The Long Term Capital Gains (LTCG) Tax is real. The 2018-19 Union Budget came as a blow to equity mutual fund investors and stock investors when the Finance Minister Arun Jaitley proposed to levy a tax of 10% on LTCG equity funds beyond Rs 1 Lac and on unlisted non-equity funds. It also levies a 20% (with Indexation) tax on listed non-equity mutual fund units.
Before delving deeper into managing your equity portfolio and implementing tax-efficient strategies, it is imperative to learn the facts about this tax.
2. 1 lac or less earned in LTCG in a year is tax exempt
3. Tax is applicable only on sale of equity that happens after March 31, 2018
4. LTCG that is accumulated till January 31, 2018 is exempt of this tax
Investors in retail were active and getting comfortable with the equity market. Now, they are mostly looking for answers to face the present conditions. The last few years saw the fund houses and distributors aggressively pushing balanced funds to their investors. These are mainly funds with the dividend option. This was easy due to the tax-fee status of the same. Quite expectedly, the corpus of such balanced funds mushroomed out of size. The assets managed by these funds grew from Rs. 0.17 lacs to Rs. 1.35 lacs, i.e. almost 8 times, as on September 2017.
Now dividends will also be taxed at 10%. That is definitely not a good news considering the past investor financial activities. Sadly, even senior citizens who invested in equity-oriented mutual fund dividend plans, face the brunt.
Therefore, before you put your money in an equity mutual fund, do consider the tax implications. Let us find out how the LTCG tax impact your returns.
The open-ended equity diversified funds generated returns of about 12% to 14%. This happened over a period of 5 to 7 years. As a result, the investors who revelled in such double-digit gains will finally have to share a 10% in tax with the Government. For example, if you invest Rs. 2 lacs in a stock fund, in the next 5 years this fund will generate a return of 12% (compounded). This means you gain Rs. 1.53 lacs if you redeem this fund at the end of the 5-years period. You will pay about Rs. 15,247 as tax deduction. After the tax implementation, your returns will work out to 11.05% CAGR.
Again, if you invest Rs. 2 lacs in a separate fund with a 12% CAGR for a year, the gains will be around Rs. 24,000. After the implementation of revised budget 2018-19, this return will be at 10.80% CAGR.
However, if you invest the same amount for 10 years, at 12% CAGR, there turns after tax will be 11.22% CAGR.
It is quite evident that by increasing your holding period, you are able to take advantage of the power of compounding while earning a higher return.
You must consider the above-mentioned scenarios to change your current plans and plans for new investments. The rate of return will surely vary post tax implementation in the financial year 2018-19. Although the difference in percentages might seem nominal, the value difference in terms of money will be quite significant because of compounding. You must make the right assumptions for your returns unless you want to be disappointed post tax implementation.
If you already have a Systematic Withdrawal Plan (SWP) or a Systematic Transfer Plan (STP) from your stock fund to other funds or your bank account, this is perhaps the right time to review them. These ‘switches’ or systematic redemptions will be taxable in the financial year 2018-19. You can always continue with the STP’s and SWP’s but it is advisable to check the tax impact on the ongoing transfers.
If you intend to grow your wealth, the dividend option will not work. Dividends generally eat into your accumulated gains at regular intervals. This will not let your profits be reinvested, especially in case of the dividend payout option. If you are not looking at regular income, then you can give this option a miss. Although, dividends are usually pushed due to its tax-free nature, they always get in the way of compounding.
Therefore, considering the changing market and the confusion, it is imperative to watch the market, make your assumptions based on current data, and create alterations to your portfolio as per your requirements.