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Business News/ Money / Investment: Tax reforms can give better choices
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Investment: Tax reforms can give better choices

STCG on an equity mutual fund is taxed at 15% but that on bonds is taxed at the slab rate

The capital gains on the maturity of an Ulip are tax-free if the total sum of premiums remains under ₹2.5 lakh per year. Premium
The capital gains on the maturity of an Ulip are tax-free if the total sum of premiums remains under 2.5 lakh per year.

A 58-year-old man in my neighbourhood was looking to increase his retirement corpus before retiring two years later. After much research, he was set to park about 80% of his proceeds from the sale of a spare flat in a debt mutual fund and move the rest to a Nifty-50 index fund. Investment in a debt mutual fund would have protected his capital from the market’s wild swings, and equity could gain meaningfully in the long run. However, he met a mutual fund distributor-cum-investment-adviser who gave him a different perspective on taxation and suggested a reversal in his allocation—80% in equity and the rest in debt—because the long-term capital gain tax on equity is merely 10% compared to debt mutual funds, which are taxed at slab rates. Even in the short term of less than 12 months, equity mutual funds are taxed at 15%. My neighbour planned to work part-time after retirement and expected to be in the 20% tax bracket. Thus, the advice resonated with him, and he followed it.

(Graphic: Mint)
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(Graphic: Mint)

So, what’s wrong with the advice? The first flaw is that equity is highly volatile, at least in the short term. So, someone close to retirement should ideally start reducing equity allocation and focus more on capital protection. My neighbour took a huge risk in going the other way around. What worried me even more was that he did not decide this based on his financial goals but to minimize the tax outgo. His case is not unique. Thousands of insurance agents have been selling flawed unit linked insurance plans (Ulips), endowment plans, and other such financial instruments to gullible investors because of their tax advantage over equity. Below are some examples:

The capital gains on the maturity of an Ulip are tax-free if the total sum of premiums remains under 2.5 lakh per year. Rebalancing within a ULIP (from debt to equity, dividend to growth plan, etc.) also does not attract taxes, unlike mutual funds where moving from an equity to a debt scheme (or vice-versa) within the same asset management company is treated as buying and selling activities and attracts taxes.

Capital gain from real estate is eligible for indexation benefits. With certain conditions, reinvestments of the sales proceeds from the old property into a new one is also tax-free. Due to these disparities, investors often invest in real estate in anticipation of capital gains with optimal taxation. Unfortunately, most get stuck with low rental yields and a long-drawn sale process.

Everything remaining constant, short-term capital gains (STCG) on an equity mutual fund is taxed at 15% compared to bonds where STCG is taxed at slab rate. Thus, investors in the higher tax bracket have a clear disadvantage in investing in bonds or debt mutual funds. Similarly, fixed deposits are taxed at a slab rate.

To be sure, over the last couple of years, the government has taken many steps to bring parity regarding the tax treatment of different asset classes. For instance, removing the LTCG indexation benefit for debt mutual funds brought these at par with fixed deposits and corporate bonds. Similarly, taxing the employee provident funds contributions over and above 2.5 lakh a year also reduced the disproportionately high tax advantage for people in the higher tax slab. However, there is a need to expedite this effort across all investible asset classes .

Anshul Gupta is co-founder and chief investment officer, Wint Wealth.

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Published: 30 Oct 2023, 10:58 PM IST
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