What is LTCG and STCG Tax on Mutual Funds? Everything a New Investor Should Know

Mutual funds are a popular investment choice for new investors due to professional management and diversification benefits. However, understanding how taxes apply to mutual fund gains is crucial to maximizing returns. Two key tax concepts every investor should know are Long-Term Capital Gains (LTCG) and Short-Term Capital Gains (STCG) taxes on mutual funds.

What Are Capital Gains?

When you sell mutual fund units for a profit, the profit is called a capital gain. Capital gains are classified based on how long you held the investment before selling:

• Short-Term Capital Gains (STCG): Gains from selling units held for a short duration.

• Long-Term Capital Gains (LTCG): Gains from selling units held for a longer duration.

The holding period that distinguishes STCG from LTCG depends on the type of mutual fund.

Holding Periods for Mutual Funds

• Equity-oriented Mutual Funds: These funds invest at least 65% of their assets in domestic stocks.

  • STCG applies if units are sold within 12 months of purchase.

  • LTCG applies if units are held for more than 12 months before selling.

• Non-Equity or Specified Mutual Funds (e.g., debt funds):

  • STCG applies if units are sold within 36 months (before July 23, 2024) or 24 months (after July 23, 2024) depending on when the investment was made.

  • LTCG applies for holding beyond these periods39.

Tax Rates on STCG and LTCG for Mutual Funds

Equity-Oriented Mutual Funds

• LTCG on equity funds is exempt up to Rs. 1 lakh (old rules) or Rs. 1.25 lakh (new rules) per financial year; gains above this threshold are taxed3679.

• STCG is taxed at a higher rate with no exemption limit, making short-term trading less tax-efficient13.

Non-Equity or Specified Mutual Funds

• STCG is taxed as per the investor’s income tax slab rate, which can be higher than equity funds’ rates.

• LTCG is taxed at 20% with indexation benefits (which adjust for inflation, reducing tax liability) if held beyond the specified holding period69.

Key Points for New Investors

• Prefer Long-Term Investments: Holding equity mutual funds for more than 12 months reduces tax liability significantly due to lower LTCG tax rates and exemption limits.

• Understand Fund Type: Tax treatment varies between equity and non-equity funds, so know your fund’s category before investing.

• Recent Tax Changes: From July 2024, STCG tax on equity funds increased from 15% to 20%, and LTCG tax threshold increased to Rs. 1.25 lakh with a 12.5% rate on gains above that3.

• Tax-Saving Options: Consider investing in tax-saving mutual funds like ELSS, which offer deductions under Section 80C, to reduce taxable income6.

• Systematic Withdrawal Plans: Redeeming mutual fund units in smaller amounts over time can help keep gains below taxable thresholds annually6.

Summary

Conclusion

For new investors, understanding LTCG and STCG taxes on mutual funds is vital for effective financial planning. Long-term investing in equity mutual funds is generally more tax-efficient due to lower LTCG tax rates and exemptions. Short-term gains attract higher tax rates, reducing net returns. Always consider your investment horizon, risk tolerance, and tax implications together to make informed mutual fund investment decisions.

This guide is based on the latest tax rules applicable in India as of 2024-25 and may be subject to changes in future budgets.13