Last week we established the foundation. Tax on investments works differently from tax on salary. The profit you make when you sell an investment is called a capital gain. You pay tax only on that profit, not on the full amount. And whether you pay at a higher or lower rate depends on two things: what type of investment you sold, and how long you held it before selling.
This week, we go product by product through the investments most Indian households own. The rates and rules here are worth knowing before you buy and before you sell.
Equity mutual funds and shares are where most investors have their largest holdings, and where the tax rules changed most significantly in the last two years. Let us be precise.
If you sell equity mutual fund units or shares that you have held for less than twelve months, the profit is a Short Term Capital Gain and is taxed at 20 percent. This rate was increased in the 2024 budget from 15 percent. If you have held them for twelve months or more, the profit is a Long Term Capital Gain and is taxed at 12.5 percent, also increased from 10 percent in the same budget. However, there is a significant relief: the first one lakh twenty-five thousand rupees of long term capital gains from equity every financial year is completely exempt from tax. You pay 12.5 percent only on gains above that threshold.
In practice: if you have been running a SIP for several years and redeem it, the gains are long term, the first one lakh twenty-five thousand is tax-free, and anything above that is taxed at 12.5 percent. For most investors this is considerably lower than their salary tax rate.
Debt mutual funds changed significantly in 2023. Until March of that year, debt funds held for more than three years enjoyed long term capital gains with an indexation benefit that reduced your taxable gain by accounting for inflation. That benefit was removed. From April 2023, gains from debt funds are taxed as per your income tax slab regardless of how long you held them. A debt fund held for one year and one held for ten years are now taxed exactly the same way. This brought debt funds on par with fixed deposits from a tax perspective, which is why the case for debt funds today rests more on their liquidity and flexibility than on any tax advantage.
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Fixed deposits have always been taxed as per your income tax slab. The interest is added to your income and taxed at your applicable rate with no distinction between short term and long term. If your FD earns fifty thousand rupees in a year and you are in the twenty percent bracket, you pay ten thousand in tax on that interest.
PPF, or Public Provident Fund, is one of the most tax-efficient instruments available. Contributions up to one lakh fifty thousand rupees a year qualify for deduction under Section 80C. The interest is tax-free. The maturity amount is tax-free. This triple advantage, on the investment, on the interest, and on the final corpus, is why PPF remains valuable even though its headline return of 7.1 percent looks modest. For someone in a higher tax bracket, the effective return after tax savings is considerably better.
Gold is worth understanding carefully because the holding period varies depending on how you hold it. Physical gold and gold mutual funds require a holding period of twenty-four months to qualify for long term treatment. Gold ETFs, being listed on exchanges, qualify for long term treatment after just twelve months, the same as equity. In all cases, long term gains on gold are taxed at 12.5 percent without indexation, and short term gains are taxed at your income slab rate.
Sovereign Gold Bonds, for those who hold them, have a more favourable treatment. If you hold an SGB until its eight-year maturity, the capital gain at redemption is completely tax-free. If you sell before maturity, gains are taxed like gold ETFs.
Real estate follows its own rules. Property held for less than twenty-four months attracts short term gains taxed at slab rates. Property held for more than twenty-four months attracts long term gains at 12.5 percent without indexation. There is one important exception: if your property was purchased before July 23, 2024, you have the option to choose between paying 12.5 percent without indexation or 20 percent with indexation, whichever results in a lower tax. For property purchased after that date, only 12.5 percent without indexation applies.
Before we close, a few things worth keeping in mind as you apply all of this.
Always think in financial years rather than calendar years. The financial year runs from April to March, and holding periods are calculated from the date of purchase to the date of sale. When redeeming a SIP you started years ago, remember that each monthly instalment has its own purchase date. Units from month one have been held longer than units from month thirty-six. Most platforms calculate this automatically when you redeem, but it is good to understand the logic.
Losses can also work in your favour. A loss on one investment can be set off against a gain on another in the same financial year, reducing your total taxable gain. Short term losses can be set off against both short term and long term gains. Long term losses can only be set off against long term gains.
And one last thing: tax should inform your investment decisions, but it should never be the main reason for them. Selling a good investment early because of tax anxiety, or holding a poor investment longer than you should just to qualify for a lower rate, are both costly mistakes. Tax is one consideration among several. It is rarely the most important one.
Most people hand this knowledge to someone else. You no longer have to.
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