What is Grandfathering in mutual funds LTCG Tax?

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The finance ministry, in its budget announcement on Feb 1st, re-introduced the tax on Long-Term Capital Gains (LTCG) at 10% without indexation benefits. This is applicable for gains above Rs 1,00,000. This new law is applicable from 1st April 2018. So does that mean all the gains made up till now should be taxed? No. Gains made up to 31st January 2018 are tax-free. This is called grandfathering.

What is grandfathering?

The literal meaning of grandfathering is “An alteration of the rules that apply to a certain investment or investment technique while stipulating that investment actions taken before a certain date remain subject to the old rules.”

This basically means one can enjoy the benefit of their investment they made before the new tax law has come into the picture. Capital gains made up to 31st January 2018 are exempted from tax. Only the gains made after 31st January 2018 are taxed with an exemption of Rs 1,00,000.

Example of LTCG tax on shares

Let’s say you have invested Rs 3 lakhs in equity shares in April 2015. The value of this investment on 31st January 2018 is Rs 5 lakhs. You decide to sell your investments on any day after 31st March 2018, then the LTCG will be calculated using the 31st January 2018 price. If you sell your investments at Rs 6.5 lakhs, then the gains will be calculated using January 31st, 2018 price of Rs 5 lakhs. The gains are Rs 1.5 lakhs. Out of which the Rs 1 lakh is exempted from being taxed. So you will pay 10% tax on Rs 50,000, which is Rs 5,000.

1st April 2015 InvestmentRs 3,00,000
31st January 2018 value of investmentRs 5,00,000
Redemption of investment any day after 31st March 2018Rs 6,50,000
Gains calculated using 31st January 2018Rs 1,50,000 (Rs 6,50,000 - Rs 5,00,000)
Tax CalculationRs 5,000 (Tax on Rs 50,000 as LTCG of Rs 1,00,000 is exempt from taxes)

If you sold your investment before 31st March 2018 then you needn’t pay any tax.

Example of LTCG tax on mutual funds

Calculation of LTCG for mutual funds SIP investment can be a bit challenging. Especially when the grandfathered portion of LTCG is to be calculated. One has to calculate the acquisition cost for all the SIP installments made so far on each of the equity funds. Considering you made profits, you will have to deduct this cost of acquisition from the NAV of January 31st, 2018 of the accumulated units.

One can request their mutual fund distributor or advisor to give a statement of capital gains on all the mutual fund holdings. This will help them to calculate their cost of acquisition. The NAV of the fund on 31st January 2018 can be obtained from NSDL CAS statement. This is a single statement of all the investments made by a person in the securities market.

Let’s say you have purchased a mutual fund in April 2015 at a price of Rs 100. On January 31st, 2018, the NAV of the fund is Rs 400. You decide to sell/redeem your investment any day after March 31st, 2018, then the LTCG will be calculated using the NAV value on 31st January 2018. If you sell your investment at a NAV of Rs 450. Then the LTCG will be calculated using the price on 31st 2018, which is Rs 400. So the LTCG will be Rs 50 (Rs 450- Rs 400).

1st April 2015 InvestmentRs 100
31st January 2018 value of investmentRs 400
Redemption of investment any day after 31st March 2018Rs 450
Gains calculated using 31st January 2018Rs 50 (Rs 450- Rs 400)

Benefitting from losses

One can book long-term losses if they sell their investments at a loss after 31st March 2018. Unadjusted losses can be carried forward and set off against gains for up to eight financial years.

Let’s say you have invested Rs 3 lakhs in equity shares in April 2015. The value of this investment on 31st January is Rs 2 lakhs. If you sell the investments after March 31st, 2018 at Rs 2 lakhs, which is a loss, then this loss can be adjusted for other long-term gains. If you make Rs 3 lakh LTCG in the next financial year then you won’t pay any tax. This is because Rs 1 lakh is exempt from tax and Rs 2 lakhs loss can be adjusted against the loss made last year.

Bottom line

After the grandfathering clause, one can now stop feeling unfair about the long-term tax levied on equity investments. Be happy there is an escape for the tax through the grandfathering clause.

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