Decoding Tax on SIPs

Taxes on mutual funds are somewhat like club membership fees. When you join a club, you get to enjoy activities like playing golf or relaxing by the pool, but you have to pay a fee. Similarly, investing in mutual funds offers profit potential but comes with the obligation of dealing with taxes. Taxation plays a significant role in shaping your take-home returns. This article will talk about how tax on SIPs (Systematic Investment Plans) is levied in the case of mutual fund schemes. Let's dive into the world of taxes and mutual funds!

How are investments through SIPs taxed?

Understanding how your investments made through SIPs will be taxed is important. The rules of taxation are different for different types of mutual funds. 

• If you invest in equity funds and hold them for more than one year, any gains you make are considered Long-Term Capital Gains (LTCG). LTCG exceeding Rs 1 lakh in a financial year are taxed at a rate of 10%. If you sell your equity investments within one year of buying them, the profits are considered Short-Term Capital Gains (STCG), and they are taxed at a rate of 15%.
• When it comes to gains from debt funds, there are two key scenarios. Any profits earned from debt fundswith 35% or less equity allocation are treated as part of your taxable income and are subject to taxation based on your individual income tax slab. Gains earned from debt funds with more than 35% equity allocation which are held for more than 36 months are taxed at 20% with indexation benefit.
• In the case of hybrid funds, the taxation depends on whether they are equity-oriented or debt-oriented.

Calculating gains and taxes on SIPs can be confusing due to their extended investment horizon. SIPs involve regular contributions over a period, resulting in a mix of long-term and short-term investments. Thus, for simplification, each SIP instalment is considered a separate investment. The holding period for each instalment is calculated accordingly. When calculating the holding period, mutual funds typically use the FIFO (First In - First Out) method. This means that the units you bought first are assumed to be sold first when you decide to redeem your investment. FIFO ensures a fair and consistent way to determine your profit for tax purposes.

Tax on ELSS 

ELSS is a special tax-saving fund with a mandatory lock-in period of three years. It offers tax savings under Section 80C of the Income Tax Act, 1961. ELSS follows the same tax rules as regular equity funds –

if you hold your investment for more than one year, any gains are considered LTCG. If you sell it before completing one year, the gains are treated as STCG. Since ELSS has a lock-in period of three years, the gains thereon will, by default, be subject to a LTCG tax.

It is important to note that while you can claim Section 80C benefits for all your SIPs in ELSS within a financial year, the three-year lock-in period will apply to each SIP instalment separately. Thus, you cannot withdraw your entire investment at once.

Now that you have understood the tax rules for different types of investments, you must be wondering how to lower your tax.

How to save taxes through SIPs?

• Start an SIP in equity for the long-term: LTCG from equity SIPs attract lower tax rates, helping you save money and maximise your returns. Also, LTCG up to Rs 1 lakh/year are tax-free.

• Start an SIP in ELSS: ELSS allows you to claim a tax deduction of up to Rs 1.5 lakh from your taxable income every financial year. The lock-in period of three years helps in long-term wealth creation while saving taxes.

Conclusion

It is essential to stay informed about prevailing tax laws and regulations to make informed investment decisions. Tax-saving strategies should indeed be part of your financial plan but should not overshadow your broader financial goals. While saving on taxes is essential, your investments should primarily align with your overall goals.  

An investor education initiative by Edelweiss Mutual Fund

All Mutual Fund Investors have to go through a one-time KYC process. Investors should deal only with Registered Mutual Fund (RMF). For more info on KYC, RMF and procedure to lodge/redress any complaints, visit - https://www.edelweissmf.com/kyc-norms  

MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS. READ ALL SCHEME-RELATED DOCUMENTS CAREFULLY