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BS Primer: How to withdraw from mutual funds without getting taxed

Archit Gupta / Mumbai 24 Oct 18 | 06:17 AM

What is Capital Gain tax on Mutual Funds?

You earn capital gains when you sell units of your mutual fund. Capital gains is the difference between the selling price of mutual fund units and the cost of acquisition. This sale may attract tax at your end. The rate of taxation depends on the type of fund and the holding period. The holding period is simply the time period for which you remained invested in the fund.

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Equity funds are taxed differently from debt funds. In case of equity funds, a period of less than one-year is treated as short-term and more than one-year is known as long-term. When you sell units of equity funds within 1 year from the date of purchase, the resultant gains are treated as short-term capital gains (STCG). Conversely, the gains made on the sale of units after 1 year from the date of purchase are called long-term capital gains (LTCG). 

In case of debt funds,  a period of less than three-years is treated as short-term and more than three-years is known as long-term. When you sell units of debt funds within 3 years from the date of purchase, the resultant gains are treated as short term capital gains (STCG). Conversely, the gains made on the sale of units after 3 years from the date of purchase are called long-term capital gains (LTCG). 

Earlier, the long-term capital gains (LTCG) earned on redemption of equity fund units were tax-free. However, after the amendments made in the 2018 budget, the LTCG on equity funds in excess of Rs 1 lakh are taxable at the rate of 10%. 

How are Mutual Funds Taxed? 

The tax rates on capital gains are different for equity funds and debt funds.

In case of equity funds, the short-term capital gains (STCG) on redemption of equity fund units are taxed at the rate of 15%. However, the tax treatment of LTCG has changed after the recent union budget. The modifications which were introduced are as follows:

Starting from 1 April 2018, LTCG exceeding Rs 1 lakh on redemption of ELSS units would be taxable at the rate of 10% without the benefit of indexation.

As regards the existing investors, they will receive an exemption on the LTCG made up to 31 Jan 2018. The LTCG made after this cut-off date will be taxable at 10% without indexation benefit. Moreover, investor redeeming the units before 1 April 2018 will enjoy the exemption (provided the units were purchased before 31 January 2018).

In case of debt funds, the STCG earned on redemption of units becomes part of investor’s total income and is taxed as per his income slab. On the contrary, the LTCG earned on debt fund redemption is taxable at the rate of 20% with the benefit of indexation.

How to withdraw from mutual funds without getting taxed

As the capital gains are taxable on mutual funds, so you need to plan out your withdrawal well in advance to save taxes. It may look very cumbersome but a little proactiveness at your end may work wonders. Here are a few tips to help you manage taxation on capital gains of mutual funds:

1. Usually, investors make sudden exits and attract unplanned tax liability when they think they have chosen the wrong fund. The easiest way to overcome this is not to stick to inappropriate funds. You can analyse a fund in a comprehensive manner before investing in it. Use both qualitative and quantitative parameters to evaluate its performance. You can also consult a professional adviser to increase your probability of successful exit. 

2. As regards equity funds, investors tend to buy and sell frequently by reacting to market fluctuations. Don’t do that; every exit is treated as a redemption and is thereby taxable. Look at equity investing from a long-term perspective. Choose only those funds which have remained resilient and have consistently performed well over a long period of say at least 5 years.

3. You may use the upper limit of exemption of Rs 1Lakh available in equity funds for long-term capital gains. Utilise this upper limit to weed out those mutual funds which are not performing as per your expectations.

4. You need to be very prudent while initiating Systematic Transfer Plans (STPs) and Systematic Withdrawal Plans (SWPs). Each transfer/withdrawal is treated as a redemption and would be taxable as per the holding period. In case of STPs from a debt fund to an equity fund, get the money transferred as quickly as possible to take advantage of stock investing.

5. In case of debt funds, to enjoy tax-efficiency, ensure a holding period of at least 3 years and align the exit with your overall financial planning goals.

( Author is the founder & CEO of ClearTax)

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