What are Capital Gains on Mutual Funds?
A capital gain on a mutual fund is the difference between the purchase price of the mutual fund units and their selling price. When the selling price is higher than the buying price, the investor is said to have made capital gains on that fund. For example, suppose you bought 100 units of a mutual fund at ₹100 per unit, thus totalling an investment of ₹10,000. Now, suppose that the value of each mutual fund unit increased over time from ₹100 to ₹120. Then, your total investment in 100 units will now be valued at ₹12,000, and you will have made capital gains worth ₹2,000. Capital gains can be short-term or long-term, depending on the holding period of the fund units. The exact timeline depends on the type of mutual fund that you are dealing with.What Are Short-Term Capital Gains?
Short-term capital gains (STCGs) are capital gains that are realised upon the sale of assets held for less than a certain period of time, which is 12 months for equity funds and hybrid equity-oriented funds, and 36 months for debt funds. The categorisation of short term capital gains is important for the following reasons:- Taxation of your capital gains on mutual funds is done differently for short term capital gains and long term capital gains. Hence, you need to understand how short term gains are defined for your specific fund.
- Your returns from a fund may differ over time. Having a sense of short term and long term returns helps you understand the patterns shown by a fund. This will help you make better investment decisions.
Tax Implications For Short Term Capital Gains
Section 111A of the Income Tax Act, 1961 is applicable in case of STCG arising on the transfer of equity-oriented mutual fund units. Such a gain is taxed at the STCG tax rate of 15%, plus surcharge and cess as applicable. The surcharge and cess rates vary depending on the income tax category of the investor. Normal STCG is STCG from assets that are not covered under section 111A. Such assets include debt funds or debt-oriented funds. Normal STCG is taxed at the rates corresponding to the income tax slab of the taxpayer.Short Term Capital Gains Tax as per Types of Mutual Funds
The following table summarises the short-term capital gains tax implications for different types of mutual funds:| Type of Mutual Fund | Holding Period for STCG | Tax Rate |
| Equity Funds | Less than 12 months | 15% plus surcharge and cess |
| Debt Funds | Less than 36 months | Taxed at the slab rate of the investor |
| Hybrid Equity-oriented Funds | Less than 12 months | 15% plus surcharge and cess |
| Hybrid Debt-oriented Funds | Less than 36 months | Taxed at the slab rate of the investor |
Example of STCG on Equity Funds
Suppose you invest ₹10,000 in an equity fund on January 1, 2023, and sell all your units on December 1, 2023, for ₹12,000. The capital gain realised in this case is ₹2,000. Since the holding period is less than 12 months, the capital gain will be treated as STCG and taxed at the STCG tax rate of 15% plus surcharge and cess. However, let us look at the example where you bought debt fund units worth ₹10,000 in January 2018 and sold the units for ₹12,000 in January 2020. Since the holding period is less than 36 months, you pay the short term capital gains tax.Short-Term Capital Loss
A short-term capital loss (STCL) is a capital loss that is realised on the sale of assets held for less than the holding period specified for STCGs. STCLs can be offset against STCGs on mutual funds and other assets. If the STCLs exceed the STCGs, the excess STCLs can be carried forward for up to 8 years and offset against STCGs realised in those years.Tips for Reducing Taxes on Short Term Capital Gains
Ideally, you should not place tax implications as the primary criteria for investment. However, you can use the following methods to reduce the tax liability of your portfolio:- Invest for the long term. The longer you hold your mutual fund units, the more likely you are to generate long-term capital gains (LTCGs), which are taxed at a lower rate than STCGs.
- You can increase the proportion of your investment in ELSS funds as they give you tax advantages. Investing in mutual funds through Equity-Linked Savings Schemes (ELSS) can help you reduce your tax liability on capital gains.
Why is Understanding STCG important?
The concept of short term capital gains is helpful in understanding both the returns from a mutual fund as well as the taxability of mutual funds. Both of these approaches are important things to consider when choosing the right mutual fund to invest in. For example, you may choose to invest in a mutual fund which you expect to provide a higher short term capital gain. This is true, especially if your investment timeline itself is for the short term. On the other hand, you may choose to hold the investment for the long term, if the impact from the difference in applicable tax rates is too high. For example, if you are gaining ₹5,000 from an STCG but not holding the fund for the long term, it is costing you ₹6,000 more in taxes, then it may make sense to stay invested to avoid the overall loss.Final Words
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What counts as a capital gain?
The appreciation in the value of capital assets is considered as capital gain. Capital assets can include not only financial assets such as stocks and bonds, but also physical assets such as gold, property, jewellery, archaeological collections and works of art.
Are short-term capital gains taxable?
Yes, short term capital gains (STCG) are taxable in India. The exact rate is 15% if the STCG falls under Section 111A of the IT Act, 1961. If the STCG does not fall under Section 111A, then the rate depends upon the income tax slab of the investor.
What timeline is considered short term with relation to capital gains in India?
The capital gain must be realised before 12 months in the case of equity funds and hybrid equity-oriented funds, and 36 months in the case of debt funds, in order for it to be considered short term.
What is the capital gains account scheme?
The government in India allows you to gain exemption from capital gains tax if you re-invest the capital gains in certain assets within a certain time limit as per Section 54 to Section 54GB. In case, the date of filing tax returns is near but you have not re-invested the capital gains yet, you can put the capital gain in a capital gains account scheme to avail the tax exemption.
