The Union Budget of 2018-19 has changed the tax treatment of all equity and equity-oriented mutual funds by introducing a 10% tax on any long-term capital gain (LTCG) exceeding Rs 1 lakh a year. In addition, the dividend plans of equity-oriented funds will also now be subject to a dividend distribution tax (DDT) of 10%, which will be deducted at source. Equity mutual funds were exempt from both the LTCG tax and DDT earlier. This article aims to explain this change in the LTCG tax calculation, how these new levies will impact the returns of equity fund investors and why investors should not let them alter their long-term financial plans.
The new levies
The new LTCG tax is applicable to all equity-oriented mutual funds which hold more than 65% of their assets in equities. LTCG arises when the investments are held for over a year in the case of equities. The short-term tax on equity holdings for less than a year continues to be 15.6%.
There are some caveats, however. The new LTCG tax of 10% (or 10.4% including the health and education cess) will only be applicable from April 1, 2018, so any redemption of units from equity-oriented funds until March 31, 2018, will be exempt from the tax. Moreover, its immediate impact on investor returns has been cushioned by grandfathering or exempting any gains that have accrued until January 31, 2018. However, the LTCG will be calculated without the benefit of indexation, that is, without adjusting the acquisition cost of the investment to the cost inflation index.
Since the announcement of the LTCG tax, many investors are perplexed about its calculation and how it will impact their returns. Rather than shying away from investing in equity mutual funds, it is imperative that investors fully understand the new tax provision and continue to focus on the big picture of wealth creation to meet their long-term financial goals.