When you invest in mutual funds, you earn different types of income. Some funds offer periodic payouts of a portion of their profits, known as dividends. Additionally, if you redeem your mutual fund investments at a profit, you earn capital gains. Before you make a lump sum or SIP investment in mutual funds, you should know how to calculate capital gains tax on mutual funds.
In this article, we take a closer look at what capital gains are, how they are classified based on the holding period of the funds and how to calculate capital gains tax on mutual funds.
What are capital gains on mutual funds?
The term capital gains refers to any profits made from the sale of a capital asset. Since mutual fund schemes are financial capital assets, any profits you earn when you redeem your mutual fund investments are classified as capital gains. These gains may be added to your total income and taxed at the income tax slab rate that applies to you, or they may be taxed at a different flat rate.
How to calculate capital gains tax: A step-by-step guide
- Determine your basis
Your basis is usually the purchase price of the asset, plus any commissions or fees paid. For certain assets, like stocks, reinvested dividends can also increase your basis. - Determine your realised amount
This is the selling price of the asset, minus any commissions or fees you paid during the sale. - Calculate the difference
Subtract your basis (purchase price) from your realized amount (sale price) to find the difference.- If you sold the asset for more than you paid, the result is a capital gain.
- If you sold the asset for less than you paid, it’s a capital loss, which may be used to offset capital gains tax.
- Check applicable tax rates
Based on the descriptions below, determine which tax rate applies to your capital gains.
Capital gains tax rate: short vs long
Capital gains tax is levied on the profit earned from the sale of capital assets such as property, stocks, or mutual funds. The rate of taxation depends on how long the asset is held before selling. If the asset is sold within a short period—typically less than 36 months for real estate and less than 12 months for listed securities—it is considered a short-term capital gain and taxed at a higher rate. In contrast, gains from assets held for longer durations are categorised as long-term capital gains and are usually taxed at a lower rate. This distinction encourages long-term investments and impacts how investors plan their asset sales for tax efficiency.
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Different categories of mutual funds for tax purposes
To understand the fundamentals of how to calculate capital gains tax on mutual funds, it is necessary to first become familiar with the different categories of mutual funds for tax purposes. Primarily, we have three categories, as outlined below:
- Equity mutual funds (that invest 65% or more in equity):
These are mutual funds that invest at least 65% of their assets in equity and equity-related instruments. Some examples of such funds include equity mutual funds, arbitrage funds and aggressive hybrid funds. - Debt mutual funds (that invest 65% or more in debt):
These mutual funds invest at least 65% of their assets in debt instruments and securities. Some examples of funds in this category include debt mutual funds, floater funds and conservative hybrid funds. - Other mutual funds (that invest over 35% but below 65% in equity):
These funds invest in both debt and equity. However, the percentage of investment in equity is between 35% and 65% of the total assets. Balanced hybrid funds typically belong in this category as they invest 40% to 60% of their assets in equity (and the rest in debt).
Capital gains tax on the different categories of mutual funds
Now that you have seen the different types of mutual funds for tax purposes, let us delve into the types of capital gains and the tax rates applicable to them. Based on the holding period of the fund’s units before redemption, the profits can be any one of two types: Short-Term Capital Gains (STCG) and Long-Term Capital Gains (LTCG).
Here is how the holding period affects the type of capital gains for the three different categories of funds.
- Capital gains on equity mutual funds
If the holding period is less than 12 months, the profits from the sale of equity funds are considered to be STCG and taxed at a flat rate of 15%. If the holding period is 12 months or more, the gains are LTCG and taxed at 10% without indexation benefits. - Capital gains on debt mutual funds
As per a recent amendment introduced in Budget 2023, capital gains from the transfer of debt funds and hybrid debt funds are always considered to be STCG and taxed at the income tax slab rate applicable to you. This has been in effect from April 1, 2023.
Capital gains taxes and your tax forms
Filing capital gains correctly is essential to avoid notices or penalties. The reporting process varies depending on the asset class and the duration of holding:
- Short-term capital gains (STCG)
These are gains from assets held for a short period—typically less than 12 months for equities or 36 months for real estate. STCG is reported under Schedule CG of ITR-2 or ITR-3, depending on the taxpayer’s profile. - Long-term capital gains (LTCG)
Gains from assets held beyond the defined holding period are reported separately. If your LTCG from listed equity exceeds Rs. 1.25 lakh, you must disclose details like ISIN codes, acquisition cost, and sale value in a tabular format. - Form selection matters
Salaried individuals with capital gains generally use ITR-2. Business owners may use ITR-3. Choosing the wrong form can lead to filing errors or rejected returns.
How to avoid capital gains tax?
While capital gains tax is applicable in many scenarios, you can legally reduce or defer it using these strategies:
- Reinvest under Section 54 or 54EC
If you’ve sold a residential property, reinvesting the gains in another residential property (Section 54) or in notified bonds (Section 54EC) can help you claim tax exemption. - Hold assets for the long term
Selling assets after the long-term holding period qualifies you for lower tax rates, and in some cases (like equity), benefits from an exemption of up to Rs. 1 lakh. - Offset with capital losses
You can reduce your taxable gains by adjusting them against short-term or long-term capital losses from other assets. - Donate appreciated assets
In some cases, donating long-held assets to eligible charitable institutions may offer you a deduction, while avoiding the capital gains tax entirely.
Conclusion
Now that you know how to calculate LTCG tax and STCG tax on mutual funds, you can plan your mutual fund investments smartly. Your choice of mutual funds may depend on your risk tolerance, expected returns and tax planning needs. To find the mutual fund scheme that best suits these criteria, check out the 1,000+ funds available on the Bajaj Finserv Mutual Funds Platform. You can even compare mutual funds available and make an informed choice for your portfolio.
