The primary goal of investing should always be to grow one’s savings in order to fund key life events such as marriage, house, foreign vacation and so on. Therefore, some popular “investment” routes, such as insurance (life or health), are not investments in the true sense of the term. Other options, such as mutual funds, ULIPs, PPF, and NSCs, are actual investments simply because of the fact that they make your wealth grow over time. However, the degree to which such growth can potentially occur differs from one investment route to another. It is, however, noteworthy that the profits you earn on your investment may be subject to tax in most cases. Short – term capital gains refer to profits made on your investments in the short – term, usually up to 3 years. In the following sections, we will discuss how the definition of “short – term” varies in case of 3 popular investment routes – equity funds, non-equity funds and real estate as well as the taxation rules governing them.
Short – Term Capital Gains for Equity Mutual Funds
Equity funds by definition invest mainly in listed and unlisted company equities, i.e. listed and unlisted shares. In the case of equity mutual funds, profits in the form of capital gains are obtained when these mutual fund investments are switched or redeemed. In the case of equity funds, short – term capital gains refer to profits as a result of units being switched or redeemed before completion of 1 year from the date of their allotment to the investor. Additionally, if there are no profits as a result of such a sale, no short – term capital gains will be realized in such a case.
Short – Term Capital Gains for Non-Equity Mutual Funds
Non-equity mutual funds refer to a much broader class of investment options that include debt funds, gold funds and hybrid funds as the major groups along with all their applicable subtypes. These funds are mainly invested in money market and debt instruments, while equities would form only a minor portion of the portfolio. The definition of “short – term” in this case is a little different from the one in the case of equity mutual funds. Short – term capital gains of non-equity funds refer to profits obtained from redemption/switching of the investment within 3 years from the date on which units were allotted.
Short – Term Capital Gains for Real Estate
Real estate investments, including residential property, are also subject to short – term capital gains tax rules. The definition of a short – term in the case of real estate was 3 years from the date of purchase till FY 2016-17. In the recent Union Budget for FY 2017-2018, this has been reduced to 2 years. Hence, short – term capital gains tax rules will now apply to real estate investments only if the property being sold has been held for a period of less than 2 years.
Taxation of Short – Term Capital Gains for Equity Mutual Funds
As discussed earlier, short – term capital gains tax rules apply to equity mutual funds in case they have been held for less than 1 year from the date of unit allotment. The current rate of taxation as per applicable Income Tax rules is 15% on the profits obtained through such a sale. For example, if you had invested Rs. 10,000 in an equity mutual fund in January and sold those units in August of the same year for Rs. 11,000, then your short – term capital gains on the transaction would be Rs. 1000. Considering the prevailing tax rate on this transaction at 15% of the profits earned, you are liable to pay Rs. 150 as a short – term capital gains tax. This leaves you with a net profit of Rs. 850 on the transaction. A special class of equity funds – ELSS or tax-saver funds which have income tax deduction benefits under Section 80C – are beyond the ambit of short – term capital gains. This is because, this specific type of mutual fund features a lock-in period of 3 years from the date of allotment, therefore they have to be compulsorily held beyond the 1 year period specified under short – term capital gains taxation rules.
Taxation of Short – Term Capital Gains for Non-Equity Mutual Funds
As mentioned in an earlier section, non-equity funds include a wide range of investments including various types of debt and hybrid funds while the time period considered as short – term is up to 3 years from the date of unit allotment. The applicable tax rate, in this case, is based on the income tax slab of the investor. Profits obtained from the sale of non-equity mutual funds are added to the annual income of the investor for the relevant assessment year under the head “Capital Gains”. For example, if you were to make an investment of Rs. 10,000 in a liquid fund in January 2017 and sold the units in June 2017 for a Rs. 11,000, your profit of Rs. 1000 would be in the ambit of short – term capital gains. This profit of Rs. 1000 would be added to your taxable income for the assessment year 2018-2019 and taxed as per the applicable slab rate. Thus if your annual taxable income for the assessment year 2018-2019 is over Rs. 2.5 lakhs and up to Rs. 5 lakhs, the tax rate would be 5%, the applicable rate will be 20% with the incremental amount for taxable income over Rs. 5 lakhs and up to Rs. 10 lakhs and so on.
Difference between Short – Term Capital Gains and Dividends
Dividends earned by an investor on mutual fund investments may be considered as a profit earned from the investments, however, short – term capital gains tax rules are not applicable in this case. Dividends earned from mutual fund investments irrespective of equity or non-equity funds are not considered to be capital gains as per existing rules hence they are tax-free in the hands of the investor. However, a separate tax termed as “dividend distribution tax” is applicable in case dividends are declared and distributed by a fund house. The dividend distribution tax is payable directly to the government by the fund house, hence the investor does not need to worry about the tax implications of dividends earned from mutual funds.