Is the indexation benefit available only to debt mutual funds and not equity when it comes to calculating long-term capital gains (LTCG) tax?
- Shivananda Yalsangi
Yes, the understanding is correct. The indexation benefit is currently available only for calculating the long-term capital gains (LTCG) taxes on debt funds and not equity ones. So, the way it works is that if you hold on to your equity investments for more than one year, then the gains are taxed at a flat rate of 10 per cent. On the other hand, in the case of debt funds, you need to hold the fund for at least three years, beyond which the capital gains are taxed at a rate of 20 per cent after providing the indexation benefit.
Now, this indexation is a very useful and logical concept. It adjusts your cost of acquisition for any security to inflation. So, for instance, if you are buying a security at a cost of Rs 100 and you hold on to it for several years. Now, over this time period, owing to inflation, the value of Rs 100 would appreciate to Rs 125. This would now be considered your cost of acquisition when it comes to calculating your capital-gain tax liability, instead of the original Rs 100. So, indexation has the benefit of lowering your capital gains while calculating the tax liability and therefore, it lowers your overall tax liability.
But you should remember that although the indexation benefit is not available in equity, the tax rate is lower. Now whether that works out in your favour or not will depend on the accumulated levels of capital-gain tax and the prevailing inflation rate during your holding period. So, these are the factors that will govern whether the indexation benefit works to your advantage or not. But these are the variables that are beyond one's control. Tax laws are such and we have to play by them.