Grandfathering of LTCG on equity MFs (31 January 2018)

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Grandfathering of LTCG on equity mutual funds refers to the statutory mechanism under Section 55(2)(ac) of the Income Tax Act 1961 that protects gains accrued on equity-oriented mutual fund units before 1 February 2018 from being taxed under Section 112A. The provision was inserted by the Finance Act 2018 simultaneously with the reintroduction of LTCG tax on equity after a 14-year hiatus. It operates by deeming the cost of acquisition of pre-2018 units to be the higher of the actual purchase price and the fair market value (FMV) of the units on 31 January 2018, subject to an upper cap of the actual sale price. The effect is that all appreciation up to 31 January 2018 is excluded from the taxable LTCG base.

Tax advice disclaimer. This article is for educational reference only and does not constitute professional tax or financial advice. Tax law changes frequently and individual circumstances vary widely. Readers should consult a qualified Chartered Accountant or tax adviser before making any investment or tax-filing decision.

Background

Before 1 April 2018, long-term capital gains on equity-oriented mutual fund units were fully exempt from income tax under Section 10(38), provided STT had been paid. The Finance Act 2018 removed Section 10(38) and inserted Section 112A, taxing LTCG at 10% above Rs 1,00,000 (now revised to 12.5% above Rs 1,25,000 by the Finance Act 2024). To prevent retrospective taxation of gains that had accumulated over many years in the expectation of a permanent exemption, Section 55(2)(ac) was inserted to provide the grandfathering protection. This broader provision is discussed in grandfathering rule for LTCG.

Applicability

The grandfathering provision applies to equity-oriented mutual fund units:

  • Acquired before 1 February 2018; and
  • Transferred (redeemed or switched) on or after 1 April 2018 (i.e., after the Section 10(38) exemption was removed and Section 112A came into force).

For units acquired on or after 1 February 2018, the actual purchase NAV is the cost of acquisition and grandfathering does not apply.

The Section 55(2)(ac) formula

The deemed cost of acquisition under Section 55(2)(ac) is:

Deemed cost = Maximum of:

  1. Actual cost of acquisition (original purchase NAV x units); and
  2. Lower of:
    • FMV as on 31 January 2018 (closing NAV of the scheme on that date); and
    • Full value of consideration (actual sale price / redemption NAV x units).

In plain English: the deemed cost is the 31 January 2018 NAV, unless either (a) the original purchase price was higher than the 31 Jan 2018 NAV, or (b) the sale price is lower than the 31 Jan 2018 NAV.

Case analysis

Case 1: Normal appreciation (most common)

  • Purchase NAV (2015): Rs 50.
  • 31 January 2018 NAV: Rs 80.
  • Sale NAV (2025): Rs 150.
  • FMV capped at lower of Rs 80 and Rs 150: Rs 80.
  • Deemed cost = max(Rs 50, Rs 80) = Rs 80.
  • Taxable gain = Rs 150 – Rs 80 = Rs 70 per unit.
  • Untaxed pre-2018 gain = Rs 80 – Rs 50 = Rs 30 per unit (grandfathered).

Case 2: Market fell between Jan 2018 and redemption (loss scenario)

  • Purchase NAV (2015): Rs 50.
  • 31 January 2018 NAV: Rs 80.
  • Sale NAV (2020): Rs 60.
  • FMV capped at lower of Rs 80 and Rs 60: Rs 60.
  • Deemed cost = max(Rs 50, Rs 60) = Rs 60.
  • Taxable gain = Rs 60 – Rs 60 = Rs 0 (no gain, no loss at the grandfathering level).
  • Actual gain from original cost: Rs 60 – Rs 50 = Rs 10 (this is also eliminated).

Note: In Case 2, no capital loss can be carried forward arising from the grandfathering deemed cost calculation. The deemed cost cannot produce a loss greater than what would arise using the actual purchase price.

Case 3: Purchase price higher than 31 Jan 2018 NAV

  • Purchase NAV (January 2018): Rs 90.
  • 31 January 2018 NAV: Rs 88.
  • Sale NAV (2025): Rs 130.
  • FMV capped at lower of Rs 88 and Rs 130: Rs 88.
  • Deemed cost = max(Rs 90, Rs 88) = Rs 90 (actual cost governs).
  • Taxable gain = Rs 130 – Rs 90 = Rs 40 per unit.

In Case 3, since the purchase price was already above the 31 Jan 2018 NAV, grandfathering provides no additional benefit.

Case 4: Sale price below purchase price (pure loss)

  • Purchase NAV (2015): Rs 100.
  • 31 January 2018 NAV: Rs 80.
  • Sale NAV (2021): Rs 70.
  • FMV capped at lower of Rs 80 and Rs 70: Rs 70.
  • Deemed cost = max(Rs 100, Rs 70) = Rs 100 (actual cost governs).
  • Taxable gain = Rs 70 – Rs 100 = negative Rs 30 per unit (capital loss).

The capital loss of Rs 30 per unit can be carried forward for eight years against LTCG.

How to find the 31 January 2018 NAV

For open-ended mutual fund units, the 31 January 2018 NAV is the closing NAV published by the AMC on that date. Sources:

  1. AMFI’s NAV repository: The Association of Mutual Funds in India (AMFI) maintains historical NAV data at amfiindia.com. The closing NAV for all open-ended schemes on 31 January 2018 is available in downloadable text format.
  2. AMC website: Each AMC publishes NAV history on its website, searchable by scheme name and date.
  3. Capital gains statement: Zerodha Coin, Groww, and other MF platforms often pre-compute the grandfathered cost and reflect it in the annual capital gains statement.

For closed-ended funds (such as FMPs) that were not active on 31 January 2018, the FMV is the price at which the fund would have been redeemable, typically the last available NAV before 31 January 2018 or the NAV calculated by reference to the scheme’s portfolio on that date.

SIP and grandfathering

In a SIP, each instalment is a separate lot. Only lots allotted before 1 February 2018 are subject to grandfathering. Instalments allotted after 31 January 2018 use the actual purchase NAV as the cost. When a partial redemption occurs (in a SIP portfolio spanning both pre- and post-2018 units), the FIFO method allocates the redemption first to the earliest units. The SIP taxation FIFO article explains how the grandfathering calculation interacts with FIFO.

ELSS and grandfathering

ELSS funds with units acquired before 1 February 2018 that were still within the three-year lock-in as of 31 January 2018 could only have been redeemed after 1 April 2018 (when Section 112A came into force). Such units are eligible for grandfathering on redemption.

Effect of Finance Act 2024

The Finance Act 2024 changed the Section 112A rate and threshold but left Section 55(2)(ac) and the grandfathering mechanism entirely intact. The deemed cost formula and the 31 January 2018 FMV reference date remain unchanged.

See also

References

  1. Income Tax Act 1961, Section 55(2)(ac) – grandfathering deemed cost.
  2. Income Tax Act 1961, Section 112A – LTCG on equity-oriented funds.
  3. Finance Act 2018, insertion of Section 55(2)(ac) and Section 112A.
  4. Finance Act 2024, revision of Section 112A rates (grandfathering unchanged).
  5. Income Tax Act 1961, Section 10(38) – repealed exemption for equity LTCG.
  6. CBDT Circular on computation of FMV for grandfathering purposes (2018).
  7. AMFI NAV data archive – amfiindia.com.

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