The sale of shares in a mutual fund or business trust can give rise to capital gains, which are subject to taxation. Both mutual funds and business trusts are popular investment vehicles, and understanding how capital gains tax applies to the sale of shares in these entities is essential for investors.
The Income Tax Act, 1961 provides specific rules for the taxation of capital gains arising from the sale of mutual fund units and business trust units. These rules determine whether the capital gain is classified as short-term or long-term, how it is computed, and the applicable tax rate.
In this blog, we will explore the rules for capital gains on the sale of shares in mutual funds and business trusts and explain how capital gains tax is computed for such transactions.
What Are Mutual Funds and Business Trusts?
Before diving into the tax implications, let’s first understand what mutual funds and business trusts are:
- Mutual Funds: A mutual fund is an investment vehicle that pools money from many investors to invest in securities such as stocks, bonds, or other financial assets. Investors purchase units in the mutual fund, which represent their share in the fund’s portfolio.
- Business Trusts: A business trust (such as a Real Estate Investment Trust or Infrastructure Investment Trust) is a type of investment structure that allows investors to pool capital to invest in income-generating assets like real estate or infrastructure projects. Units of these trusts are traded on the stock exchange, and investors earn returns based on the income generated by the trust’s assets.
How Are Capital Gains Taxed on the Sale of Mutual Fund Units?
When mutual fund units are sold, the capital gains tax is determined based on the holding period of the units. The holding period refers to the time between the purchase and sale of the mutual fund units.
1. Classification of Capital Gains on Mutual Fund Units
- Short-Term Capital Gains (STCG): If the mutual fund units are sold within three years of purchase, the capital gain is considered short-term capital gain.
- Long-Term Capital Gains (LTCG): If the mutual fund units are sold after three years, the capital gain is considered long-term capital gain.
2. Tax Rates for Capital Gains on Mutual Fund Units
- Short-Term Capital Gains (STCG): If the units are sold within three years, the STCG on the sale of equity-oriented mutual fund units is taxed at 15%. For debt-oriented mutual fund units, the STCG is taxed at the individual’s applicable income tax slab.
- Long-Term Capital Gains (LTCG): If the units are sold after three years, long-term capital gains on equity mutual fund units are exempt up to ₹1 lakh per year. Above ₹1 lakh, LTCG is taxed at 10% without the benefit of indexation. For debt mutual funds, LTCG is taxed at 20% with indexation.
3. Capital Gains Computation on Sale of Mutual Fund Units
The capital gains on the sale of mutual fund units are computed as follows:
Where:
- Sale Price: The price at which the mutual fund units are sold.
- Cost of Acquisition: The amount paid to acquire the mutual fund units. If the units were purchased over time, the average cost of acquisition is used.
Example of Capital Gains on Mutual Fund Units:
| Details | Amount (₹) |
|---|---|
| Sale Price of Mutual Fund Units | ₹1,50,00,000 |
| Cost of Acquisition | ₹1,00,00,000 |
| Holding Period | 4 years (Long-Term) |
| Capital Gain | ₹50,00,000 (Sale Price – Cost of Acquisition) |
| Taxable Capital Gain (LTCG) | ₹50,00,000 (LTCG taxed at 10%) |
| Tax Payable | ₹5,00,000 (10% of ₹50,00,000) |
In this case:
- The units were held for 4 years, qualifying as long-term capital gains.
- The capital gain of ₹50,00,000 is subject to a tax rate of 10%, amounting to ₹5,00,000 in taxes.
How Are Capital Gains Taxed on the Sale of Business Trust Units?
The tax treatment of capital gains on the sale of business trust units (such as REITs and InvITs) is similar to that of mutual fund units but with a few important differences based on the nature of the trust and the underlying assets.
1. Classification of Capital Gains on Business Trust Units
- Short-Term Capital Gains (STCG): If the business trust units are sold within three years from the date of purchase, the gain is considered short-term capital gain.
- Long-Term Capital Gains (LTCG): If the units are sold after three years, the gain is considered long-term capital gain.
2. Tax Rates for Capital Gains on Business Trust Units
- Short-Term Capital Gains (STCG): The STCG on the sale of business trust units is taxed at 15% if the units are held for less than three years.
- Long-Term Capital Gains (LTCG): LTCG on the sale of business trust units is taxed at 10% if the units are held for more than three years. If the units are redeemed by the trust, the tax treatment may differ based on whether the redemption results in a gain or a loss.
3. Capital Gains Computation on Sale of Business Trust Units
The capital gains on the sale of business trust units are calculated similarly to mutual fund units:
Where:
- Sale Price: The price at which the business trust units are sold.
- Cost of Acquisition: The price paid for acquiring the units, including any transaction costs.
Example of Capital Gains on Business Trust Units:
| Details | Amount (₹) |
|---|---|
| Sale Price of Business Trust Units | ₹80,00,000 |
| Cost of Acquisition | ₹60,00,000 |
| Holding Period | 4 years (Long-Term) |
| Capital Gain | ₹20,00,000 (Sale Price – Cost of Acquisition) |
| Taxable Capital Gain (LTCG) | ₹20,00,000 (LTCG taxed at 10%) |
| Tax Payable | ₹2,00,000 (10% of ₹20,00,000) |
In this case:
- The business trust units were held for 4 years, making it long-term capital gains.
- The capital gain of ₹20,00,000 is subject to 10% tax, resulting in a tax payable of ₹2,00,000.
Tax Exemptions and Deductions
- Section 54EC – Investment in Bonds:
- If the proceeds from the sale of mutual fund units or business trust units are reinvested in specified bonds (such as bonds issued by the National Highway Authority of India or Rural Development Bonds), the investor may be eligible for an exemption under Section 54EC.
- Section 80C:
- Investors cannot claim exemptions for the capital gains arising from the sale of mutual fund units or business trust units under Section 80C, as this section applies to deductions on investments and not capital gains.
Conclusion
The tax treatment of capital gains on the sale of mutual fund units or business trust units depends on whether the holding period qualifies for short-term or long-term capital gains. If the units are held for more than three years, they are eligible for long-term capital gains tax at a lower rate, and the benefit of indexation applies for debt funds. If held for less than three years, they are treated as short-term capital gains and taxed at higher rates.
Investors must carefully track the holding period and understand the applicable capital gains tax rates for their mutual fund or business trust investments. Proper tax planning and reinvestment strategies, such as utilizing exemptions under Section 54EC, can help reduce the tax burden.
Additional Resources
Learn more about Tax Provisions on the official Income Tax India website.
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