Short-Term Capital Gain on Mutual Funds

What is Short-Term Capital Gain (STCG) Tax on Mutual Funds?

Short-term capital Gain (STCG) tax on mutual funds is the tax levied on profits rendered from the sale of mutual fund units within a specified holding period. This duration varies based on the type of mutual fund. In the case of equity-oriented mutual funds, the STCG holding period is less than 12 months, with a flat tax rate of 15%, irrespective of your income tax slab, plus applicable surcharge and cess. This rule applies to funds investing at least 65% in equity and related instruments. On the other hand, for debt-oriented mutual funds, the STCG holding period is less than 36 months, and the tax rate depends on your income tax slab (no fixed 15% rate). This category pertains to funds primarily investing in debt instruments like bonds and government securities.

Taxability of STCG on Equity Mutual Funds

The holding period of equity mutual fund units significantly influences the tax treatment of capital gains. If the holding period is less than 12 months, the gains from selling such units are categorized as Short-Term Capital Gains (STCG). Regardless of the individual's income tax slab, the applicable tax rate for STCG on equity-oriented mutual funds, investing at least 65 percent of their corpus in equity and equity-related instruments, is a flat 15%.

The calculation of STCG involves subtracting the purchase price from the selling price, resulting in a capital gain. If the capital gain is positive, it is subject to taxation at a fixed rate of 15%. In addition to this, there are additional charges to be considered. A Securities Transaction Tax (STT) of 0.001% of the sale value is levied at the source on the sale of units. Furthermore, surcharge and cess apply based on the individual's income tax slab, computed on the STCG amount.

For instance, if an investor initially allocates Rs. 10,000 in an equity mutual fund and subsequently sells the units after eight months for Rs. 12,000, the capital gain is computed as Rs. 12,000 (selling price) minus Rs. 10,000 (purchase price), resulting in Rs. 2,000. The STCG tax is then determined as Rs. 2,000 (capital gain) multiplied by 15%, equaling Rs. 300. The total tax liability comprises the STCG tax and the surcharge/cess amount, the latter being contingent upon the investor's income tax slab.

Taxability of STCG on Debt Funds

When it comes to debt mutual funds, the holding period plays a critical role in determining the tax treatment of capital gains. If the holding period is less than 36 months, gains from selling debt mutual fund units within this timeframe are categorized as Short-Term Capital Gains (STCG).

In contrast to the previous regime, where there was a flat 15% tax rate on STCG for debt funds, the current system aligns the taxation with the investor's income tax slab. This means the STCG on debt funds is now taxed at the applicable income tax bracket. This tax treatment is extended to all non-equity-oriented mutual funds, predominantly investing in debt instruments such as bonds and government securities.

The calculation of STCG for debt funds mirrors that of equity funds, involving the subtraction of the purchase price from the selling price to determine the capital gain. If the capital gain is positive, it is considered STCG and subject to taxation according to the investor's income tax slab. Unlike equity funds, debt funds do not incur Securities Transaction Tax (STT) on the sale of units. However, surcharge and cess apply based on the income tax slab on the STCG amount.

A noteworthy shift from previous rules is eliminating the flat 15% STCG rate for any holding period of less than three years on debt funds. The current system introduces complexity as investors are now required to factor in their income tax bracket when calculating their tax liability. This marks a departure from the earlier straightforward taxation on debt funds.

Taxability of STCG on Hybrid/Balanced Funds

The tax treatment of hybrid funds is subject to chance upon their equity exposure, and two scenarios outline the applicable rules. In Scenario 1, when a hybrid fund allocates at least 65 percent of its assets to equity and related instruments, it is subject to the same tax regulations as an equity mutual fund for Short-Term Capital Gains (STCG). This implies that for a holding period of less than 12 months, the STCG tax rate is a fixed 15%, irrespective of the investor's income tax slab. Additional charges include a Securities Transaction Tax (STT) of 0.001% of the sale value and surcharge and cess as per the investor's income tax slab.

Conversely, in Scenario 2, when the hybrid fund's equity exposure falls below 65%, it is taxed akin to a debt fund for STCG purposes. For a holding period of less than 36 months, the STCG tax rate aligns with the investor's income tax slab, eliminating the previous flat rate. Notably, there is no imposition of Securities Transaction Tax (STT) on the sale of units in this scenario. Additional charges encompass surcharge and cess, again determined by the investor's income tax slab. These distinct tax treatments highlight the nuanced approach required when assessing the tax implications of hybrid funds based on their varying equity exposures.

Taxation of STCG on SIP

Systematic Investment Plans (SIPs) are a favored investment approach among individuals seeking to invest in mutual funds incrementally. Through SIPs, investors contribute a fixed amount at regular intervals, allowing them to accumulate units in a chosen mutual fund scheme over time.

When opting for the best SIP mutual funds, each SIP payment results in the purchase of a specific number of units, and the redemption of these units adheres to the first-in-first-out principle. To illustrate, consider an investor who engaged in a year-long SIP in hybrid equity-oriented funds and decided to retrieve the invested amount after 13 months. In this scenario, the units acquired in the first month of the SIP investment qualify for long-term capital gains, having been held for over a year. Conversely, Short-Term Capital Gains (STCG) are realized on units purchased from the second month onwards, with the STCG tax rate fixed at 15%, accompanied by the applicable cess and surcharge, irrespective of the investor's income tax slab.

In addition to the STCG tax on mutual funds, investors should be mindful of the Securities Transaction Tax (STT) levied by the Government of India. STT is imposed at the source on the purchase or sale of equity mutual fund units at a rate of 0.001%. It is important to note that no STT is applicable to transferring or selling units related to debt funds. Understanding the tax implications associated with SIPs and mutual fund transactions enables investors to make informed decisions and optimize their investment strategies.