Tax query: How capital gain tax rules have changed on NFO investments after Union Budget 2024 

Taxation of New Fund Offers (NFOs), along with other mutual funds, is primarily determined by the type of fund (equity or debt) and the duration of the investment. NFOs provide asset management firms with a method to generate funds for launching new mutual funds. They function similarly to IPOs and have a limited availability period.

Earlier this week, Sebi published a consultation paper outlining the timelines for asset management companies (AMCs) to deploy funds collected in new fund offers (NFO) based on the scheme's asset allocation within 30 business days. Sebi advises AMCs to establish achievable timelines in the Scheme Information Document (SID) regarding fund deployment in line with the specified asset allocation of the scheme, and to raise funds during the NFO accordingly.

AMCs may be required to invest the funds raised in NFO within the specified timeframe from the date of unit allotment. If an AMC is unable to deploy the funds within 30 business days, it must provide a written explanation detailing efforts made to deploy the funds, which will be presented to the Investment Committee.

Taxation of Equity Mutual funds

The taxation of equity mutual funds depends on the type of fund and the holding period. Equity mutual funds have at least 65% equity allocation in their portfolios. Gains from the sale of units are categorized as long-term or short-term based on the holding period from acquisition to sale date. If units are held for more than 12 months, the gains are considered long-term capital gains; otherwise, they are short-term capital gains.

Short-term capital gains from equity mutual funds are taxed at a rate of 15% (increased to 20% from 23rd July 2024) under section 111A of the Income Tax Act. 

Long-term capital gains are subject to a tax rate of 10% (increased to 12.5% effective from 23rd July 2024) under section 112A of the Income Tax Act, provided that such gains exceed the threshold of Rs. 1.25 lakh in a financial year (previously Rs. 1 lakh before the Finance (No. 2) Act 2024).

Taxation of Debt Mutual Funds

Like Equity Mutual Funds, the taxation of Debt Mutual Funds is determined by the duration of holding the units, whether they are considered long-term or short-term. If the units are sold within 36 months, they are classified as short term gains. However, if sold after 24 months (as of 23rd July 2024), they would be categorized as long term gains. The long-term capital gains are subject to a 10% tax rate, which has been increased to 12.5% effective from 23rd July 2024 under section 112A of the IT Act. This applies only if the long-term capital gains exceed the threshold limit of Rs. 1.25 lakh in a financial year, previously set at Rs. 1 lakh before the Finance (No. 2) Act 2024. 

Short term capital gains would be taxed at the applicable marginal slab rate of the investor whereas Long term capital gains of debt fund are taxed at 20% with indexation (12.5% without indexation w.e.f. 23rd July 2024) u/s 112 of the Act.

For any designated mutual funds (with less than 35% of its total proceeds invested in domestic company equity shares) acquired on or after April 1, 2023, the profits obtained from these mutual funds will be considered as short-term capital gains under section 50AA of the IT Act and will be subjected to taxation based on the applicable marginal slab rates for the investor/taxpayer.

Please note that starting from April 1, 2025, a "Specified Mutual Fund" will refer to a mutual fund:

> A Mutual Fund that invests more than 65% of its total proceeds in debt and money market instruments; or
> A fund that invests 65% or more of its total proceeds in units of a fund mentioned in clause (a).

The stipulation of investing no more than 35% in equity shares has impacted certain funds that do not primarily focus on debt investments but have equity holdings below 35%. These affected funds include Exchange Traded Funds (ETFs), Gold Mutual Funds, Gold ETFs, Foreign Funds, and Fund-of-Funds (FoFs).

To provide clarification on the application of section 50AA of the Act, the Finance Act 2024 has revised the definition of section 50AA. This amendment specifies that the provisions of section 50AA will not apply to the aforementioned funds unless they adhere to the updated investment criteria outlined in the revised definition. Consequently, these specified mutual funds sold on or after 1st April 2025 will be subject to taxation similar to debt mutual funds.