Budget 2024: Capital Gains Tax Hiked — Mutual Fund Winners And Losers
Here is a detailed look at how the new taxation rules in Budget 2024 will impact various categories of mutual funds.
Source: NDTV Profit
A change in taxation for debt funds some time ago resulted in the inclusion of several other categories of funds, such as gold funds, international funds, and even fund of funds, under the debt funds category for taxation. This resulted in a significant tax burden for investors in these funds, but the 2024 Union Budget now includes a relief measure for them.
The definition of what qualifies as a debt mutual fund has been changed, and this, along with the higher tax rate on equity oriented funds, will have an impact across multiple categories.
Here is a detailed look at the new situation for various categories of mutual funds.
Specified Mutual Fund
Section 50AA of the Income Tax Act qualifies a specified mutual fund for a different mode of taxation. According to this section, a mutual fund's entire gains would be calculated as short-term capital gains. Regardless of the duration of holding the mutual fund, there would be no long-term capital gains, and the entire benefit would be of a short-term nature. This meant that the individual would add the gains to their income and then tax them at the applicable rates.
This aim is to tax debt-oriented funds similarly to other debt products, such as fixed deposits and debentures, by adding the generated income to the total income.
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Change Of Definition
One of the key parts of Section 50AA was the definition of which funds would qualify as a specified mutual fund. Earlier, those funds that did not have a minimum investment of 35% in domestic equities fell into this category. This implied that the coverage extended to all debt funds. Furthermore, some hybrid categories with a low equity component fell under this mode of taxation.
However, categories such as gold funds, silver funds, international funds, and even fund of funds experienced the biggest impact, as they lacked the required minimum exposure to domestic equities. They thus became collateral damage as the section that sought to target debt funds snared them into the new calculation too.
Now, the budget has sought to rectify the situation by changing the definition of a specified mutual fund. According to the new definition, this section would qualify funds that hold a minimum of 65% in debt and money market instruments during the year. Also, a fund that invests in units of such a fund holding more than 65% in debt and money market instruments would also qualify under the new definition. This covers a fund of funds that have a predominantly debt exposure.
Gold, Silver, Fund Of Funds, International Funds
This changed definition now means that there is relief for the other categories of funds like gold funds, silver funds, exchange-traded funds, international funds, and even fund of funds that were subject to debt fund taxation. These funds do not meet the new definition, would not be classified as a debt fund, and would be subject to different modes of taxation.
Under the changed capital gains rules, if these funds are held for a period of 24 months or more, they would become long-term assets. If the holding is less than 24 months, then the gains from these funds would be short-term in nature, and they would be added to the income for the purpose of taxation, and the applicable rates would have to be calculated. On the other hand, if there are long-term capital gains, then the applicable rate would be 12.5%, but there would be no benefit from indexation. The important thing to note is that this change will be applicable from the next financial year, 2025–26, and not the current financial year.
Hybrid Funds
Hybrid funds need a careful look to see which definition they fall under. Those fund categories, like balanced advantage funds or aggressive hybrid funds, where the equity component in the portfolio is more than 65%, would be subject to equity fund taxation. The rates for these funds have been raised, so the short-term capital gains for holdings less than a year will be taxed at 20% and the long-term capital gains for holdings more than a year will be taxed at 12.5%.
Hybrid categories like conservative hybrid funds, where the debt component is more than 65%, would be subject to the special debt taxation norms. For these funds, all the gains will be short term in nature, no matter how long the holding period. These gains are added to income and taxed at the applicable rate.
A hybrid fund where the holdings between debt and equity are balanced and do not cross 65% in either category would have a holding period of 24 months for classification as a long term asset with a tax rate of 12.5% for long term and an addition to the income for short term gains.
Equity And Arbitrage Funds
There is no change in norms for taxation of equity and arbitrage funds, but there is an immediate impact on investors of these funds as the rates have changed. There will be a higher tax impact on both the long term and short term gains. The holding period for classification as a long term asset remains at 1 year. The short-term gains for such funds would now be at 20%, while the long-term gains would be at 12.5%. Both represent a rise from the earlier rates.
Arnav Pandya is founder of Moneyeduschool