Thursday, December 18, 2014

Mutual Fund SIPs and their Capital Gains Taxation

Systematic Investment Plans Or SIPs is a very convenient and most commonly used method for most investors to enter the equity market via Mutual Funds. By understanding the tax implications of SIP transactions, you can time your withdrawals accurately and save on taxes.



What is SIP?
One of the best ways to invest in the equity market is to take the Systematic Investment Plan (SIP) route where a fixed sum of money is invested on a fixed date irrespective of market conditions.

Advantages of SIP route
1. It inculcates regular investment discipline since the money is automatically deducted on a fixed date from the bank account.
2. Leads to risk aversion because of rupee cost averaging since the users cannot try and time the market.

Capital Gains and Taxation on SIPs
Investors are usually confused at the time of withdrawal of money from mutual funds wrt the calculation of capital gains and the applicability of short term or long term capital gains tax
But actually, the process is extremely simple. 

Rules
Consider the following rules and there will never be any confusion:
1. Each SIP transaction is considered as a separate investment.
2. When you redeem a part of the units, the withdrawal units are settled on a first come first served basis ie the first investments done via SIP will be settled first and so on.
3. Since each transaction is looked at separately from capital gains and taxation perspective, your MF portfolio may have a mix of Short Term Capital Gain transactions or Long Term Capital Gains transaction depending on the number of units withdrawn and the time for which they were invested.
4. Any transaction where the units were kept for less than 12 months are considered to have Short Term Capital Gains or Losses
5. Any transaction where the units were kept for more than 12 months are considered to have Long Term Capital Gains or Losses

An Example
Rohit starts investing in SIPs as per the following details:
Start Date : 10-Jan-2014
Frequency : Monthly
SIP Amount : 5,000
First withdrawal : 12-Apr-2015
Units withdrawn : All
His SIP investments keep continuing but he withdrew all units that were accumulated till 12-Apr-2015. Let us understand his tax implications in the table below











:





 







Points to be noted in the above table:
1. Each SIP is considered as a separate transaction with an independent decision on Long Term or Short Term capital gains.
2. Only first 4 transactions were applicable for Long Term Capital Gains tax (0%) since they had completed more than 12 months.
3. All other transactions attracted short term capital gains tax ie 15% of the gain, since they had not yet completed 12 months duration as an independent transaction.
4. A smarter way for Rohit would be to start withdrawing the amount on a monthly basis starting 12-Jan-2015 and continue to withdraw on a same number of units that was invested a year back. This way, he will have to pay zero tax on the entire amount. This strategy is refereed to as SWP (Systematic Withdrawal Plan).

Get smarter, save taxes.


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Cheers

Manoj Arora
elevate your life...

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