Short Term Capital Gains Tax on Mutual Funds

Read more to understand STCG and how it will help you make informed decisions and optimise your tax planning strategy.
Short Term Capital Gains Tax on Mutual Funds
3 mins read
31-May-2024

When it comes to investing in mutual funds and other financial instruments, it is essential to be aware of the tax implications, especially regarding capital gains. Capital gains are the profits earned from the sale or transfer of an asset, and they can be categorized as short-term or long-term based on the holding period of the asset.

In this article, we will delve into the world of Short-term Capital Gains Tax (STCG), exploring what it is, how it is calculated, and the exemptions available to investors. Whether you are a seasoned investor or a newcomer to the financial world, understanding STCG will help you make informed decisions, and optimise your tax planning strategy.

What are the gains in mutual funds?

Mutual funds yield returns in two primary forms: capital gains and dividends. Capital gains represent the profit gained by an individual upon selling or transferring mutual fund assets, whereas dividends denote the income received when the underlying assets generate interest or earnings.

For tax purposes, capital gains from mutual funds are taxed at the investors' hands, while dividends on mutual funds are subject to the Dividend Distribution Tax (DDT), which is levied on fund companies on behalf of investors.

Capital gains from different types of mutual funds are categorised into long-term and short-term gains based on the duration of fund holding. Funds held for less than 12 months (or 36 months in some cases) are subject to short-term capital gain tax.

Understanding the various types of mutual funds and the capital gains they generate is crucial for comprehending the tax implications associated with mutual fund investments.

Short-term capital gains tax rate on mutual funds for FY 2024-2025

Short-term capital gain tax pertains to profits generated from investments held for shorter durations. The definition of ‘short-term’ varies among different mutual funds. For instance, in debt funds, STCG applies if the investment tenure is less than 36 months, while in equity funds, it is applicable for investments held for less than 12 months upon redemption.

Mutual fund type

Short-Term Capital Gain (STCG) holding period

Equity Funds

Less than 12 months

Debt Funds

Less than 36 months

Hybrid Equity-Oriented Funds

Less than 12 months

Hybrid Debt-Oriented Funds

Less than 36 months


Tax on short-term capital gains

The tax rate on short-term capital gains depends on the type of asset and the individual's income tax slab.

STCG on equity and non-equity assets:

  • Equity-oriented assets such as equity mutual funds are subject to STCG tax at a flat rate of 15% if held for less than 12 months. For example, if an investor sells equity shares after holding them for 9 months and earns a profit of Rs. 50,000, the STCG tax of 15% would apply to this gain.
  • For non-equity assets like units of debt oriented mutual funds, bonds, and gold, the short-term capital gains tax is added to the individual's total income and taxed as per their applicable income tax slab.

Short-term capital gain on property:

  • Calculation: Short-term capital gain on property = Final sale price - cost of acquisition - improvement cost of assets – Transfer expenses.
  • For real estate properties, the short-term holding period is less than 24 months. If a property is sold within this period, any gains made from the sale would be classified as short-term capital gains. Hence, profit earned from selling such capital asset is categorized as an individual’s income and is liable to taxation according to Indian Income Tax Act, 1961.
  • Certain exemptions are available on short-term capital gains from the sale of specific assets, like residential house properties under Section 54, which states, if the gains from the sale of a residential house property are reinvested in another residential house property within the specified time, the investor can claim exemption on the capital gains.

Taxation of short-term capital gains on Hybrid funds:

  • Hybrid funds combine both debt and equity instruments, offering investors portfolio diversification. Tax rates for STCG on these funds vary based on holding periods and equity exposure. Funds with over 65% equity exposure are taxed like equity funds; otherwise, debt fund tax rules apply. It's essential for investors to know the equity exposure of chosen hybrid funds.

Taxation of short-term capital gains on SIP:

  • SIPs allow investors to regularly invest in mutual funds. Redemption of SIP units follows the first-in-first-out principle. For instance, if you redeem units after 13 months, units bought in the first month incur long-term capital gains, while those bought later incur STCG taxed at 15%, regardless of income tax slab. Additionally, equity mutual fund transactions incur Securities Transaction Tax (STT) at 0.001%.

Example of Short-Term Capital Gain Tax (STCG) on Mutual Funds

Calculating short-term capital gain for a share is straightforward. Just subtract the original cost of the share from its final selling price. For example, consider the purchase of 100 shares of ABC Ltd. at Rs. 100 each, sold at Rs. 120 each after six months:
Sale Price = Rs. 120 x 100 shares = Rs. 12,000
Purchase Price = Rs. 100 x 100 shares = Rs. 10,000
Short-Term Capital Gain = Rs. 12,000 - Rs. 10,000 = Rs. 2,000

Tips for reducing taxes on short term capital gains

While minimising taxes is attractive, it shouldn't be your primary driver for choosing mutual funds. A strong investment strategy aligns with your financial goals and risk tolerance. However, you can incorporate tax-efficiency strategies to enhance your overall returns:

  • Harness the power of long-term investing: Holding mutual fund units for a longer period (typically over one year) helps you benefit from lower tax rates. Long-term capital gains (LTCGs) on equity funds attract a more favourable tax treatment compared to short-term capital gains (STCGs).
  • Explore tax-saving investment options: Consider allocating a portion of your portfolio to Equity-Linked Saving Schemes (ELSS). These mutual funds offer a tax deduction on your investment amount under Section 80C of the Income Tax Act. This can significantly reduce your taxable income and offer some tax savings benefits.

By combining a long-term investment approach with tax-efficient options like ELSS funds, you can achieve your financial goals while minimising your tax burden. Remember, consult a financial advisor to ensure these strategies align with your specific investment needs and risk profile.

Why is understanding STCG important?

The concept of short-term capital gains (STCGs) plays a crucial role in understanding your potential returns and tax implications when investing in mutual funds. Both factors are essential for making informed investment decisions.

STCGs and investment horizon:

  • Targeting short-term gains: If your investment horizon is short-term (less than a year), you might prioritise mutual funds with the potential for higher STCGs. This approach can be suitable for meeting short-term financial goals.
  • Long-term considerations: For long-term investment goals, tax efficiency becomes more critical. STCGs are generally taxed at a higher rate compared to long-term capital gains (LTCGs). Therefore, if the potential tax difference on a Rs. 5,000 STCG outweighs the immediate gain (e.g., facing a Rs. 6,000 higher tax bill), holding the investment for the long term to qualify for LTCG benefits might be a wiser strategy. This allows you to potentially keep more of your returns.

Conclusion

In conclusion, short-term capital gains tax (STCG) is an important aspect of taxation that investors must consider while making financial decisions. Understanding the holding period of assets and the applicable tax rates can help investors optimise their tax liabilities and plan their investments more efficiently.

Additionally, exploring the exemptions available on short-term capital gains can further enhance the tax efficiency of your investment portfolio. As with any tax-related matters, it is advisable to seek professional advice and stay updated with the latest tax regulations to make the most of your investments and achieve your financial goals effectively.

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Frequently Asked Questions

What is the tax rate on short-term capital gains?

Short-term capital gains in India are taxed at a rate according to the individual's applicable income tax slab. For example, if your total income falls within the 30% tax bracket, your short-term capital gains will also be taxed at 30%.

What is the exemption of capital gains tax?

Certain investments, such as Equity Linked Savings Schemes (ELSS) and investments in specified bonds, enjoy exemptions from capital gains tax under Section 54F of the Income Tax Act, provided specific conditions are met.

Can we claim 80C and 80U deduction against short term capital gain?

No, deductions under sections 80C to 80U are not applicable to short-term capital gains. These deductions are primarily related to specific investments, expenses, and disabilities, and they apply to the computation of total income.

How do you avoid short term capital gain tax?

Investors can avoid short-term capital gains tax by holding onto their investments for longer periods to qualify for the benefits of long-term capital gains taxation, which generally attracts lower tax rates compared to short-term gains.

What is the time period for short-term capital gains?

Short-term capital gains apply to profits made from the sale of assets held for less than 36 months, excluding certain assets like equity shares and mutual fund units, which have a shorter holding period for short-term capital gains tax applicability.

Is short term capital gain taxable?

Yes, short-term capital gains are subject to taxation at the applicable income tax rates. These gains arise from the sale of assets held for a short duration, typically less than 36 months, and are taxed according to the individual's income tax slab.

How much short-term capital gain is tax free?

Short-term capital gains on listed equity shares and equity-oriented mutual funds are taxed at a flat rate of 15% if the total gains in a financial year exceed Rs. 1 lakh. Below this threshold, short-term capital gains remain tax-free.

What is an example of a short-term capital gain?

Selling shares of a company within a year of purchase and making a profit from the sale qualifies as a short-term capital gain. For instance, if you buy shares at Rs. 500 each and sell them for Rs. 700 within a year, the Rs. 200 profit per share is considered a short-term capital gain.

Is short-term capital gain below Rs. 1 lakh taxable?

Short-term capital gains on listed equity shares and equity-oriented mutual funds are tax-exempt up to Rs. 1 lakh per financial year. Gains exceeding this limit are taxed at a flat rate of 15%.

Is short-term capital gain taxable at 30%?

Short-term capital gains are taxed at the individual's applicable income tax slab rates, which may reach up to 30% for higher income brackets. However, listed equity shares and equity-oriented mutual funds are taxed at a flat rate of 15%.

How to calculate short-term capital gain on shares?

To calculate short-term capital gains on shares, subtract the purchase price from the selling price. Any expenses related to the sale, such as brokerage fees, can be deducted. The resulting amount is your short-term capital gain, which is taxed according to the applicable income tax slab rates.

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