Importance of Understanding The Changes in Tax Structure for Mutual Funds
Significant changes have been announced in terms of tax structure for mutual fund schemes in the 2024 Union Budget. If you are an investor in mutual funds, it is crucial that you are well aware of the taxation changes made for mutual funds in the budget.
To help you get up to speed, mutual fund investments attract two types of taxation for the investor based on the holding period. Short-Term Capital Gains Tax (STCG) on investments with a holding period of less than 12 months and Long-Term Capital Gains Tax (LTCG) for investments with a holding period of more than 12 months.
The Finance Minister (FM) in the Union Budget 2024 has announced that both the LTCG and STCG liability of equity mutual fund investors is subject to an increase of 12.5% and 20%, respectively, effective 23 July 2024. The FM also stated that the LTCG liability increase to 12.5% is not just for equity mutual fund investments; it applies to any long-term gains from investments in financial and non-financial assets. The budget also mentioned that the STCG liability of investors is increased to 20% for specific financial asset investments like equity mutual funds. Apart from the specific financial asset investments listed in the budget, the STCG increase will not affect other investments in financial or non-financial asset classes.
As an investor, understanding the tax liabilities of your investments is crucial to determining your return on investments (ROIs). So, let’s take a detailed look into the taxation changes for mutual funds announced in the Union Budget and how they affect your mutual fund investments.
Pre-2024 Tax Structure for Mutual Funds
Before the 2024 Union Budget, equity mutual fund schemes were taxed at 15% and 10% STCG and LTCG respectively. The taxation structure of other mutual fund schemes was different based on the type of mutual fund in which you’re invested. The Union Budget 2024 announcements are expected to have an effect on all types of mutual fund investments, including equity, debt, hybrid, overseas, and gold mutual fund schemes.
Prior to the budget, the tax structure of mutual fund schemes was as follows:
- Equity Mutual Funds: 15% STCG on a holding period of less than 12 months and 10% LTCG on a holding period of more than 12 months.
- Debt Mutual Funds: STCG and LTCG on debt-oriented mutual fund schemes were calculated based on a holding period of less or more than 36 months for STCG and LTCG, respectively. Both these taxes were calculated as per the investor’s income tax slab.
- Hybrid Mutual Funds: Hybrid mutual fund schemes were taxed based on their orientation. If the fund’s portfolio was 65% or more invested in equity, it was taxed as per equity mutual fund rules. A portfolio makeup of 65% or more in debt caused the fund to be taxed as per debt mutual fund rules.
- Overseas Mutual Funds: Overseas funds were taxed based on the holding period. Investments with a holding period of over 36 months were considered long-term capital gains and taxed at 20% with indexation benefits. For holding periods of less than 36 months, the STCG was calculated as per the investor’s income tax slab.
- Gold Mutual Funds: Gold mutual funds were taxed based on a holding period of less or more than 36 months previously. Both LTCG and STCG were calculated as per the investor’s income tax slab for gold mutual fund investments.
Summary of The Major Changes in The Tax Structure for Mutual Funds
The major changes in the mutual fund tax structure announced in the Union Budget 2024 were the increase in LTCG and STCG tax rates, as mentioned above. Another important announcement and significant change to the mutual fund tax structure was the change of holding periods.
The FM in the Union Budget 2024 announced the holding period of several mutual fund schemes, which was previously 36 months and above for the consideration of LTCG and has now been reduced to 24 months or 2 years. Lowering the holding periods ensures that more investments will be liable for LTCG taxes, increasing the tax burden on investors. However, to help reduce the tax burden on investors, the LTCG exemption limit has been increased from ₹1 lakh each financial year to ₹1.25 lakh per financial year.
Let’s review the impact of these changes on some of the different types of mutual fund schemes.
Impact on Equity-Oriented Mutual Funds
The tax rates for equity-oriented mutual fund schemes have increased. The LTCG tax rate has increased from 10% to 12.5%, and the STCG tax rate has increased from 15% to 20%. The holding period for tax calculation of equity-oriented mutual fund schemes has not changed. This means any holding period beyond 12 months for equity-oriented mutual funds will attract LTCG taxes.
Impact on Debt-Oriented Mutual Funds
For debt-oriented mutual fund schemes, there have been no changes to the tax rate. The investments are still taxed as per the investor’s income tax slab, both for short-term and long-term capital gains taxes. However, the holding period for tax calculation of LTCG has been reduced from 36 months to 24 months.
Impact on Hybrid Mutual Funds
The tax rate and holding period of hybrid mutual fund investments have changed after the Union Budget 2024. Earlier, if the holding period was more than 36 months, these schemes were taxed as per investors’ tax slab (LTCG and STCG). The holding period for specified mutual funds, which have more than 65% in debt, has been changed to more than 24 months and will continue to be taxed as per investors’ tax slabs for LTCG and STCG tax calculations.
Impact on Overseas Funds
Overseas funds or international mutual fund schemes have also experienced changes in their taxation structure in the Union Budget. Much like hybrid mutual fund schemes, the tax rate and holding period for overseas funds have changed. The LTCG tax rate has been changed from the investor’s income tax slab to 12.5% on overseas fund investments. The holding period for LTCG calculation has been reduced from 36 months to 24 months. The STCG tax rate remains unchanged per the investor’s income tax slab.
Impact on Gold Mutual Funds
The taxation liability on gold mutual fund investments has also changed. The holding period for LTCG calculation has been reduced from 36 months to 24 months, and the LTCG tax rate has been fixed at 12.5%. No changes have been made to the STCG tax calculation, which is still taxed according to the investor’s income tax slab.
Practical Implications for Investors After The Changes on Tax Slab
The practical implications for investors after the mutual fund taxation changes depend quite a lot on the type of mutual fund scheme in which you’re invested. For equity-oriented mutual fund schemes, which are among the most common mutual fund investments, the tax liability of investors has increased. This can potentially lower the investor’s returns, be it short-term or long-term.
On the other hand, in mutual fund schemes where both the LTCG and STCG taxes were calculated as per the investor’s income tax slab, the changes to the LTCG tax rate will be a welcome relief. Income tax slabs go as high as 30%, meaning any investment in such mutual fund schemes would have long-term returns taxed at a maximum of 30%. This has now been reduced per the new guidelines, with a cap of 12.5%. This benefit applies to various mutual fund schemes, including overseas and gold mutual fund schemes.
Future Outlook
According to market experts, the budget has simplified the taxation of mutual fund investments and brought uniformity to mutual fund taxation. The formation of only two holding periods of 12 months and 24 months is expected to provide clarity and simplicity in mutual fund taxation for investors, as per the expert. Experts have also added that a reduced holding period benefits investors and reduces the complications with mutual fund taxation. For more information about the Union Budget and how it affects the stock market, feel free to check out the Sharekhan Knowledge Center. Our insightful pieces on the stock market and investor best practices will help you learn the critical aspects of retail investing.
