How mutual funds will be taxed after the 2024 Union Budget

The 2024 Union Budget has introduced major modifications to the tax structure for mutual fund schemes. If you invest in mutual funds, it's important to understand the new taxation rules. Mutual fund investments are taxed in two ways based on the holding period: Short-Term Capital Gains Tax (STCG) for investments held for less than 12 months and Long-Term Capital Gains Tax (LTCG) for those held for more than 12 months. The Finance Minister announced that from July 23, 2024, the LTCG tax rate for equity mutual fund investors will rise to 12.5%, and the STCG tax rate will increase to 20%. This LTCG rate hike applies not only to equity mutual funds but also to long-term gains from other financial and non-financial assets. The STCG rate increase to 20% is specific to certain financial assets, such as equity mutual funds, and will not impact other financial or non-financial asset classes. Understanding these tax liabilities is essential for assessing your return on investments (ROIs). Let's examine the detailed taxation changes for mutual funds in the Union Budget and their implications for your investments.

Pre-2024 Tax Structure for Mutual Funds

Before the 2024 Union Budget, equity mutual fund schemes were taxed at 15% and 10% STCG and LTCG respectively. The taxation structure of other mutual fund schemes was different based on the type of mutual fund in which you’re invested. The Union Budget 2024 announcements are expected to have an effect on all types of mutual fund investments, including equity, debt, hybrid, overseas, and gold mutual fund schemes.

Prior to the budget, the tax structure of mutual fund schemes was as follows:

• Equity Mutual Funds: 15% STCG on a holding period of less than 12 months and 10% LTCG on a holding period of more than 12 months.

• Debt Mutual Funds: STCG and LTCG on debt-oriented mutual fund schemes were calculated based on a holding period of less or more than 36 months for STCG and LTCG, respectively. Both these taxes were calculated as per the investor's income tax slab.

• Hybrid Mutual Funds: Hybrid mutual fund schemes were taxed based on their orientation. If the fund’s portfolio was 65% or more invested in equity, it was taxed as per equity mutual fund rules. A portfolio makeup of 65% or more in debt caused the fund to be taxed as per debt mutual fund rules.

• Overseas Mutual Funds: Overseas funds were taxed based on the holding period. Investments with a holding period of over 36 months were considered long-term capital gains and taxed at 20% with indexation benefits. For holding periods of less than 36 months, the STCG was calculated as per the investor’s income tax slab.

• Gold Mutual Funds: Gold mutual funds were taxed based on a holding period of less or more than 36 months previously. Both LTCG and STCG were calculated as per the investor’s income tax slab for gold mutual fund investments.

Summary of The Major Changes in The Tax Structure for Mutual Funds

The major changes in the mutual fund tax structure announced in the Union Budget 2024 were the increase in LTCG and STCG tax rates, as mentioned above. Another important announcement and significant change to the mutual fund tax structure was the change of holding periods.

The FM in the Union Budget 2024 announced the holding period of several mutual fund schemes, which was previously 36 months and above for the consideration of LTCG and has now been reduced to 24 months or 2 years. Lowering the holding periods ensures that more investments will be liable for LTCG taxes, increasing the tax burden on investors. However, to help reduce the tax burden on investors, the LTCG exemption limit has been increased from ₹1 lakh each financial year to ₹1.25 lakh per financial year.

Let’s review the impact of these changes on some of the different types of mutual fund schemes.

Impact on Equity-Oriented Mutual Funds

The tax rates for equity-oriented mutual fund schemes have increased. The LTCG tax rate has increased from 10% to 12.5%, and the STCG tax rate has increased from 15% to 20%. The holding period for tax calculation of equity-oriented mutual fund schemes has not changed. This means any holding period beyond 12 months for equity-oriented mutual funds will attract LTCG taxes.

Impact on Debt-Oriented Mutual Funds

For debt-oriented mutual fund schemes, there have been no changes to the tax rate. The investments are still taxed as per the investor’s income tax slab, both for short-term and long-term capital gains taxes. However, the holding period for tax calculation of LTCG has been reduced from 36 months to 24 months.

Impact on Hybrid Mutual Funds

The tax rate and holding period of hybrid mutual fund investments have changed after the Union Budget 2024. Earlier, if the holding period was more than 36 months, these schemes were taxed as per investors' tax slab (LTCG and STCG). The holding period for specified mutual funds, which have more than 65% in debt, has been changed to more than 24 months and will continue to be taxed as per investors' tax slabs for LTCG and STCG tax calculations.

Impact on Overseas Funds

Overseas funds or international mutual fund schemes have also experienced changes in their taxation structure in the Union Budget. Much like hybrid mutual fund schemes, the tax rate and holding period for overseas funds have changed. The LTCG tax rate has been changed from the investor’s income tax slab to 12.5% on overseas fund investments. The holding period for LTCG calculation has been reduced from 36 months to 24 months. The STCG tax rate remains unchanged per the investor’s income tax slab.

Impact on Gold Mutual Funds

The taxation liability on gold mutual fund investments has also changed. The holding period for LTCG calculation has been reduced from 36 months to 24 months, and the LTCG tax rate has been fixed at 12.5%. No changes have been made to the STCG tax calculation, which is still taxed according to the investor’s income tax slab.

Practical Implications for Investors After The Changes on Tax Slab

The practical implications for investors after the mutual fund taxation changes depend quite a lot on the type of mutual fund scheme in which you’re invested. For equity-oriented mutual fund schemes, which are among the most common mutual fund investments, the tax liability of investors has increased. This can potentially lower the investor’s returns, be it short-term or long-term.

On the other hand, in mutual fund schemes where both the LTCG and STCG taxes were calculated as per the investor’s income tax slab, the changes to the LTCG tax rate will be a welcome relief. Income tax slabs go as high as 30%, meaning any investment in such mutual fund schemes would have long-term returns taxed at a maximum of 30%. This has now been reduced per the new guidelines, with a cap of 12.5%. This benefit applies to various mutual fund schemes, including overseas and gold mutual fund schemes.

Future Outlook

According to market experts, the budget has simplified the taxation of mutual fund investments and brought uniformity to mutual fund taxation. The formation of only two holding periods of 12 months and 24 months is expected to provide clarity and simplicity in mutual fund taxation for investors, as per the expert. Experts have also added that a reduced holding period benefits investors and reduces the complications with mutual fund taxation. For more information about the Union Budget and how it affects the stock market, feel free to check out the Sharekhan Knowledge Center. Our insightful pieces on the stock market and investor best practices will help you learn the critical aspects of retail investing.