How Budget 2024 impacts mutual fund investors and what should you do?

The long-term capital gains tax on equity-oriented investments will also be spiked from 10 per cent to 12.5 per cent from July 23, 2024.

Finance Minister Nirmala Sitharaman announced several tax changes across income slabs and Budget 2024 brought significant changes to the taxation landscape, particularly impacting capital gains, mutual funds, and gold investments.

Capital Gains Tax

• The LTCG tax rate for all financial and non-financial assets has been increased from 10% to 12.5%.
• Higher Short-Term Capital Gains (STCG) Tax: The STCG tax on specified financial assets has risen from 15% to 20%.
• Removal of Indexation Benefit: This benefit, which allowed taxpayers to adjust the purchase price of an asset for inflation, has been eliminated for all assets.
• The exemption limit for long-term capital gains will be increased to Rs 1.25 lakh a year from Rs 1 lakh.

"The LTCG exemption limit is a saving grace. The basic exemption limit for LTCG on equity-oriented investments has been raised from Rs 1 lakh to Rs 1.25 lakh per year. Meaning, let's assume you invested in a listed financial asset for over a year and made a gain of less than Rs 1.25 lakh, you'd be excused from paying any kind of tax. In the case of unlisted financial assets, you'd have to hold the investment for at least two years," said Dhirendra Kumar of Value Research.

 

Additionally, there will be no indexation benefits for capital gains made from all assets starting July 23, 2024. This will negatively impact the tax efficiency of long-term investments.

Mutual Funds (MF)

End of Ambiguity: The tax treatment of various MF categories like hybrid funds, gold ETFs, and fund of funds has been clarified. Hybrid funds with at least 65% exposure to equity can now claim LTCG benefits after holding for over 24 months. Hybrid funds with 35-65% equity exposure will lose indexation benefits if held for more than three years.

Taxation of mutual funds before and after Budget 2024, as explained by Fisdom

 Gold mutual funds, ETFs, and gold ETFs have been brought under the LTCG tax regime.

The ambiguity around the tax treatment of FoFs has been resolved. They are now treated as equity or debt funds based on their underlying investments. FoFs investing primarily in equity funds can now avail LTCG benefits after a holding period of over 24 months.

"Some mutual funds were taxed as long term and short term, some mutual funds were taxed with marginal taxation rates, and some mutual funds had this concept of indexation. With this Budget, all of this gets simplified, and the concept of indexation goes away, said Radhika Gupta, Edelweiss MD and CEO of Edelweiss Asset Management Company (AMC).

Now, you have three categories of taxation, Radhika Gupta explained. Category one is for equity and mutual funds that have more than 65 per cent equity. They are taxed as capital assets—20 per cent in the short term and 12 and a half per cent in the long term, with long-term being anything held for more than one year.”

Explaining the second category, Gupta said , “They are funds that hold more than 65 per cent in debt securities and are taxed at the marginal rate with no concept of short-term and long-term.” 

"The third category is the one that does not fit into either category, like a gold index fund or gold ETF or could be funds of fund investing in equity fund or an international fund or could be a conservative hybrid or hybrid fund. These have taxation in the short term at marginal rate, and long term is 12 and a half per cent where the long term means more than two years,” she added.

According to Gupta, the second category remains unchanged like last year, and the third category offers a “material benefit” if you are a long-term investor, although it remains the same in the short term. She said, “If you are a long-term investor, instead of attracting the marginal rate of taxation, they now attract 12 and a half per cent capital gains tax over a two-year long-term.”

“The definition of specified MFs has however been amended and now applies only to MFs which invest more than 65 per cent of its total proceeds in debt and money market instruments. This will benefit mutual funds investing in gold, offshore securities or funds of funds as well as offshore mutual funds where the redemption proceeds will not be deemed to be short term gains now,” noted Rajesh Gandhi, Partner, Deloitte India. Industry body the Association of Mutual Funds in India (Amfi) had called for such changes in its Budget proposals.

Key changes 

• Gold and silver ETFs, equity and hybrid FoFs, and international schemes will once again qualify for long-term capital gains (LTCG) tax benefits. These schemes were previously classified as debt funds and lost their LTCG benefits.
• The definition of debt funds has been changed to schemes investing more than 65% in debt and money market instruments.
• Indexation benefits have been removed for all asset classes, impacting some newly launched hybrid funds.
• LTCG tax rate for equity-oriented schemes has increased from 10% to 12.5%.
• Debt mutual fund taxation remains unchanged.

Impact on investors

• Investors in gold, silver ETFs, equity and hybrid FoFs, and international schemes will benefit from LTCG tax treatment.
• Some newly launched hybrid funds may face higher taxes due to the removal of indexation benefits.
• Equity fund investors will pay a higher LTCG tax.
• Debt fund investors will see no change in their tax treatment.

Moreover, in order to rationalise tax deducted at source (TDS) rates, Sitharaman has proposed to withdraw the 20 percent TDS rate on the repurchase of units by mutual funds or UTI. 

Before October 1, 2024:

• Mutual fund redemptions exceeding Rs. 1 lakh were subject to a 20% TDS.
• Investors received a reduced amount after the TDS deduction.

After October 1, 2024:

• There will be no TDS on mutual fund redemptions.
• Investors will receive the full redemption amount.
• However, investors are still responsible for calculating and paying capital gains tax on their returns when filing their income tax return.

Ritika Nayyar, Partner, Singhania & Co explains the significance of this move:

In a move to rationalise various TDS rates, the Government has proposed doing away with the TDS under section 194F of the Income Tax Act. This section primarily deals with TDS on redemptions from mutual funds and United trust of India. It mandated these organisations to deduct TDS at a rate of 20% on redemptions (if the aggregate amount exceeded Rs 1Lacs) of investments in mutual funds units of any Mutual Fund specified under section 10 (23D) or the units of the Unit Trust of India, on which deductions were claimed under section 80CCB.

However, when such money is returned (redeemed) to them either by repurchase of such units or on the termination of the plan, that shall be deemed to be the income of the taxpayer and shall be charged to tax accordingly. Therefore, when this payment had to be remitted to the taxpayer, this was subject to TDS @20%, which is now proposed to be withdrawn from 1st Oct 2024.

Therefore, a taxpayer withdrawing his money from the above funds/ units will have no tax deduction at source after 1st October 2024. For example, if you decide to redeem an amount of Rs 1,50,000 prior to this amendment date, you would get Rs 1,50,000 less 20% (ie. 30,000) which is Rs 1,20,000 in your account. After this withdrawal there will be no deduction at source, and you will get full amount. However, the taxpayer may still be responsible for calculating and paying capital gains tax, if any, on the gains when filing their income tax return.

What should investors do? 

"With the marginal increase in LTCG from 10% to 12.5%, long-term investors might be paying slightly higher taxes. However, with the exemption limit raised to Rs 1.25 lakh, small investors will see modest benefits. The increase of STCG from 15% to 20% will impact short-term equity investors. Although the tax rates are marginally increased, equity mutual funds remain an attractive investment opportunity compared to other asset classes. Therefore, we do not anticipate that the change in tax rates will significantly affect the flows towards equity mutual funds," said Feroze Azeez, Deputy CEO Anand Rathi Wealth.

Equity:
Analysts at Fisdom Research believe that Bottom-up opportunities still exist. Investors should follow 60:20:20 when it comes to large, mid and smallcap allocation. It’s a buy-on-dip market.

Debt Market

Fisdom has advised investors to increase their exposure to debt instruments and follow a barbell strategy: This involves investing in both short-term and long-term bonds to manage interest rate risk.

Duration Play: Focus on bonds with longer maturities to benefit from potential interest rate declines.

Positive Outlook: Reduced fiscal deficit and increased foreign investments are expected to support bond prices.

Gold
Fisdom maintains a modest position in gold as a hedge against inflation or market volatility and advises investors to buy gold when prices decline.

International Equities:

Neutral: Maintain current exposure without increasing or decreasing it.