemes is not taxable
    Fact: Every time an investor switches between Financial Institutions or schemes within a mutual fund, it is considered a sale/purchase of units in the fund. That means even if one switches from one mutual fund scheme to another of the same fund house, it is treated as selling and buying again, causing capital gains or losses to arise.
  • Myth: Mutual fund gains are taxed at a fixed rate.
    Fact: Taxation varies based on the holding period. Short-term gains and long-term gains tax is levied on mutual funds based on the holding time.

Frequently asked questions

Are capital gains taxable in India?

Yes, capital gains are taxable in India. Capital gains tax is levied on the sale of capital assets like property, stocks, bonds, and mutual funds. In India, capital gains are categorised into two types, short-term capital gains tax (STCG) and long-term capital gains tax (LTCG), and they are taxed based on the holding period and the type of asset sold.

What are capital losses?

Capital losses arise when the sale price of an asset falls below the purchase price, resulting in a loss.

How to calculate short-term capital gains tax?

The formula to calculate short-term capital gains tax is “Sale price - Purchase price”. The short-term capital gain is taxed based on the tax slab of the individual investor.