Understanding the world of taxation can be quite complicated. You’re traversing a tangled labyrinth of capital gains on investments. The landscape of mutual funds, stocks, real estate, and gold has significantly changed in 2024, especially the revised taxation rates for short-term capital gains (STCG) and long-term capital gains (LTCG).
This blog simplifies the implications of these new tax regulations and explores how they affect your investment strategy. Now that the long-term capital gains are set at 12.5% across several asset classes, such as equities and gold, investors face a new challenge – how should portfolios align with these changes to optimize returns?
We shall focus on the nuances of tax reforms to help you make informed decisions. Seasoned investor or merely a beginner, you should understand the tax implications of your assets to further maximize your financial potential.
Table of Contents
Overview: What Are Capital Gains Taxes?
Capital gains tax is a tax imposed on the profit you make after selling a capital asset such as real estate, stocks, and bonds among others. It’s quite similar to paying taxes on the money earned from your job.
It’s important to understand capital gains tax as an investor as it impacts your overall returns. First, your investment strategy planning becomes more effective if you know how capital gains tax works.
Second, you make more informed decisions about when to purchase and sell investments resulting in minimum tax liability and an increase in gains.
Third, avoid being caught off-guard about the amount of taxes you owe when you sell an investment. Limited knowledge leads to long-term liability.
Taxation Policies for Short-term and Long-term Capital Gains
The Income Tax Act of 1961 comprises the capital gains tax in India. It is the tax imposed on the generated profits from a successful selling of capital assets such as vehicles, securities, land, and stocks. Union Budget 2024 has reiterated the holding periods for short-term and long-term capital gains along with a hike in capital gain taxes. The goal is to standardize and simplify the taxing system.
First, let’s understand the two types of taxability applicable to capital gains – short-term and long-term.
Short-term capital gains are the profits generated from assets that have been held for less than a year. Assume that you buy a concert ticket for Rs. 5000 and sell it for Rs. 10,000 a few weeks later. The Rs. 5000 profit is the short-term capital gain. As you sold it quickly, weeks before the date of the concert, the demand for the ticket was quite low but you still made a reasonable gain. Similarly, when you sell an asset within a single holding year, the government taxes your profits at a regular and higher income tax rate.
Meanwhile, long-term capital gains are generated from assets held for more than a year. Imagine that you purchase a vintage car for Rs. 3,00,000 and then sell it for Rs. 5,00,000 after four years. The Rs. 2,00,000 profit is the long-term capital gain. Since the car was held for a longer period, the government taxes it at a lower rate allowing you to keep more of the profit.
Taxation on mutual funds has been tweaked here and there in the last few years. It has been a significant move from the 10% tax levied on long-term capital gains exceeding Rs. 1,00,000 without any indexation benefits introduced by Arun Jaitley in 2018.
Previously, the tax rates varied for STCG and LTCG based on the assets and the payment of applicable transaction tax. Manoj Purohit, Partner & Leader at Financial Services Tax, Tax & Regulatory Services, asserts that tax rates should be amended to involve different asset classes under “long-term capital assets” after a year of holding. A single tax rate should also be introduced for STCG and LTCG, irrespective of equity or debt investment – listed or unlisted.
Furthermore, major voices in the financial landscape, such as Shalini Jain, Tax Partner at EY India, and Manish Jain, the Director of Institutional Business, have also stressed the need to simplify the tax regime to drive participation in the equity market.
The Union Budget 2024: Vital Changes in Tax Rates and Holding Periods
To address such aforementioned concerns, the Union Budget 2024 has overhauled capital gains tax on several assets including mutual funds. These taxation rules have come into effect since 23 July 2024. The key point to remember here is that the holding period is a crucial determinant of your capital gains tax.
Here are some of the significant changes that you should be aware of:
- Gains generated from debt ETFs, debt mutual funds, unlisted bonds and debentures, and market-linked debentures are not recognized as short-term capital gains going forward. This is irrespective of the holding period.
- The holding period for short-term and long-term capital assets has been revised to 12 and 24 months respectively. If the listed securities (on Indian stock exchanges) are held for over a year, they will be classified as long-term. However, the other asset classes have to be held for over two years to be categorized as long-term.
- The indexation benefits used for long-term capital gains have been removed in Budget 2024. This is a significant shift from the previous 20% LTCG tax with indexation benefits which enabled taxpayers to manage an asset’s purchase price for inflation.
- Now, long-term capital gains, for all asset classes, will be taxed uniformly at 12.5%. LTCGs were taxed based on the asset class before.
- Previously, short-term capital gains were taxed at 15% for equity funds, stocks, and business trust units. This has been revised to 20%. However, there have been no changes made to the STCG tax rate for any other assets.
- The Budget shifted the tax-free (exemption) limit for LTCGs on equity investments from Rs. 1 lakh to Rs. 1.25 lakhs.
- The tax rate applicable to capital gains is now streamlined for resident and non-resident taxpayers.
Applicable Tax Rates Based on Different Asset Classes
The Govt. of India has now established that the holding periods of assets will determine if they are short-term or long-term i.e., 12 months for listed securities and 24 months for other assets.
Listed Securities
The applicable tax rate for listed securities (bonds and debentures) is reduced to 12.5% without indexation. For capital gain taxation purposes, the “listed” securities will hereon include:
- Equity, Gold, and Bond ETFs
- Foreign equity ETFs listed in Indian stock exchanges
- Equity mutual funds
- Real estate investment trusts (REITs)
- Sovereign Gold Bonds (SGBs)
- Listed Bonds
If the above-listed securities are held for more than a year, the profits generated will be recognized as long-term capital gains. Whereas, if the holding period is exactly 12 months or less, the profits shall be short-term capital gains.
Unlisted Securities
Profits generated from “unlisted” securities held for more than two years (24 months) will be recognized as long-term capital gains. Unlisted bonds and debentures will now be taxed at the income tax slab rate just as other debt instruments. The unlisted securities comprise:
- Real estate
- Gold mutual funds
- Debt mutual funds (bought before 1 April 2023)
- Physical gold
- Immovable property
- Indian or international unlisted stocks
- Foreign equity funds
Note that the holding period of gold, bonds, and debentures has been decreased from the previous 36 months to 24 months.
Mutual Funds
For mutual funds, the gains from equity investments held for a year or less will be considered short-term, but if the holding period is more than a year, the gains will be long-term. The tax rate for STCG on these funds has been increased from 15% to 20% accordingly. However, STCG on equity-related investments will be taxed at the income slab rate as before.
The tax rates levied on debt mutual funds remain unchanged, hence, they will entail taxes at the investor’s slab rate irrespective of its holding period. Meanwhile, gains generated from other mutual funds will be recognized as short-term if the holding period is less than two years, and long-term if it is more than two years.
Besides, the Union Budget 2024 clarified the taxability of mutual funds to align with those debt instruments. The final budget has also revised the definition for “specified” mutual funds under section 50AA:
- Mutual funds with more than 65% assets invested in debt and market instruments will be recognized as debt funds to be taxed accordingly i.e., at the applicable slab rate.
- A mutual fund shall invest 65% or more of the total in units of a fund referred to the sub-clause (a).
Besides, equity-oriented mutual funds with more than 65% equities exposure will have a higher capital gains tax. If you hold these for less than 12 months, the STCG will be 20%. But, if held for more than a year, the LTCG will be 12.5%.
Gold ETFs and Gold Mutual Funds
The tax levied on short-term gains generated from Gold ETFs and Gold mutual funds will remain dependent on the applicable slab rate. While the holding period for them to be recognized as STCG remains 24 months, it was changed to 24 months from 36 months for physical gold.
Meanwhile, Gold mutual funds, Gold ETFs, and physical gold are subject to 12.5% of the long-term capital gain tax hereafter. Investing in physical gold may also incur long-term benefits if held for over two years.
Real Estate Funds and Other Mutual Fund Investments
Amongst all changes, the indexation benefits removal is likely to impact real estate investors. This might discourage any long-term investments in the real estate domain. Hence, they are pushed towards alternative short-term holdings.
Overall, the tax levied on short-term gains generated from Gold ETFs, Gold funds, foreign equities, and real estate will remain dependent on the applicable slab rate.
The wider gap between STCG and LTCG is an incentive for long-term holdings. It standardizes taxation across asset classes and simplifies investment.
Conclusion
To align with the goal of standardization, the Financial Minister also hiked securities transaction tax from 0.062% to 0.1% while futures and options securities were hiked from 0.01% and 0.02%. This impacts frequent traders and cools down hyperactive trading activities. Sitharaman, the finance minister, also added that the income received on share buyback shall be taxed according to the recipients.
The Union Budget 2024 focuses on economic stability and growth. It aims to negate the negative impacts of LTCG and STCG tax, hence, effectively stabilizing investor sentiment over the upcoming years. However, the indexation benefits removal may hamper the sentiments all the same. Simplification and consistency have been introduced to relatively favor equity investment against other asset classes. Overall, standardization has been the priority to ensure investor confidence and question any potential concerns over how tax policies influence the future market.
Please share your thoughts on this post by leaving a reply in the comments section. Also, check out our recent post on: “REITs vs. Real Estate Mutual Funds: What’s the Difference?“
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Disclaimer – This article is for educational purposes only and by no means intends to substitute expert guidance. Mutual fund investments are subject to market risks. Please read the scheme-related document carefully before investing.
