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I invest in different schemes of HDFC mutual fund. If I invest Rs 1 lakh each in a liquid and a gold fund and the amount grows to Rs 1.1 lakh in both funds after a year, will it be tax-free? What is indexation? Please explain the taxation of these gains.
-Bhagwan Methe
Gold funds and liquid funds are taxed similarly. In your case, returns after a year will be taxed as long term capital gains which are subjected to either 10 per cent flat tax or 20 per cent after indexation.
Indexation allows to adjust the gains made on your investment, with inflation. The compounding effect of inflation can depress the real gains you make on an investment. Meaning, an investment made over last 15 years may have quadrupled now, but the purchasing power of money is down to less than half of what it used to be when you made the investment. Following indexation, government does not tax you on the portion of gains that have been eaten away by inflation. Investors are given this benefit to compensate the loss of purchasing power in case of long-term capital gains. Indexation is calculated by applying an appropriate factor from the Cost Inflation Index to the original price of units.
Long term capital gains are calculated after applying indexation and then taxed at 20 per cent. If the tax so calculated exceeds the amount of 10 per cent flat tax (the one without indexation), the excess has to be ignored.
This article was originally published on October 29, 2013.
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