While equity mutual funds continue to be one of the best ways to earn higher returns, lack of tax planning may erode your gains. Returns on equity mutual funds are no longer exempted from tax as they were in past.
"Long-term capital gain is chargeable to tax in the year in which mutual funds are sold by the investor. Long-term capital gain on sale of equity oriented mutual fund is chargeable to tax at 10 per cent from April 1, 2018, prior to that it was exempted from tax in the hands of investor. However, long-term capital gain up to Rs 1 lakh is exempt from tax," says Kapil Rana, Founder & Chairman, HostBooks.
Every penny of reduction in tax outflow boosts your return. If your expected long-term capital gain is below Rs 1 lakh, your gains will be completely exempted and hence you would not need to go for any additional effort to save taxes. However, if your gain through equity MF is more than Rs 1 lakh then depending upon the quantum of gain you need to plan your investment and withdrawals in tax efficient ways.
Set off the gains against capital losses
The very first thing which you can use to offset your gain from equity MF is any capital loss incurred. "Long-term capital loss from equity MF can be set off only against long-term capital gain from equity MFs. However, short-term capital loss can be set off against long-term or short-term capital gains both," says Rana of HostBooks.
Short term capital loss on equities can be utilised against both short-term and long-term gains on any capital asset. This will help you save tax on other gains. When it comes to LTCG, once you exhaust the offset limit of capital loss you can utilise the Rs 1 lakh exemption. This will enhance your overall ability to adjust higher capital gain without incurring any tax.
In case you are not able to adjust your capital losses in the same year you can carry it forward for the next eight years and set it off whenever you make gains. However, to do this you have to file your ITR each year and show the losses even when you do not have any income to show.
Split withdrawal with gains between Rs 1 and Rs 2 lakh
If your total long-term capital gain has gone above Rs 1 lakh but is still below Rs 2 lakh, you may save tax by withdrawing in two parts. "One can save taxes by splitting one's sale transaction in two financial years if market conditions allow him to do so," says CA Geetanshu Bhalla, Founder, The Virtual Compliance. For instance, you can withdraw your investment to utilise exempted withdrawal up to Rs 1 lakh gain now and the rest of it when the new financial year starts from April 1.
For gains above Rs 2 lakh churn the portfolio
If the gains are much more than Rs 2 lakh and you have a long-term horizon, it will not be practical to wait for more than one year just to make withdrawals. In such a case you may churn your portfolio. "One should always try to focus on churning the portfolio in such a way that one can claim exemption of Rs 1 lakh," says Rana of HostBooks.
Bhalla agrees with this strategy and suggests that income tax provision does not restrain anyone to do so. "A taxpayer can do it provided his risk-bearing capacity allows him to do so."
For bigger gains buy a residential property
In case of capital gains above Rs 15-20 lakh no amount of churning can help in saving a big part of the capital gains tax. In such a situation you have the option of buying a residential property to save the capital gain tax on your mutual fund investment.
"One can buy a residential property to save the LTCG tax on equity MFs provided one does not own more than one residential house on the date of transfer of MFs and will not purchase or construct any residential property other than the said residential property within one year or three years respectively from the date of transfer of MFs. Moreover, income from said new residential property shall not be chargeable to tax under the head House property," says Bhalla of The Virtual Compliance.
Also note that in order to save the total tax liability, not only do you have to invest the capital gains in the residential property, but also the entire sales proceed.
"If the cost of the new house is not less than the value of the asset sold, full amount of capital gain is exempt from income tax. But if a part of the capital gain is invested, then only that part will be exempted proportionately (i.e. cost of new house * capital gain amount /Net consideration) and the balance amount will be taxable at 20 per cent," says Rana of HostBooks.
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