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Taxation terms-II

The mutual fund investments are subject to capital gains tax, which is applicable to gains from the sale of fund units. This tax is levied directly on investors, as opposed to DDT, which is charged to the fund. Let us consider the capital gains tax at the 2008-9 rates.

twitter-logoSameer Bhardwaj | Print Edition: September 18, 2008

In the first part of the sub-series on mutual fund taxation (Taxation Terms), we covered the dividend distribution tax (DDT) applicable to dividend/income schemes of mutual funds. The mutual fund investments are also subject to capital gains tax, which is applicable to gains from the sale of fund units. This tax is levied directly on investors, as opposed to DDT, which is charged to the fund. Let us consider the capital gains tax at the 2008-9 rates.

How capital gains tax is levied
 Equity fundDebt fund
No. of units purchased1,0001,000
Entry NAV (Rs)1515
Exit NAV (Rs)2525
Gain/profit (Rs)9,937.510,000
Pre-tax returns66.25%66.67%
SHORT-TERM CAPITAL GAINS

If sold within 12 months:
  
STCG tax (Rs)1,688.883,399#
Post-tax returns54.99%44.01%

LONG-TERM CAPITAL GAINS

If sold after 12 months:

  
LTCG tax (Rs)Nil1,133*
Post-tax returns66.25%59.11%
Assuming same exit NAV in both cases; No entry-exit load; Gain/profit of equity fund is net of STT; * Taxed at 10% plus surcharge and cess (without indexation method); #Assuming investor is in the higher tax bracket

Capital gains are of two types: short term and long term. If the units are sold within 12 months of the date of purchase, they are considered short-term capital assets and gains from such sales are subject to shortterm capital gains tax. If the units are sold after 12 months, they are regarded as long-term capital assets and the gains are subject to long-term capital gains tax. The long- and shortterm capital gains tax rates applicable to different mutual fund categories are:

Equity schemes:
While long-term capital gains are exempt for these funds, short-term capital gains are charged at 15%. After including surcharge and cess, the effective short-term tax rate is 16.995%. The sale of equity fund units is also subject to securities transaction tax, which is 0.25% of the redemption value.

Debt schemes:
The IT Act offers the benefit of indexation for long-term gains. The assessee can opt for 10% on capital gains without the benefit of indexation, or for 20% on capital gains after including the impact of indexation. Added to this are surcharge and cess of 10% and 3%, respectively. The indexation benefit is calculated by inflating the purchase cost using the cost inflation index.

To understand this better, consider the following example. In 2007, Mr. A sold 500 units of a debt fund at Rs 18 per unit. He had purchased these in 1999 at Rs 10 per unit. The cost inflation index for 1999 was 260, and for 2007, 371 (both hypothetical). So the sale value is Rs 9,000 (500x18) and the purchase cost is Rs 5,000 (500x10). Now, Mr. A can choose from:

a) Capital gains without indexation Capital gains: {Sale value — purchase cost} Tax: 11.33% of Rs 4,000, which amounts to Rs 453.2.
b) Capital gains with indexation Capital gains:
Sale value(Purchase value X 2007’s cost inflation index/ 1999’s cost inflation index)

Tax:
22.66% of Rs 1,865.38, which amounts to Rs 422.69.

The short term capital gains on debt schemes is clubbed with the investor’s income and is taxed at the slab rate. Assuming that the investor is in the higher tax bracket, the effective short term tax rate works out to 33.99% (30% + 10% + 3%).

Previous instalment: Taxation Terms
Next issue: Assessing Risk

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