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.