How to reduce the impact of LTCG tax on your equity MF holding
February, 07th 2018
BSE Index has fallen by more than 1,000 points in last 3 days after Finance Minister's announcement of 10 per cent long term capital gain (LTCG) tax on equity and equity oriented mutual funds.
The tax is applicable only on long-term capital gain made on such investments beyond 31st Jan 2018. This means, for calculating capital gain tax, NAV of 31st Jan 2018 will be considered as the purchase price. This is what is termed as "grand-fathering" of the gains till 31 Jan 2018.If you are holding equity oriented mutual funds then LTCG tax of 10 per cent would be applicable on your gains, provided you have held the units for more than one year. For holding period below one year, short term capital gain of 15 per cent is applicable and that has been in existence for several years.
Everyone seems to be of the opinion that given that the gain has been grandfathered, there is no point in exiting your investment based on the introduction of LTCG tax.
However, based on the way mutual fund investment is largely done, there is a distinct possibility of reducing the impact of the LTCG tax to a very large extent.
Most of us invest our money through intermediaries like brokers and advisors. If that is how you invest then most likely you are holding regular plan of mutual fund schemes.
You can reduce the impact of LTCG tax on current holding to at least some extent by switching your investment from Regular Plans to Direct Plans if you plan to hold on to the investment for at least one more year.
Direct plans are replicas of regular plans in terms of shares and other assets they invest in, except in case of the direct plan, the investment is done by the end user without any broker or intermediary. Mutual funds do not have to pay commission to intermediaries and hence the return on the direct fund (especially equity oriented fund) is higher. This difference could even exceed 1 per cent p.a.
For instance, say you are holding 50,000 units of a fund with NAV of 20 on 31st Jan 2018. This means that the value of your holding is Rs 10 lakh (20 x 50,000).
Let's say that you plan to hold on to these units for another three years and expect a return of 10 per cent p.a. In three-year time, the value of your holding in the regular plan will be Rs 13.31 lakh. Assuming the NAV of 20 pertained to 31st Jan 2018, you need to pay tax 10 per cent LTCG on Rs 3.31 lakh that you have made over the value for Rs10 lakh beyond 31 Jan 2018.
This would amount to LTCG tax of Rs 33,100 and your net redemption value would be Rs 12,97,900.
Now let's look at the direct plan. Assume that it generates an additional return of 1 per cent p.a over the regular plan. Thus it would generate a return of 11 per cent p.a. If we were to do the same calculations, our net redemption value, after paying LTCG tax of 10 per cent comes to almost equal to Rs 13.31 lakh, which was the value of the regular fund - if there was no LTCG tax.
The additional return generated by the direct fund would help us offset at least some impact of 10 per cent LTCG tax on existing MF holding if they are in regular plans.
Take help of your financial advisor, if required.
How can you move from Regular Fund to D irect Fund?
Well, it is extremely easy.
You already have a folio number in which your Regular mutual fund units are held. Presumably, all your paperwork is already in place as you are already holding the units of the fund. You just need to switch from Regular Plan to Direct Plan. There will be no movement of funds. The mutual fund house will liquidate your holding in Regular Plan and move it to the Direct Plan using the NAV of the day on which you request the switch. Most likely there will be capital losses as most equity-oriented funds' NAVs have fallen vis-a-vis their value on 31st Jan 2018. You will be able to offset these losses against gains arising in next 8 years if required (check with your advisor for better clarity).
Many of these funds houses have apps and one can switch to direct plan using such apps too.
Please keep in mind that you chose Direct Plan, and select Broker as None. The name of the Mutual Fund scheme will be identical except for "Regular" getting changed to "Direct". For instance, following are the name of a regular plan and direct plan for one of the IDFC schemes.
IDFC Focused Equity Fund - Regular Plan (G)
IDFC Focused Equity Fund - Direct Plan (G)
Please do bear in mind that the above names are only used for illustration and we are not recommending investment in this or any other schemes. Please do talk to your financial advisor.