BackPast budgets have tossed around tax rules for MF investors
Equity funds are taxed at 15% short-term capital gains tax (STCG) if sold within a year of purchaseExperts advise investors to weigh multiple factors such as risk, return and liquidity, apart from tax
PremiumSaving and investing has become a complex mesh of products, tax rules and cost structures for the Indian investor. Each successive budget has added a new layer of complexity rather than reducing it. Orphaned savings products litter the landscape such as the infrastructure bonds in the 2010 budget and the Rajiv Gandhi Equity Savings Scheme (RGESS) created in 2013 that was abandoned after 2014.
In this piece, Mint traces out the successes and failures created by past budgets and explores how much MF investors should consider tax rules while investing.
Success: deduction on ELSS investment
Equity-linked savings scheme (ELSS) allows investors to get a tax deduction under Section 80C of the Income-tax Act up to ₹1.5 lakh. Such schemes have to invest at least 80% of their corpus in equities and have a lock-in of three years.
Despite the relatively short lock-in compared to other products within the Section 80C ambit, the three-year period has allowed equity investors to have a longer time frame. According to data from the Association of Mutual Funds in India (Amfi), as on 30 September 2020, only 49% of all equity assets are held for more than two years.
However, financial planners feel that the length of the lock-in needs to increase. “The lock-in of three years is not sufficient. It should be at least five years, on a par with tax-saver fixed deposits (FDs). People recycle their money into these funds every three years just to get a fresh tax break, rather than invest more money," said Suresh Sadagopan, founder, Ladder7 Financial Advisories, a Sebi-registered investment adviser.
Failure: Qualifying Period for LTCG
Equity funds are taxed at 15% short-term capital gains tax (STCG) if sold within a year of purchase. If sold after a year, they are taxed at 10% and gains up to ₹1 lakh per year are exempt from tax. Before 2018, LTCG rate on equity funds was nil, and gains after a year became tax-free.
Despite the increase of LTCG rate in 2018, the budget did not change the qualifying period for the same, creating a disparity between equity and debt fund taxation. Debt funds are taxed at the slab rate under STCG if sold within three years and at 20% with the benefit of indexation under LTCG after this period. The qualifying period for LTCG in debt is three years. “Having one year as the threshold for equity in the long term incentivizes a trading mentality and not long-term investing. This needs to be increased and at least brought on a par with debt," said Sadagopan
Experts advise investors to weigh multiple factors such as risk, return and liquidity, apart from tax. “Investors should not choose products for tax benefits alone. The classic example is insurance policies where investors get 4-5% returns just for a tax deduction. The same money invested in an equity fund can get higher returns, even post tax," said Vidya Bala, co-founder, Prime Investor, a research portal.
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