How to redeem equity funds and avoid taxation?

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The Union Budget 2018-19 brought back the long-term capital gains (LTCG) tax on equity-oriented mutual funds. It called for a change in the strategy in which investors used to deal with the redemption of equity fund units to avoid the impact of taxation. 

What is Long Term Capital Gain (LTCG) tax on Equity Funds

Redemption of equity mutual funds may generate capital gains that attract tax. The rate at which the gains are taxed depends on the holding period. The holding period refers to the tenure for which you remain invested in the equity fund. If you sell the units of equity funds after one year from the date of allotment, such a holding period would be termed as long term. The gains, thus, made on the sale of units that were held for more than one year are called long-term capital gains (LTCG).

Conversely, the gains made on the sale of units of equity fund within one year from the date of allotment are known as short-term capital gains (STCG). Earlier, the long-term capital gains (LTCG) made on the sale of equity fund units were exempt from tax. However, post Budget 2018, the LTCG on equity funds are now under the tax umbrella. This has resulted in investors looking for innovative ways to tackle the changes in taxation rules. However, the LTCG on equity funds can be easily managed through simple methods.

How are Equity Funds taxed

The Union Budget 2018 specified how the LTCG on equity-oriented funds would be taxed. The following modifications were introduced during the Union Budget presentation:

  • Starting from 01 April 2018, the long-term capital gains over Rs 1 lakh on sale of units of equity funds are taxable at the rate of 10% without the benefit of indexation.
  • All the existing investors will get an exemption on the capital gains earned up to 31 January 2018. The capital gains made after the cut-off date will attract tax liability.

You can compute long-term capital gains (LTCG) by subtracting the cost of acquisition from the sale price of equity fund units. Let us understand the taxation of LTCG of equity funds with the help of an example.

You have invested Rs 3 lakh in an equity mutual fund on September 03, 2015. The net asset value (NAV) of the equity fund is Rs 50. You get 6,000 units of the equity fund. You have redeemed all the units of the equity fund on August 09, 2019.

The NAV on 31 January 2018 = Rs 60.

The investment amount = Rs 60 * 6000 = Rs 3,60,000.

The NAV on 09 August 2019 = Rs 80

Your investment amount = Rs 80 * 6000 = Rs 4,80,000

The value of capital gains considered for taxation = Rs 4,80,000 – Rs 3,60,000 = Rs 1,20,000. 

You have Rs 1 lakh per year exempted from long-term capital gains tax. You have to pay LTCG tax only on Rs 20,000 at the tax rate of 10% which translates to Rs 2,000. 

How to manage LTCG tax on Equity Funds

The introduction of the tax on long-term capital gains (LTCG) on equity-oriented funds should not deter you from investing in equity funds. You can still build wealth in a stress-free manner. Depending on the manner in which you do the equity mutual fund investment, you can easily reduce the effect of the LTCG tax on your returns considerably. These tips will help you to face the challenge in a streamlined way:

  • Ensure a complete understanding of the equity fund scheme before making an investment decision. This will prevent you from sticking to the wrong equity funds so that there are no unplanned exits that attract tax liability. Analyse the fund both qualitatively as well as quantitatively. In case you find it challenging to make the right choice, consult a professional financial adviser to reduce the probability of incurring losses.
  • Avoid frequent buying and selling of units of the equity fund. Investing in equity funds should be looked upon as a long-term investment.
  • Select only those equity funds that have a track record of performance for an extended period (at least five years). This will ensure that the equity funds have faced both ups and downs of the market resiliently.
  • It would be best if you kept in mind that the upper limit of tax exemption of long-term capital gains is Rs 1 lakh annually. Try to make the best use of this upper limit effectively by selling the units of the equity fund that are not meeting your expectations.
  • Invest in equity funds from an overall financial planning point of view. Your entry and exit have to be timed as per your investment horizon and personal goals.
  • Under ordinary conditions, equity investments have given a better inflation-adjusted performance over the long term. Also, owing to higher after-tax returns, equity funds have performed better than debt funds over some time.

How to invest in Equity Funds

Investing in equity-oriented funds can be a complicated process at times if you do not have enough financial knowledge. If you are finding it hard to pick suitable equity funds, then contact us. You can invest in the equity funds hand-picked by our in-house experts in a hassle-free and paperless manner. Start your investment journey by:

  • Step 1: Log on to cleartax.in 
  • Step 2: Enter all the requested details 
  • Step 3: Get your e-KYC done, it takes less than 5 minutes 
  • Step 4: Invest in your preferred hand-picked mutual fund

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