A reader asks, “Consider a mutual fund that is expected to hold more than 35% equity. If the monthly fact sheet of the fund reports an equity allocation of 35% or lower for one month alone, should I pay tax as per slab if I redeem that financial year?”
Background: The govt has amended the financial bill 2023 to remove the LTCG taxation at 20% with indexation for mutual funds holding 35% of lower Indian equity. The gains from such funds will be taxed as per slab, regardless of the age of the unit. This rule applies to purchases made on or after 1st April 2023.
Taxation status from 1st April 2023
- Funds holding 65% or more of Indian equity or Indian equity ETFs are equity funds (no change in this)
- Funds holdings less than 65% Indian equity but more than 35% Indian equity are non-equity funds (type 1). Gains from units purchased on or before 3Y are short-term gains and taxed as per slab, and gains from older units are taxed at 20% with indexation (no change in this).
- Non-equity funds (type II): Funds holding less than or equal to 35% equity will be taxed as per slab, regardless of the age of the unit. This will only apply to fresh purchases made from 1st April 2023.
But how does one determine whether the holding is higher than 35% (or less than 65%)? The wording in the budget amendment shows the way.
The percentage of the equity shareholding held in respect of the specified mutual fund shall be computed with reference to the annual average of the daily closing figures.
Therefore, as long as this annual average over a financial year does not drop to 35% or lower for non-equity funds (or drop to less than 65% for equity funds), the taxation status will not change.
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How to implement this rule practically? As we have explained in an earlier article – Should I pay more tax if my fund’s equity holdings drop below 65%? – the value of this annual average in the month of redemption will determine the taxation rate.
If a fund’s annual average changes to the extent that its tax status changes, the AMC should alert investors. SBI Dynamic Asset Allocation Fund (now closed) could change its equity allocation from 0% to 100%
The fund defined the annual average as “The percentage of equity shareholding of the fund shall be computed with reference to the annual average of the monthly averages of the opening and closing figures.” This data was available every month on its website.
We recommend investors in dynamic asset allocation or balanced advantage funds to find out if their AMC provide such data. Naturally, it is simpler for an AMC not to vary equity allocation too much, causing trouble for investors. Still, it may be necessary if market conditions demand it and the scheme mandate allows it.
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Dr M. Pattabiraman (PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over 14 years of experience publishing news analysis, research and financial product development. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free, AUM-independent investment advice. Connect with him via Twitter(X) LinkedIn YouTube Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (Published by CNBC TV18) for DIY investors. 
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