Nothing is more disheartening than watching your profits from mutual fund investments dwindle due to high capital gains taxes. Here’s how to save capital gain tax on mutual funds
We share with you effective strategies and tips that can significantly reduce your tax burden and help you maximize your returns.
Overview of Capital Gains Tax on Mutual Funds in India
Capital gains tax is levied on the profit made from the sale of capital assets, including mutual funds.
It depends on two key factors: the type of mutual fund and the holding period – short term capital gains (STCG) and Long term capital gains (LTCG).
How to Save Capital Gains Tax on Mutual Funds : 12 Strategies That Can Help
To save tax on ESOPs in India, employees can utilize various strategies such as:
Hold for Long-Term Gains
Mutual funds are taxed based on the holding period.
Be it equity or debt fund, holding it for long term can help you reap the benefits of a lower capital gains tax.
Cost Averaging:
By investing periodically rather than in a lump sum, you reduce the average cost of buying units.
When markets are down, you buy more units, and when markets are up, you buy fewer units.
This reduces your overall cost, potentially lowering capital gains when you sell, thereby saving on tax.
Invest Through Systematic Transfer Plans (STP)
Instead of selling all units at once, you can gradually move your investments from one mutual fund to another via Systematic Transfer Plans (STP).
This spreads out your capital gains, allowing you to manage the taxable income and stay within lower tax brackets.
It also avoids triggering large gains in one financial year, which could result in higher taxes.
Get in Touch With a Professional
Indian tax laws are complex, and a tax professional or financial advisor can guide you through tax-saving strategies.
Get in touch with professionals like PKC Management Consulting for optimized investment and withdrawal plans based on your financial goals and current tax laws.
Employ Tax Harvesting
Another smart move is using rax harvesting. Here you sell mutual funds that have accrued gains up to Rs 1.25 lakh in a financial year to take advantage of the tax-free LTCG limit on equity mutual funds.
You can repurchase the same fund, resetting the cost price, and effectively “harvesting” the gains without incurring tax liability.
This reduces future tax when the investment grows further.
Plan Withdrawals Strategically
Spread withdrawals over multiple financial years, to manage the taxable gains.
If you are close to the tax-free limit (Rs 1.25 lakh LTCG for equity funds), consider deferring some withdrawals to the next financial year.
This ensures you stay within favorable tax brackets and reduce your overall tax liability.
Utilize Tax-Deferred Accounts:
Consider investing through tax-deferred accounts like a Public Provident Fund (PPF) or National Pension System (NPS).
Here the capital gains can grow without immediate tax implications.
Invest in Hybrid Funds:
Hybrid funds invest in both equity and debt instruments.
Equity-oriented hybrid funds are taxed similarly to equity mutual funds, with LTCG up to Rs 1.5 lakh being tax-exempt and the rest taxed at 12.5%.
This can be a more tax-efficient way to invest in both equity and debt instruments.
Utilise Indexation Benefit:
Indexation allows for the adjustment of the purchase price of debt mutual funds to account for inflation.
This effectively reduces the taxable capital gains when the investment is sold after a holding period of more than two years.
Indexation benefits (taxed at 20%) have been removed from future assets but it is still applicable for long term assets purchased till 23rd July 2024.
Set Off Against Losses
You can reduce your tax liability by offsetting capital gains with capital losses from other investments.
Short-term capital losses can be set off against both short- and long-term capital gains, while long-term losses can only be set off against long-term gains.
This helps in lowering the total taxable gains.
Reinvestment in Specified Bonds:
If you have long-term capital gains, you can invest the proceeds in specified bonds (like NHAI or REC bonds) within six months of the sale.
Investments of up to Rs 50 lakh can be made in these bonds, and the gains reinvested are exempt from capital gains tax.
Timely Selling
Timing your sale can make a significant difference in how much tax you pay.
For instance, if you are near the end of a financial year and close to the tax-free LTCG limit, you can postpone your sale to the next financial year.
This avoids paying taxes in the current year and spreads out your gains over time.
Frequently Asked Questions
- What is capital gains tax on mutual funds?
Capital gains tax is the tax you pay on the profit made from selling mutual fund units. The tax depends on the type of mutual fund (equity or debt) and the holding period of the investment.
- Can I switch between mutual funds to avoid paying capital gains tax?
Some funds allow internal switching between schemes. While this may not necessarily exempt you from paying capital gains tax, switching within the same fund house may defer taxes, helping you spread your tax liability across multiple financial years.
- Can indexation be used to save tax on mutual funds?
From July 2024, indexation benefits are no longer available for tax on certain capital assets including mutual funds.
- Can I spread my withdrawals to reduce capital gains tax?
Yes, by planning your withdrawals across different financial years, you can spread out your capital gains.
- Apart from capital gains, what other taxes are applicable on mutual funds?
Mutual funds in India are also subject to Securities Transaction Tax (STT) on the purchase and sale of units. Tax Deducted at Source (TDS) is also applicable on dividends exceeding Rs 5,000, which is deducted at a rate of 10% for resident investors.
