Over a fortnight has passed since the presentation of the Union Budget. However, confusion still seems to be reigning on proposals to ‘simplify and standardise’ capital gains taxation. Here’s a simplified account of what changes for retail investors in mutual funds (MFs), after a deep dive into the budget documents.

Equity: Mild rise

Prior to Budget, there were multiple rates and methods of calculation applied to capital gains made on MFs, depending on the equity-debt mix of a fund. This Budget has somewhat clarified the picture by clearly differentiating between equity-oriented and debt-oriented MFs.

All MFs which own 65% or more of the assets in equities are treated as equity funds. Now ,capital gains from equity funds will be taxed at 20% if there are short-term and 12.5% if they are long-term. The holding period to define ‘long term’ will remain at 12 months.

Earlier, long term and short-term gains from equity funds were taxed at 10% and 15% respectively. Apart from active equity funds, index funds, arbitrage funds and hybrid fund categories such as aggressive equity funds, balanced advantage funds, equity savings funds and multi-asset funds with a more than 65% equity weight, will also fall into the ‘equity’ category and taxed at the above rates.

Equity fund investors have, however, bagged a mild sweetener to soften the blow from higher tax rates. They will now be liable to pay long term capital gains tax only if annual gains from this source exceed ₹1.25 lakh, as opposed to ₹1 lakh earlier.

If you are a long-time investor in equity funds, all gains prior to January 31, 2018 will continue to be grandfathered (protected from tax) and only gains made thereafter will be taxed. The new tax rates kick in from July 23, 2024, the date of the Budget.

Debt: No climb-down

Budget 2023 dealt an unkind cut to debt MFs by decreeing all the capital gains made from these funds, irrespective of the investor’s holding period, would be treated like income and taxed at the investor’s Income-Tax slab rate.

This stance has not been changed in the 2024 Budget. All the gains from debt MFs will continue to be taxed at your slab rate, irrespective of how long you held the fund. Debt MFs for this purpose will be defined as funds which invest 65% or more of the portfolio in bonds.

Therefore, taxation at slab rates will apply to all categories of debt funds whether short term, medium term or long term, gilt funds, target maturity funds and hybrid funds which invest 65% or more in bonds.

However, the Budget may have introduced a new element of uncertainty for debt fund investors by doing away with indexation benefits in toto.

In the 2023 Budget, when deciding to tax all gains from debt funds at slab rates, the government kept legacy investments made before April 1, 2023 out of the purview of this change. This meant debt fund investments made prior to April 1, 2023 still enjoyed long-term capital gains tax at 20%, after indexing purchase cost for inflation.

But indexation benefits are no longer part of the statute after July 23, 2024. Therefore, it appears likely long-term capital gains on debt funds bought before April 1, 2023 will also be taxed at 12.5% without indexation. The holding period to determine ‘long term’ will be 24 months. It however needs to be seen if this is rectified, as was done in the case of legacy investments in property.

Global, gold funds

Both equity and debt-oriented funds won no concessions in this Budget. But funds which fall in neither of these categories saw some relaxations.

With the Budget changing the definition of ‘specified mutual funds’ under section 50AA of the Income Tax Act, funds which do not invest 65% or more of assets in bonds will no longer see capital gains taxed at slab rates.

The 2023 Budget, while subjecting capital gains from ‘specified mutual funds’ (read debt funds) to tax at slab rates defined these as funds which invest ‘not more than 35% in equity shares’. This had inadvertently swept categories such as fund of funds, balanced hybrid funds, international funds and gold funds into debt taxation.

With this slip-up remedied now, only funds with over 65% investment in bonds will be subject to taxation at slab rates. Therefore, fund of funds (which do not invest over 65% in either equity or debt funds), gold and international funds will now see short-term capital gains taxed at slab rates, while long-term capital gains will be taxed at 12.5%. The holding period to decide long term is 24 months.

If you own international, gold funds don’t rush to sell as the changes take effect from April 1, 2025.

Prior to Budget, there were multiple rates, methods of calculation applied to capital gains on MFs, depending on equity-debt mix of fund

The Budget may have introduced new element of uncertainty for debt fund investors by doing away with indexation benefits in toto

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