Several people were suspecting Long Term Capital Gains Tax to make a comeback. Frankly, I wasn’t. Now that it has come, it is causing a lot of confusion. Let me attempt to clear the air here.
OK. So what did the finance minister propose?
Long Term capital gains tax on equity was zero till January 31, 2018.
Starting April 1, 2018, you will have to pay 10% long term capital gains tax on equity (direct stocks), equity oriented mutual funds, hybrid (equity oriented) funds such as balanced funds, arbitrage funds, etc.
There is a minor exemption. The first 1 lakh of capital gains in a year is exempt. Over and above that, there will be 10% tax.
So, if you bought a mutual fund at Rs. 150 and the current value is Rs. 200, you have a gain of Rs. 50. Assuming you have completed 1 year from purchase and sell it today, you will pay tax on Rs.50 (Rs. 200 – Rs. 150). The tax is 10% of Rs. 50, that is, Rs. 5.
However, the finance minister also felt that the older gains in equity or equity funds should not be subject to this. Much like how old people like our grandfather may not be able to take shocks! They should be treated gently. Similarly, the older capital gains have been treated gently too.
Hence, you are now allowed to consider your cost in equity mutual funds as the higher of
- Your original purchase NAV, or
- NAV of Jan 31, 2018.
Let me explain.
So, I might have bought my fund 1 year ago at Rs. 150 NAV, but its NAV as on Jan 31, 2018 is Rs. 199. So, if I sell it today at the NAV of Rs. 200, my long term capital gain is Re. 1 (Rs. 200 – Rs. 199). I pay tax at 10% on this Re 1, that is 10 paisa.
However, if your NAV as on Jan 31, 2018 drops to 145, you can still take your cost of purchase as Rs. 150, the original buy price. In that scenario, the gain will be Rs. 200 – Rs. 150 = Rs. 50. The tax on the same is Rs. 5.
Don’t forget. The first Rs. 1 lakh of capital gain is exempt from this tax.
The other important thing is that you will not be allowed to inflate your cost of purchase as you do in real estate or debt funds. This is also known as cost inflation indexation.
Does that hurt you?
Of course, it does. But it had to come at some point.
Do you need to take any action now?
In my view, no action. Laws keep changing over time. It’s the asset class that we are invested in and we are using them for our goals. There is no change in the view on equity as an asset class.
Dividends taxed too
In other news, dividends from equity mutual funds, which were hitherto exempt from Dividend Distribution Tax will now have 10% DDT.
As an investor, you will receive a dividend net of taxes as the mutual fund will pay it on your behalf, so it is tax free in your hands.
Now, if you are a long term investor, who is accumulating wealth, dividend was never a good option. It is worse now.
Read more: Dividend or Growth – what should I choose?
Disclaimer: This understanding is based on the current proposal by the Finance Minister. It is yet to be signed as an Act. The rules are subject to change before finalisation. Speak to your advisor or consult your CA before taking any decision.
Can one accumulate (carry forward) the 1L/yr capital gain tax benefit? Or does one have to redeem and re-invest once a year to take advantage of this?
Not sure if your comment is clear. You always consider the aggregate gain at the point of selling. Buying and selling every year is of no benefit.
Suppose 10 lac is invested in equity and that it returned 10% p.a for two successive years. So, the value of the investment is 11 lac after one year and 12.1 lac after two years. (a) Redeem after two years. Capital gain is 2.1 lac. Tax outgo is 11k (10% of 1.1 lac since 1 lac is exempted). (b) Redeem-and-re-invest after the first year (no tax outgo in the first year since capital gain is 1 lac). After the second year, capital gain is 1.1 lac and tax to be paid on redemption is 1k (10% of 10k since 1 lac is exempted). So, does one have to redeem and re-invest once every year to claim the tax benefit?
No, you don’t have to sell every year. Whenever, you sell, in that year, the first Rs 1 lakh is exempt and the rest taxable at 10%.
And I see the smart application of mind in your calculation. 🙂
Sagar – as per current understanding, i would also be planning on maxing out the 1L tax free LT gain every year – even if it means selling on the last day of the year and buying back the same fund in the next financial year. That way my cost of acquisition rises
LTCG is effective from AY 2019 only. No LTCG this Fy
Yes, that’s right! thanks for adding.
So what happens if I sell shares bought more than a year back before April 1, 2018? All exempt of LTCG?
Yes, looks like to be the case for now.
So looks like better cut off date would have been 31st March 2018. Currently it seems every rise will meet selling from long term holding guys to make fresh start.
Does this put Equity MF’s at a disadvantage vs ULIP?
I was expecting this question would be asked. So you are the first one! Only from a tax point of view, yes MFs have an additional tax.
Good explanation.
2 Questions
1. The future return (% XIRR) return will be impacted for definite and accordingly future goals are to be considered with that impact and according SIP to be increased. Can brief with long term goal with example?
2. Is it not the double taxation to the equity MF holder- why I am assuming that MF is dealing with the equity , so MF houses also need to pay tax to government at 10 % rate right on trading of equity. and they will be reduce it and accordingly NAV will be reduced….. and when the investor will sell of MF units and he get LTCG beyond 1 year then also on the same when he realized, he will have to pay 10% Tax. Does is not the double taxation (double) loss for the MF investor?
Please elaborate.
Thanks..
On point 1, do use one of the calculators on Unovest with a different return expectation.
On point 2, MFs are exempt from these taxes and hence no double taxation.
Thanks
Vipin
Thanks Vipin, yet I am not clear about point #2 . Please note my example . Its bit lengthy but I can’t stopped to narrate it.
1) Assume Investor A has invested in HDFC equity fund(NAV 10 X 2 lac unites) 20 lac rs. and CAGR of 15 % brings after 5 years it becomes 40.22 lacs means profit of 20.22 lacs and he need to pay 10% LTCG equivalent to 2.02 lacs tax, which means actual profit will be 18.20 lacs with appx. CAGR will be 14%.(1 % less)-
2) Now for the same HDFC MF house that HDFC equity fund scheme holds many holds many securities and during 5 years many securities they sold and earned the profits and on that profit they have to pay 10% LTCG tax yearly basis( I think you were telling that this tax is not applicable to MF house even though they are doing trading in equity?) upon their trading and the same might have paid 10 % LTCG and they might have shown as expenses as (TER) and according they have calculated/reduced their (NAV=22 rs. X 2 lacs units) and after five years. So my point over here is that during that 5 years MF house might pay 10% LTCG.
My point here if a person who has invested in MF scheme then is it not that MF also pay 10 LTCG on equity trading done by fund managers while book the profits every year(during that 5 years of holding and transaction) and investor redeem after 5 years that mutual funds and what gain he got over that in above example pay individually 10% LTCG amount of 2.02 lacs.
Is it not considered as double time investor pay LTCG once when mf house did trading and pay LTCG on securities transaction by MF house and secondly when investor sold mf units ?
Thanks a lot.
I read your detailed note. I say it again. MFs don’t pay LTCG. We as investors will pay now onwards.
Thanks a lot – Vipin.
For Investors investing in Equity MF with Dividend option, it has the worst impact. In one hand, LTCG is to be paid @ 10% if sold (assuming gain exceeds Rs. 1 Lakh) and on the other hand, whenever MF House distributes dividend, investors will get net of DDT paid by the MF House.
Not really, Dividend funds typically have a relatively low growth in NAV since the divined is paid out on a regular basis. So, the capital gain is also low compared to growth option.
Agree but Investors have to suffer both LTCG and DDT paid by MF House provided LTCG and Dividend received by Investors are huge amount.
Can you comment on how this influences fund selection and portfolio maintenance? The common advise is to review performance and rebalance the portfolio once a year. With the new taxation, if one switches the equity fund every 2-3 years, the tax can significantly eat into the returns over a long period of time (10-20 years). Since the new taxation favours sticking to the same fund for longer, it makes the index funds a tad more attractive.
No impact on fund selection.
As for rebalancing, if you have a decent variation number to consider before rebalancing, again should not be an influencing factor.
Having said that, good funds are not sold for years and years.
Index funds will not become attractive for this reason, but for the fact that the fund managers are failing to do their job. 🙂
The problem is with fund switching. It will affect compounding. So your better not make any mistake in choosing your fund, and tough luck if an old fund starts lagging and you see no recovery for it. Seriously a bad budget for the salaried class. Utterly disappointed. No additional tax exemption. And nothing has been done to NPS to improve it as well.
I tend to agree with you. But the rules are laid out. Play accordingly.
Vipin – the market has been falling in the last month. Hence my recent purchases have a loss. Their Nav at the time of purchase was higher than the Nav of 31 Jan. So i would be a loser by the grandfathering approach. Is there any clarity on such a situation
It will the cost of purchase or NAV as on Jan 31, whichevr is higher.
I’m just mad at myself for not investing in at least an ELSS since I started working. If only I had a good financial planner. All those tax free gains! All those double digit returns! Damn.
🙂
elss are also come under LTCG… ????
Yes.
The expected return from equity is 12% for long term goals .
LTCG is 10%
So the real return will be 10.8%.
Should i reset my expected return from Equity to be 10.8% for all the goals in calculator to find the required Monthly SIP amount for all the goals which i am currently investing.
Kindly clarify whether my above calculation is correct.
Second query, Even for re balancing Equity to Debt annually will attract the LTCG tax 10%. How to minimize the tax outgo, for re balancing . Should i increase threshold numbers for re-balance in wider margin.
That’s better. reconsider your assumptions. Your need to rebalance should be less frequent, a wider threshold +- 10% may help. Usually, in an accumulation phase, ongoing savings can be redirected to correct the allocation, thus saving the hassle of buying and selling.
Hi vipin,
Is there any link of this LTCG tax with one individual income tax.i mean LTCG is 10 % irrespective of ones income tax slab or will it clubbed with your income and taxed.My question may be relevant or not 🙂 but could you clarify me on this if any idea?
Sai, Long term gains are not clubbed with your income. Both are taxed separately at respective rates.
So, can we make the following ‘hacks’ to save our return from more tax?
(1) Redeem all long term investments on 31 Mar 2018 and re-invest the same again on the same day.
(2) Book profit of Rs 1 Lac every year and invest again on the same day.
I don’t know if I am calculating right!
What’s the benefit of this exercise over say next 10 years?
Hi Vipin,
Kudos for posting this so soon after the announcement, to keep us informed. When you said that dividend payout is worse than growth for equity, is it because of the 1lac exemption on capital gains tax? Because both rates are the same at 10%.
Also, if the NAV declines (or goes up and then declines to return to the original NAV), the growth option requires no capital gains tax, while the dividend option still requires paying the DDT on dividend that was paid out.
Are these the two reasons why dividend is worse than growth for equity funds?
There’s no change in taxation of debt funds, is there?
Hi Kartick, the dividend option is worse because of the interruption it causes to the compounding process. Money out of the system usually fails to go back, being used for other purposes.
There is no change in taxation of debt funds.
If I’m disciplined enough to reinvest all the dividends, then it’s okay to go for dividends, or will I end up paying more tax?
With dividends, there is now a compulsory DDT of 10%. So, every time a dividend is declared, a tax outgo happens, even though paid by the AMC from your money.
In case of LTCG, at least you get an exemption of upto Rs. 1 lakh every year. No such thing with dividends.
So, yes, you will likely pay more tax.
If I have made long term loss on equity stocks can I offset against
long term capital gains on mutual funds? And can LT Capital Loss be c/f across years?
Also this means more investors will shift to direct funds to make up the lost earnings of 1%.
From next financial year, hopefully, yes.
you have conveniently left out people who have invested in shares before oct 2004 and in i1990 and 2000 is granfathering available for such shares also since reading of sec 112 gives diffrent picture
Hi Vipn,
Thanks for the LTCG insight.
* What is the implications of LTCG on NRIs who is investing via NRE accounts ?
* To avoid(or reduce) LTCG, there is a general suggestion of yearly “sell off” and “buy back” on same day .
How does it work for MF Units ?
Say if MF units are bought via monthly SIP and when we sell off, the MF units bought first will be sold ? or the MF Units bought last ? (i.e First In First Out or Last In First Out ). How is LTCG calculated for the units bought ? its quite confusing .
Hi, For NRIs, there is a likely 10% TDS that will happen.
As for sell off and buy back, not sure how much additional gain one might expect against the effort required.
The policy of selling is FIFO or first in first out. Your oldest purchase are sold first.
Thanks
Hi,
I have a query, suppose investor A has invested in a MF from 2010 via SIP, for long term returns [assume for 15 to 20 years].At 2011 the NAV is 100, and assume that at 2030 the NAV is 1100. “A” invested 3000/month during 2011, and at the end of 2030, assume that “A” invested 7,20,000 which gave a return of 30,20,000 at 2030.
Query here is, if “A” redeem at 2030, where it earned a profit of 23,00,000 so that tax will be on 22,00,000 [ 1 lac exempt] @10% ? In this case, where is grandfather coming into picture ? and law says for a financial year only if profit exceeds 1 lac then only tax will be imposed..In this situation, how the tax will be calculated? Can you please explain?
Thanks
Siva
Siva.
Any investment that you did till Jan 31, 2018, you can lock in your cost at the higher of the original purchase price or the market value as on Jan 31, 2018. That’s your cost for the purpose of all future capital gains calculation. That is the meaning of the grandfathering clause.
So, in 2030, when you sell, you will have to divide the portfolio into 2 parts.
Till Jan 31, 2018 portfolio and the rest.
Your capital gains will be Rs. 30 lakh – cost of holdings till Jan 31, 2018 – cost of purchases acquired after that date.
From this, first Rs. 1 lakh capital gains tax will be exempt and on the rest you pay 10% tax.
Your gain will not be Rs. 22 lakhs but much lower.
Hope that clarifies.
Hi,
How will the Mutual fund investment with Dividend reinvestment will be impacted? Is it better to shift all investment in dividend reinvestment into Growth plan?? Please advise on urgent basis as I have huge investment in MF dividend Re-Investment Plan.
All dividends in equity funds will be subject to 10% dividend distribution tax, which will be deducted and paid by the mutual fund. In your hand, it is tax paid.
As far as shifting is concerned, what was your reason to choose dividend reinvestment? If you don’t need money and only want to grow, probably moving to growth option is better.
since mutual funds are taxable, HDFC started pushing ULIPS saying that there is no tax on returns under section 10 (10)D & only 2.5 % & 2 % charges for first 2 years respectively & none thereafter.. but beware since I have already burnt my fingers with ulips & will not touch even with a 10 feet pole considering the flexibility with mutual funds & low cost. your thoughts vipin.
Here’s a detailed answers Sriram. And I have included your comment in it. 🙂
http://unovest.co/2018/02/ulips-invest/
thanks for the detailed & quick response. Surprised to see my comment in that post 🙂
Hope it is a positive surprise. 🙂