Although a lot of investors invest in mutual funds and other investment tools to seek capital gains, very few tend to focus on taxation on these gains. Understanding how much you are going to be taxed for your returns is equally important. That’s because there is no point investing in a scheme whose tax ratio is so high that you end up losing all your gains to taxes.
Today we are going to discuss short term capital gains and long term capital gains in mutual funds and how these two differ from each other. But before that, let us understand what mutual funds are.
What are mutual funds?
Mutual funds are professionally managed funds that invest in equities, debt, corporate bonds, treasury bills and other money market instruments across the Indian and international markets. Mutual funds are listed at the stock market, and it is the duty of the fund manager to buy/sell securities in accordance with meeting the mutual fund’s investment objective. Different types of mutual funds are taxed accordingly, and hence you should always know how much you will be taxed on your gains before investing in any mutual fund scheme.
Before proceeding towards capital gains, let us first understand the short term and long term capital assets.
A capital asset is nothing but the security owned by an individual. These securities must adhere to rules under the SEBI Act of 1992 if they want to be considered as capital assets.
Short term capital assets: These are those assets which are held for lesser than three years from the date of purchase. In case of shares/stocks, these assets should be held for less than a year.
Long term capital assets: As a tax paying individuals any assets held by you for more than three years are considered as long term capital assets. In case of shares/stocks, these assets should be held for more than twelve months.
What are short term capital gains?
Any gains attained by an individual by withdrawing or redeeming his/her mutual fund units before 12 months from the date of purchase are treated as short term capital gains (STCG).
What are long term capital gains?
Profits/gains earned by individuals by withdrawing or redeeming his/her mutual fund units after 12 months from the date of purchase are treated as long term capital gains (LTCG).
Difference between short term capital gains and long term capital gains
| Parameter | STCG | LTCG |
| Meaning | When an individual investor earns more than what he invested and plans to withdraw his/her gains before 12 months from the date of purchase, this received consideration is termed as short term capital gains | When an individual investor earns more than what he invested and plans to withdraw his/her gains after 12 months from the date of purchase, this received consideration is termed as long term capital gains |
| Duration of assets held | If the financial assets/securities has held for less than a year the gains will be categorized as short term. | If the financial assets/securities has held for less than a year the gains will be categorized as short term. |
| Taxation | Short term capital gains attract a tax of 15 per cent | Long term capital gains attract a tax of 20 per cent. |
| Formula | STCG = sale cost of asset – cost of acquisition | LTCG = cost of selling an asset – indexed cost of acquisition |
The strategy that most investors follow is that they remain invested in schemes for the long run. This way, even if you have to LTCG, your investments grow enough that the tax deductions are negligible. But it is better that you first identify your financial goal and invest within your boundaries. Because mutual fund investments are subject to market risks and hence, it is better that you invest according to your risk tolerance so that you can remain invested for the long run and stand a chance of seeking some capital gains.