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Understanding equity funds taxation from fiscal 2018-19

The Budget 2018 has been critical for the Indian mutual funds industry. If we just focus on the equity mutual funds, the Union Budget has made a major change with respect to taxation of mutual funds. There is a major change with respect to taxation of dividends paid out by equity funds and the taxation of capital gains on equity funds. So what are the tax implications on equity mutual funds and how did the Budget 2018 impact on stock markets? Before understanding mutual fund taxation 2018-19, let us first understand what the situation with respect to taxation of equity funds is currently.


How were dividends and capital gains of equity MFs taxed up to March 31, 2018?

Let us focus on the dividends aspect first, since it is a lot less complex. The dividend paid out by an equity fund is entirely tax-free in the hands of the investor. Companies that payout dividends on equities deduct 10% dividend distribution tax (DDT) and only pay the net amount as dividend. However, in case of equity funds, there was no DDT to avoid double taxation. What about capital gains? Short term gains in case of equity funds are taxed currently at 15%. However, long term capital gains (held for more than 1 year) were entirely tax exempt in the hands of the mutual fund investor. This was the situation till March 31st 2018.


How did Budget 2018 change this status quo?

The union budget made two principal changes to mutual fund taxation. Firstly, the government decided to impose 10% dividend distribution tax (DDT) on dividends distributed by equity funds. Of course, since the company in question would have already paid out dividends, this could partially amount to double taxation. The bigger change was with respect to capital gains. Short term gains will continue to be taxed at the current rate of 15%. However, long term gains will now be subject to 10% tax if the gains in any financial year exceeded Rs.1,00,000/- The thing to remember is that whether you hold these equity funds for 1 year or for 10 years, there will be no indexation benefit available to the investor. The tax will be a flat tax on the equity capital gains above Rs.1 lakh.


Working out the numbers with respect to taxation of dividends

Alpha Equity Fund pays out Rs.4 per unit as dividend to unit holdersInvestor XPre Apr 01, 2018Post Apr 01, 2018Units of Alpha Fund5000 units5000 unitsDividend per unitRs.4/unitRs.4/unitTotal Dividend paid outRs.20,000Rs.20,000Dividend Distribution Tax (DDT)NilCharged at 10% + surchargeDDT impact (10% tax + 12% surcharge + 4% cess) = 11.648%N.A.Rs.2,330Net Dividend ReceivedRs.20,000Rs.17,670


As can be seen from the above illustration, the investor will see his net dividend go down post April 01st 2018 compared to the situation prior to the date. In a way, this does amount to a form of double taxation on dividends. Of course, the dividends paid out by an equity fund will continue to remain tax-free in the hands of the investor.


Understanding the taxation of long term capital gains (LTCG) on equity funds..

This is where the biggest change has taken place in the Union Budget 2018. Remember, the important cut-off date in case of taxation of equity funds is January 31st 2018, the day before the announcement of the Union Budget. That will be the reference point for deciding on the cut-off date for capital gains. We are focusing only on LTCG as short term gains taxation remains the same as before.


Let us assume some data points here. Rakesh had bought 50,000 units of Kappa Equity Fund at an NAV of Rs.15 on January 01, 2017. These units were sold on April 15, 2018 for Rs.26. The NAV of the fund on January 31st 2018 was Rs.23. Let us look at calculation of LTCG Tax..


ParticularsProfit / Loss CalculationTaxation on LTCGValue of Purchase (50,000x15)Rs.7,50,000
Value of Sale (50,000x26)Rs.13,50,000
Holding period (LTCG>12m)15½ months
Calculation of Selling price in the above transactionActual cost of purchaseRs.15/unit
Unit NAV on 31st Jan 2018Rs.23/unit
Sale NAV on Apr 15, 2018Rs.26/unit
Sale Price (Higher of A & B)
A – Actual Cost
B -  Lower of price on 31st Jan 2018 and selling priceA = Rs.15
B = Lower of 26 and 23
So Rs.23 NAV will be considered the sale priceLTCG per unit = (23-15) = Rs.8
LTCG = Rs.4,00,000
Exempt LTCG = Rs.1,00.000
Taxable LTCG = Rs.3,00,000


 On the taxable LTCG of Rs.3,00,000/- tax of Rs.30,000 (flat 10%) will have to be paid by the investor without indexation benefits. Few points to remember here..

The above calculation is only applicable if the fund was bought before January 31st 2018. Equity funds bought from Feb 01, 2018 will be subject to the normal 1 year rule for calculating LTCG.

Any long term capital gains on equity funds if booked before March 31st 2018 was entirely exempt. The new rule only applies in case of equity funds sold from fiscal 2018-19 onwards.

Just as capital gains on equity funds are taxable in the hands of the investor, capital losses can also be set off and carried forward for a period of 8 years.


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