InvestorQ : Will the actual result of the tax on LTCG make a significant difference to equity mutual fund returns over a longer period of time? Is it something we can ignore?
Nisha Chandani made post

Will the actual result of the tax on LTCG make a significant difference to equity mutual fund returns over a longer period of time? Is it something we can ignore?

Answer
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1 year ago


The best way is to understand this point with a live example of an Alpha equity fund that is held for more than 1 year. We will evaluate the impact of the LTCG tax under three circumstances viz. prior to Union Budget 2018, post Union Budget 2018 assuming that the limit of Rs.1 lakh is not utilized and Post Union Budget 2018 assuming that the limit of Rs.1 lakh is already utilized.

Particulars

Pre Union Budget 2018 scenario

Post Budget – But 1 lakh limit not used

Post Budget – But 1 lakh limit already used

Units of Alpha Equity Fund (Growth Plan)

1000 units

1000 units

1000 units

NAV on Jan 01st 2018

Rs.15

Rs.15

Rs.15

NAV on Feb 01st 2019

Rs.18

Rs.18

Rs.18

Return on Alpha Fund

20%

20%

20%

LTCG on Alpha Fund

Rs.3

Rs.3

Rs.3

Total Long Term Capital Gain (LTCG)

Rs.3,000

Rs.3,000

Rs.3,000

Tax on LTCG

Nil

Nil

Rs.312

Post Tax LTCG

Rs.3,000

Rs.3,000

Rs.2,688

Post Tax Yield

20%

20%

17.92%

As the above table suggests even if you consider that the entire LTCG on sale of equity funds becomes taxable at 10.4%, your overall post tax return reduces by just about a little over 200 basis points. The point is that the post tax return of 17.92% is still quite attractive when you compare with other investment avenues. In fact, as your time frame expands as is likely in case of equity funds for long term planning, your difference comes down to less than 40 bps. So the tax on LTCG on equity funds is not something for you to really worry about. Yes, it will reduce your post-tax yield (but that will keep reducing as the tenure gets longer) but the post tax return is still quite attractive. The only difference is that you need to rework your long term goals accumulation and rework your monthly allocations accordingly. Either you need to tone down your goals slightly or you need to increase your SIP amounts proportionately.