How to Pay ZERO Tax On Profits Of Mutual Funds and Stocks?

How to Pay ZERO Tax On Profits Of Mutual Funds and Stocks in India? Are there ways to avoid tax legally on the profits of Mutual Funds and Stocks in India?

Recent increases in capital gains taxation have evidently drawn the attention of mutual funds and stock investors. While I do not intend to question their motivations, it is pertinent to explore strategies for legally minimizing tax liabilities on profits from mutual funds and stocks in India, as well as to evaluate whether these options are worthwhile.

How to Pay ZERO Tax On Profits Of Mutual Funds and Stocks?

Before discuss about this, let us first understand the current taxation rules with respect to mutual funds and stocks. I wrote a detailed post on this after the Budget 2024. You can refer to the same in “Budget 2024 – New Capital Gain Tax Rules And Rates“.

Let us return to the primary objective of this post. Indeed, there are methods to incur no tax on the profits derived from mutual funds and stocks in India. The approach that is currently being widely discussed involves Section 54F of the Income Tax Act.

The provisions of Sec.54F are as follows –

Exemption under Sec.54F is available if the following conditions are satisfied.

• Who can claim exemption – Under Sec.54F, only an individual or a HUF can claim exemption. In other words, no other person is eligible for claiming exemptions under Sec.54F.
• Which asset is qualified for exemption – Under Sec.54F, the exemption is available only if the capital asset that is transferred is a LONGTERM capital asset but OTHER THAN A RESIDENTIAL HOUSE or PROPERTY (it may be a plot of land, commercial house property, gold, share or any asset but not a residential house property).
• Which new asset should be purchased or acquired – To claim the exemption under Sec.54F, the taxpayer will have to purchase one residential house property (old or new) (but must be within India) or construct a residential house property (new house). The new house should be purchased or constructed within the time limit – a) For new house – It should be purchased within 1 year or before, or within 2 years after, the date of transfer of the original asset. b) For constructing a new house – The construction should be completed within 3 years from the date of transfer of original asset.

Few points to consider are –

1. Time limit in the case of compulsory acquisition – In case of compulsory acquisition, the time limit of 1 yr, 2 years, or 3 years will be determined from the date of receipt of compensation (whether initial or additional).
2. Construction may commence before the transfer of capital asset – Construction of the house should be completed within 3 years from the date of the transfer of the original asset. The date of commencement of construction is irrelevant. Construction even before the transfer of the original asset.
3. Holding of legal title is not necessary – If the taxpayer pays full consideration or a substantial portion of it within the stipulated period given above, the exemption under Sec.54F is available even if the possession is handed over after the stipulated period or the sale deed is registered later on.
4. The residential house should be purchased/acquired (may or may not be used for residential purposes) – The requirement of Sec.54F is that the property should be a residential house. The use of the property is not the relevant criterion to consider the eligibility for a benefit under Sec.54F. What is required is an investment in a residential house. Mere non-residential use would not render a property ineligible for benefit under Sec.54F.
5. Investment in the name of the transferor – It is necessary and obligatory to have an investment made in a residential house in the name of the transferor only and not in the name of any other person.
6. Renovation or modification of an existing house – Sec.54F does not provide for exemption in case of renovation or modification of an existing house.
7. The investment made within the time limit but construction not completed – Exemption under Sec.54F can not be denied where investment in a residential house is made within the time limit but construction is completed after the expiry of the time limit.
8. The live link between net sale consideration and investment in new property is not necessary – Merely because capital gains earned have been utilized for other purposes and borrowed are deposited in a capital gains investment account, the benefit of exemption under Sec.54F can not be denied.
9. Not more than one residential house property should be owned by the taxpayer – Under Sec.54F, the exemption is available only if on the date of transfer of the original assets, the taxpayer does not own more than one residential house property. He should also not purchase within a period of 2 years after such date (or complete construction within a period of 3 years after such date) any residential house.
10. The new asset should be situated in India – As mentioned above, the new asset should be within India.
11. Joint ownership in other properties – If the taxpayer owns more than one residential house even jointly, with another person, the benefit of exemption under Sec.54F is not available.

How much maximum limit can one avail under Sec.54F?

Before the Budget 2023, there were no such restrictions. However, effective from 1st April 2024, the maximum limit available to avail of the benefit under Sec.54F is capped at Rs.10 Crore. Do note that the amount of exemption can not exceed the amount of capital gain.

What is the Scheme of Deposit under Sec.54F?

Under Sec.54F, the new house can be purchased or constructed within the time limit given above. The taxpayer has to submit his return of income on or before the due date of submission of return of income (generally 31st July or 31st Oct of the assessment year). If the amount is not utilized within the due date of submission of income, then it should be deposited in the capital gains deposit account scheme. On the basis of the amount utilized in acquiring the new property and the amount deposited in the deposit account, the assessing offer will give an exemption under Sec.54F.

By withdrawing the amount from the deposit account, a new house can be purchased or constructed within the specified time limit.

If the amount deposited is not utilized fully for purchase or construction of new house within the stipulated period, then the following amount can be treated as LTCG of the previous year in which the period of three years from the date of transfer of original asset expires.

Unutilized amount in the deposit account (Claimed under Sec.54F)* (Amount of original capital gain/Net sale consideration).

In such case, the taxpayer can withdraw the unutilized amount at any time after the expire of 3 years from the date of transfer of the original asset in accordance with the aforesaid scheme.

Is it wise to use Sec.54F to pay ZERO tax on the profits of Mutual Funds and Stocks?

The important question is whether it is prudent to utilize Section 54F to avoid taxes on gains from mutual funds and stocks. My answer is NO. However, if your investments in mutual funds and stocks are aimed at acquiring real estate, you may leverage this section to claim the associated benefits. But, if your intentions are directed towards other objectives, redeeming current equity mutual funds (debt funds are not applicable) or stocks solely for the purpose of investing in real estate to achieve tax savings is ill-advised.

The obligation to pay taxes is an unavoidable aspect of our investment journey. Furthermore, we have no influence over future tax regulations. However, focusing excessively on tax implications and investing in illiquid and low-yielding assets—particularly those that are currently subject to high taxation due to the elimination of indexation benefits—clearly constitutes a misguided decision.

It’s important to be cautious when considering social media posts about tax savings related to the sale of equity mutual funds or stocks. Rather than blindly following such advice, take the time to understand your motivations for redeeming these investments. Furthermore, evaluate whether reinvesting in real estate meets your individual requirements. This self-reflection is essential and should not be swayed by generic social media suggestions or the prevailing crowd mentality.