First, a brief recap. Long-term capital gains on equity-oriented funds (including equity balanced funds) are tax-exempt on holding for over twelve months. Short-term gains on equity-oriented funds are taxed at a flat 15 per cent, no matter your tax bracket.
On all funds other than equity-oriented funds, short-term gains are taxed at your tax slab rate. For such funds, short-term is defined as a holding period of less than 3 years. Long-term gains (holding period of over 3 years) are taxed at 20 per cent with indexation benefit. We’ve also explained how to use indexation.
It is all very neatly laid out if you make capital gains. You pay taxes, where applicable, on the gains.
What happens in the case of losses? You set it off against the capital gains you made – that is, you reduce your capital gains by the amount of losses. As your gains reduce, your taxes also drop. If your capital gains aren’t enough to fully cover the losses, the unabsorbed loss can be carried forward into the next year, and set off against the capital gains made. Such carry forward can be done for eight years.
Since you have both long-term and short-term gains, and, depending on the type of fund the taxation differs, there are rules to such setting off.
- Long-term capital gains on equity-oriented funds, because they are tax-exempt, cannot be used to set off any loss whatsoever.
- For this same reason, long-term capital loss on equity-oriented funds cannot be set off against any capital gain.
- Short-term capital losses from all funds (equity-oriented and others), can be set off against both long-term and short-term capital gains.
- Long-term capital losses on all funds other than equity-oriented funds can be set off against long-term capital gains only.
Therefore, always remember to omit long-term capital gains on equity-oriented funds while arriving at the capital gains available for set off.
Understanding all this is easier with examples. Say you made short-term capital gains of Rs 50,000 on an equity fund. You also made a short-term capital loss of Rs 30,000 on a debt fund in the same year. You can set off this Rs 30,000 loss against the short-term gain. You now pay the tax only on Rs 20,000. If you had a long-term capital loss on the debt fund instead of the short-term, you cannot do such a set-off, and you pay tax on the entire Rs 50,000.
Take another example. You made long-term capital gain of Rs 50,000 on an equity fund. You had a short-term capital loss of Rs 30,000 on a debt fund. There is no set-off that you can do. Take a third example. You made a short-term loss on a debt fund for Rs 30,000. You made a long-term gain on a gold fund for Rs 50,000. You can set the loss off against the gain and pay 20% tax with indexation on the remaining Rs 20,000. If you had instead made a long-term loss on the debt fund, you can still set it off against the gain from the gold fund.
Set off against other assets
Now, it is important to remember that you can set off the long-term and short-term capital gains in other assets (where tax is not exempt) such as property or gold against your mutual fund loss. If you have a short-term capital loss in mutual funds, you can set it off against short-term or long-term capital gain in any other asset as well. If you have a long-term capital loss in your non-equity fund, you can set it off against only a long-term capital gain in any other asset.
Showing capital gains
Mutual fund houses don’t deduct taxes when you redeem the fund, unless you’re an NRI in which case TDS will apply. Calculating capital gains and paying the taxes due on them is your exercise. Capital gains are a separate source of income, under the Income Tax Act. Therefore, you need to list it separately as a different income head at the time you file your returns.
Now, what happens if your income outside of capital gains is less than the basic exemption limit? For individuals below 60 years of age, the basic exemption is Rs 2.5 lakh, for those between 60 and 80, it is Rs 3 lakh and for those above 80 years, the exemption limit is Rs 5 lakh.
Income tax rules allow you to reduce your long-term capital gains and short-term gains from equity to the extent your income falls short of the basic exemption limit. This rule applies only if you are a resident individual (or HUF) and not if you are an NRI investor.
For example, s say you’re 25 years old. Your taxable income is Rs 200,000 excluding capital gains. After completing all the available set-off, you have Rs 300,000 of long-term capital gains from your debt mutual fund, on which you need to pay tax. Now, the basic exemption slab that applies to you is Rs 250,000. So the difference between this limit and your income is Rs 50,000. You can use this Rs 50,000 to reduce your taxable capital gains. Therefore, you will pay 20% tax (with indexation) on Rs 250,000. Similarly, if you instead had Rs 300,000 worth of short-term capital gains from an equity fund, you will have to pay tax of 15% on Rs 250,000. But if the short-term capital gains came from a debt-oriented fund, then your taxable income jumps to Rs 500,000 (Rs 200,000 + Rs 300,000). This is because the gains are added to your income and taxed at your slab rate.
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