New taxes have been levied on equity mutual funds in the budget of 2018-19, are you wondering if you will be taxed?

On 1st Feb 2018, the Finance Minister Mr. Arun Jaitley introduced two new taxes for mutual funds in the budget of 2018 which is the last full budget of the Narendra Modi government. The Nifty reacted sharply to it on the next day by falling around 2.33%.

From 1st April 2018, a Long-term capital gain of equity mutual funds exceeding Rs. 1 Lakh will now attract a tax of 10%. This taxation will be without the indexation benefit. A DDT of 10% has also been levied on the dividends distributed by the AMC.

How will the long-term capital gains in mutual funds be calculated now?
In equity mutual funds the profits that arise after holding your investment for more than 12 months are considered as Long Term Capital Gains (LTCG). The LTCG for these funds will now be taxed at a flat rate of 10% without any indexation benefits, if the cumulative gains exceed Rs 1 Lakh in a year. If the gains are less than Rs. 1 Lakh in the year, then the LTCG will be exempt from taxation.
Under this new rule LTCG from even equity oriented hybrid funds like Balanced funds and Arbitrage funds will also be taxable.
The short-term capital gain arising from the sale of units within 12 months of investment will continue to be at a flat rate of 15%.

What about ELSS tax saving fund?
ELSS are equity linked saving schemes which were also previously tax exempt. Being an equity fund, the LTCG of the ELSS tax saving mutual funds will also be taxable as per the new budget.

The grandfather clause offers some relief
The finance minister has also offered some relief to the investors who are already sitting on profits by attaching the grandfather clause. As per the clause any LTCG arising from the sale of units bought previously will be tax exempt to the extent of the gains they had as on 31/January/2018. This means that if the investor continues to stay invested and sells equity funds later on then his/her long-term gains up to 31st Jan 2018 would be exempt. And any appreciation above the Rs 1 Lakh limit and after 31st January 2018 would be taxed at 10%.

Let’s understand how the tax rules will be applicable on LTCG of equity and equity mutual funds:
Suppose you invested Rs 6 Lakhs on 1st Jan 2017 then the table below will show how you will get taxed as per the new tax regime when you sell your mutual fund investments after 1 year of holding period.

DDT at 10% has been introduced
With the LTCG tax, a dividend distribution tax (DDT) of 10% has been levied on all equity and equity mutual fund investments. Though the dividend received by an investor is tax exempt, the fund house or the AMC will have to pay a TDS of 10% to the government. This will reduce the cash surplus available for distribution and the dividend distributed will be lower.
This does make the dividend option less lucrative, however, when looking for dividends the ideal investment are debt mutual funds since they are less volatile and more stable.

Where does the new LTCG tax leave the investors?
The tax exemption benefit on the long-term investment of equity and equity mutual funds was one of it’s USP along with the high returns. This attracted a lot of investors to mutual funds. So the new budget is indeed a little disappointing. However, from the long-term perspective, the new tax is not a major dampener and the investors should not be de-motivated by this news.
Equity investments have been able to generate an average CAGR of 15% to 20% historically and a 10% taxation will bring it down to 13.5% to 18% which is much more than what any other asset class can deliver. Considering the high post-tax returns, easy liquidity (no lock-ins except ELSS) and diversification provided by equity mutual funds, we continue to recommend a reasonable proportion of equity funds in your portfolio for maximum benefits.

Conclusion
The budget is pro-agriculture, small and medium businesses and digitalization. All these are the ingredients for the growth of the economy. This will, in turn, boost the returns generated by equity and equity funds. So the investors should not be disheartened and stay focused on their goals and continue their investments in mutual funds. Among all the alternative asset classes, mutual funds still score best on post-tax returns and easy liquidity.