When an investor opts for SIPs in equity funds or balanced mutual fund schemes, any gains realised after holding the investment for more than one year qualify as long-term capital gains (LTCG). These gains are exempt from tax up to Rs. 1 lakh per financial year. For example, if an investor contributes Rs. 10 lakhs and earns a total of Rs. 20 lakhs in profits over ten years, the redemption amount of Rs. 30 lakhs may still be subject to LTCG taxation if the gains exceed Rs. 1 lakh in a year.
While SIPs offer benefits like rupee-cost averaging and disciplined investing, understanding is SIP tax free or taxable is crucial. Let’s explore the applicable tax rules and exemptions on SIPs. By grasping the tax implications associated with SIPs, investors can make informed decisions and optimise their investment strategy for better financial outcomes.
Is SIP Tax-free?
The tax treatment of SIPs depends on factors like the type of mutual fund scheme and the holding period. Capital gains from SIPs may be subject to taxes, and it's essential to understand the distinctions between short-term and long-term gains.
What are SIPs?
Systematic Investment Plans (SIPs) are a popular investment choice offered by mutual fund companies. They enable investors to regularly invest a fixed amount in a mutual fund scheme, providing the advantage of rupee-cost averaging and helping mitigate market volatility.
How Does SIP Work?
When you invest in a mutual fund scheme through a SIP (Systematic Investment Plan), you acquire a specific number of fund units based on the amount invested. The beauty of SIPs lies in the fact that you don’t need to worry about timing the market, as it allows you to benefit from both upward and downward market trends.
In rising markets, you buy fewer units, whereas in declining markets, you acquire more units. Since the Net Asset Value (NAV) of mutual funds fluctuates daily, the cost of units varies with each instalment. Over time, this fluctuation averages out, typically resulting in a lower overall purchase cost. This mechanism is known as rupee cost averaging, a key advantage of SIP investments.
Taxation of Capital Gains from SIPs
Taxation of gains from SIPs varies based on the mutual fund type and investment duration. The period of holding in case of SIP shall be calculated from each instalment of the SIP. For instance, if an investment in an equity fund through SIP is redeemed after 13 months from the date of SIP registration, initial SIP units held for over a year are considered long-term. Long-term gains up to Rs. 1 lakh are tax-free. The balance units shall be considered as short term as the units were held for less than a year on the date of redemption. Short-term gains from SIPs redeemed within a year are taxed at a 15% flat rate, with additional cess and surcharge.
Another instance of SIPs invested in debt funds involves the tax implications associated with them. In this scenario, if an investor chooses to invest in debt mutual funds through SIPs, the tax treatment differs based on the holding period of the investment.
If the debt mutual fund units acquired through SIPs are held for less than three years, any gains realised upon redemption are treated as short-term capital gains. These gains are added to the investor's total income and taxed according to their applicable income tax slab rates. However, if the units acquired through SIPs are held for more than three years, the gains are classified as long-term capital gains. For debt funds, long-term capital gains are taxed at a flat rate of 20% with indexation benefits. Indexation allows investors to adjust the purchase price of their investment for inflation, reducing the taxable gains and thereby lowering the tax liability.
Tax Treatment of Income Distribution cum Capital Withdrawal (IDCW) from SIPs
Income Distributed under Capital Withdrawal (IDCW) from units accumulated through SIPs is taxable in the hands of the investor. The payout is added to the investor's total income and taxed according to their applicable income tax slab rates.
For resident investors, if the total IDCW income exceeds Rs. 5,000 in a financial year, the mutual fund company is required to deduct Tax Deducted at Source (TDS) at 10%. In the case of non-resident investors, TDS is deducted at 20%, along with any applicable surcharge and a 4% cess.
