Equity markets have been in a tizzy ever since Union Budget 2018 imposed the 10.4% tax (including the cess and indexation) on long-term capital gain (LTCG) on equity mutual fund schemes and direct equities. While debt funds have been imposing a 20.6% LTCG tax (with indexation) after 3 years, equity funds were exempted, so far, from LTCG tax—if you had held your mutual fund units for at least 1 year. This exemption has been around since 2004. But LTCG tax is back for equity funds, though the holding period of 1 year—to distinguish long-term and short-term gains—remains the same, going forward. If you have been planning for your financial goals using mutual funds, it’s important to understand how LTCG will impact your portfolio.
Budget 2018 has protected your gains till 31 January 2018. “The grandfathering clause is very beneficial. Any investor who has been doing a systematic investment plan (SIP), for say 3-5 years, or had invested a lump sum amount all these years, do not have to pay tax. Those gains will stay tax-free," said Amol Joshi, founder, PlanRupee Investment Services. Only gains that accrue 1 February 2018 onwards (and assuming you stay invested as on 1 April 2018 and beyond) will be taxed on sale of units.
There is an additional relief. All capital gains till Rs1 lakh will be exempt. If your gains exceed Rs1 lakh, only then you will have to pay the 10.4% LTCG tax. “The exemption of Rs1 lakh will come very handy if you have been making your investments based on goal planning. This means, you would get this exemption every time your goal gets accomplished and you redeem your investments over the years," said Joshi.
But here’s also where it gets complicated. The cut-off date to lock your past gains has been fixed at 31 January 2018. As of today, it is easier to get to know the 31 January value because that was just a few days ago. But what if your SIP has been going for some years and you decide to redeem it not now but a few years later? At that time, you will need to go back all the years to find your scheme’s value as it was on 31 January 2018.
It could be a task finding these values some years into the future, but help could be on the way. V. Ganesh, chief executive officer, Karvy Computershare Pvt. Ltd, one of the two largest registrar and transfer agents (R&Ts) in the mutual funds industry, said: “We are actively considering reflecting the 31 January 2018 value on all investor account statements for convenience, till it dies a natural death."
Computer Age Management Services Pvt. Ltd (Cams: the other large R&T) and Karvy Computershare give several value-added statements to mutual fund investors, apart from the common account statement, including a capital gains statement that gives you a ringside view of your mutual funds portfolio.
An LTCG tax of 10.4% will not dent your funds’ returns by too much. To compensate for the loss, some financial advisers say that investors may need to put in extra every month, incase they have been investing through SIPs for a specific financial goal. But the increase could be negligible. Back-of-the-envelope calculations show that if on 1 April 2018, you start an SIP in a mutual fund scheme that grows at a compounded rate of 12% and invest Rs10,000 in it, you would end up with a corpus of Rs8.87 lakh after 5 years, after accounting for the LTCG tax.
If the tax had not been there, you’d have earned Rs9.08 lakh. To make up for the difference, all you need to do is to invest Rs255 extra every month and you’ll reach the figure of Rs9.08 lakh, even after paying the 10.4% LTCG tax. “The increase would mostly be negligible, but your financial adviser can do these calculations to ascertain if—and how much—extra money you should now put," said Tivesh Shah, chief executive officer, Tru-Worth Finsultants, a consulting firm for independent financial advisers. However, some planners say there may not be a need to put extra amount. “If you plan for your goals with a very conservative growth rate in mind, say 11-12%, then there is no need to do all those extra calculations to put in an extra amount. But if you had started your SIP with a big expectation of, say 18% or 20%, then you need to taper your expectations and allocate fresh money," said Srikanth Bhagavat, managing director, Hexagon Capital Advisors Pvt. Ltd.
…but should you jump through it? Although your gains up to 31 January 2018 are exempt from tax, you could still escape the LTCG tax if you sell your investment before 31 March 2018.
Prima facie, if you don’t need the money, do not sell your mutual fund investments just to save tax. But if you need to rebalance your portfolio to preserve your asset allocation (the desired amount you should have in equity and debt assets), then go ahead and rebalance; in a sense, sell the consistently underperforming funds where things have gone off the rails and get into a better-managed fund.
Remember, you should do asset allocation periodically and not just because of this new LTCG tax. In fact, when the S&P BSE Sensex crossed 35,000 points towards mid-January 2018, Mint Money had advised investors to rebalance their portfolios (read here: bit.ly/2GZrws4 ). We hope you had followed our advice then. If you haven’t rebalanced your portfolio so far, then the LTCG tax is a good reason to do it now. We repeat: do not sell your funds unnecessarily and reinvest. Besides, equity markets have seen a correction recently, so there is a possibility that you may not make much gains between 31 January and 31 March 2018, which would make the rejig exercise futile.
Already—till 6 February 2018—the S&P BSE Sensex had fallen by 6% and the S&P BSE Midcap index had gone down 10%. So far this year, mutual funds are down too. According to data by Value research, large-cap funds have fallen by 2.53% on average so far in 2018, mid-cap funds by 7% and small-cap by 7.33%. “The net asset values are lower than their 31 January 2018 levels. The 10% LTCG would kick in from April, only on profits made after 31 January 2018. But if your NAVs (net asset values) are going to be down for the remainder of this financial year, there’s no compulsion to withdraw," said Kunal Valia, director, Credit Suisse Securities India Pvt. Ltd.
But Valia cautions: “Beware of misselling and unnecessary churning. Many banks are said to be talking to investors already to get them to withdraw before 31 March 2018 and then reinvest. Such distributors get upfront commissions every time their customers buy a mutual fund scheme. Honestly, don’t churn your portfolio unnecessarily unless you have a bad scheme and you need to get rid of it," he said.
As Union Budget 2018 also imposed an 11.648% Dividend Distribution Tax (DDT), many experts are expecting funds to declare large dividends before 31 March to escape the DDT which, too, would come into effect on 1 April 2018.
But if you are invested in a dividend plan, beware. Many investors don’t pay attention to the plan in which they invest. They choose between a growth or dividend plan arbitrarily, as the dividends and capital gains so far had been tax exempt. “Such investors, who choose the dividend plan then reinvest their dividends randomly. These investors should now reassess their plans. If you need dividends, only then opt for dividend plans because now every time your fund declares a dividend, it will deduct the DDT out of your dividend. If you don’t need the money, opt for a growth plan as there the LTCG tax is imposed only when you sell your units," said Deepak Chhabria, chief executive officer and director, Axiom Financial Services Pvt. Ltd.