What is Long Term Capital Gain tax? How does it impact you if you invest in an equity mutual fund?

Let us begin by understanding what Long- Term Capital Gains mean. Capital Gains refer to profits arising from selling stocks or redeeming mutual funds units;. In case of equity oriented mutual funds, if the investment has been held for more than one year, the gains are known as Long- Term Capital Gains (LTCG). Simply put, LTCG is calculated by reducing the cost of purchase from the price at which the mutual funds or stocks are sold at.

Prior to 1 April 2018, LTCG on equity shares and equity oriented mutual funds were exempt from income tax in India. However, in the 2018 Union Budget, tax on such gains (in excess of Rs 1 lac) was introduced.

Should this really be a concern?

First, let us attempt to understand the math.

From April 1st 2018, 10% tax (without indexation) plus applicable surcharge and health and education cess will be levied on LTCG, if the overall capital gains exceed Rs. 1 Lakh, when you sell your investment in stocks or equity mutual funds. Which means, if you had remained invested for over 1 year and earned Rs. 2 Lakh in profits, the taxable LTCG will be Rs. 1 Lakh (i.e. Rs. 2 Lakh – Rs. 1 Lakh) and the tax liability will be 10% of it, or Rs. 10,000. However, if you sold on or before March 31st 2018, no LTCG tax would have been levied.

It is also important to note that if you sell your equity oriented mutual fund units/stocks without holding them for at least one year, Short- Term Capital Gains (STCG) Tax (15% plus applicable surcharge and health and education cess on Short- Term Capital Gains) will be levied provided applicable (Securities Transaction Tax was paid).

Also, it should be noted that while capital gains on equity oriented funds are subject to LTCG or STCG tax, there is no such distinction for capital gains on specified mutual funds (i.e. funds whose domestic equity allocation does not exceed 35%): the capital gains on such funds are deemed as short term capital gains and accordingly taxed basis the investor’s income tax bracket.

As an equity investor what should you do?
Don’t let Long- Term Capital Gains tax deter you from investing or staying invested in the equity markets. Irrespective of LTCG or any downturns in the market, experts recommend to invest more and to take advantage of a dip in the market. Long- term Systematic Investment Plans are a great way for individuals to gain access to the equity markets at different price points with minimal effort, to reduce your average purchase cost and to potentially create wealth over time.
It would be fair to say that as investors, we all prefer tax free investment alternatives. But let’s face it: tax on Long- Term Capital Gains is a new reality when it comes to stocks or equity oriented mutual funds and as long- term investors, this should not really be a concern.
Success in the equity markets comes to those who invest regularly and hold for the long -term. While this new tax does squeeze returns, it overall does not change the fact that the equity markets still provide tax efficient long-term wealth creation opportunities when compared against other investment avenues.
Market fluctuations do impact stock prices but don’t affect the business fundamentals on which the investments are made.
Therefore STAY INVESTED in the market for the long term and LET THAT CAPITAL GROW!