Generate tax advantages in your MF investments


Investment decisions should be based on its fundamentals and suitability. That said, for an investment that’s right for you, you’d be looking for tax efficiency. It’s about improving net tax returns, which is what you ultimately take home. Since mutual funds (MF) are the most popular investment vehicle, let’s see how to generate tax efficiencies here.

Useful Hacks You Can Follow

Systematic Withdrawal Plan (SWP): This is a method where you withdraw a pre-determined amount from your MF investments at a set frequency, usually monthly. The goal is to have a cash flow, for example in the retirement phase. The taxation of MF schemes is such that in the growth plan your investments become eligible for taxation of long-term capital gains (LTCG), after a one-year holding period for funds focused on shares. For funds focused on debt or fixed income securities, the required holding period is three years. For equity funds, the LTCG tax rate is 10% (plus mark-up and surrender, if applicable), that too beyond 1 lakh of capital gains per financial year. This tax rate is much lower than the other options which are Short Term Capital Gains (STCG); or the dividend option (now known as the capital withdrawal income distribution option) which is your marginal slab rate. The marginal tax rate is generally 30% (plus surtax and deductible) for most investors. For debt funds, the LTCG rate is 20% (plus surcharge and cess) but after the benefit of indexation, which significantly reduces the effective tax rate. The idea is that when considering starting a SWP, do so so that it starts one year after your investment in this fund for equity funds and three years for debt funds. If you are investing in installments, for example a Systematic Investment Plan (SIP), accounting for tax purposes works on a first-in, first-out (FIFO) basis, so you need to ensure this gap between each installment and withdrawal.

Tax collection: For equity funds, in the growth option, LTCG taxation works from the ANR of acquisition to the ANR of redemption. That is to say that the tax rate of 10% is applicable on the extent of the increase from the net asset value of purchase to the net asset value of sale. As mentioned earlier, until 1 lakh of LTCG per financial year, in equity and equity, is exempt. Therefore, as your stock price and the net asset values ​​of MF shares increase, you can sell and reserve LTCG up to 1,000,000. You should redeem the same shares or funds, as shares are intended for long-term investments. The benefit of doing this hullabaloo is that you create a higher baseline or benchmark for your ultimate taxation, when you finally sell the stock or fund.

To illustrate this, let’s say you bought a stock fund at a net asset value of 100 two years ago. You will eventually redeem the fund after 10 years of ownership, at a net asset value of 200. To date, the NAV is 125. If you redeem it today and redeem it, you create a higher base of 125 instead of 100, when you finally redeem it. To reiterate, in this exercise you should limit yourself to 1 lakh per fiscal year.

Offsetting Gains with Losses: Debt funds are often compared to bank deposits. In indebted MFs, the STCG is taxable at your marginal slab rate. Interest on bank deposits is also taxable at your marginal slab rate. If your holding period in a debt fund is less than three years, there is apparently no tax advantage over bank deposits. However, there is potential to generate some tax efficiency here as well. Bank deposits are taxable as interest, as “income from other sources” in your calculation and there is no scope. In indebted MFs, the STCG can be deducted from the capital loss, if you have any, which leaves you room for manoeuvre. The rule is that the short-term capital loss can be offset by both STCG and LTCG, where the definition of short or long is that of the other asset against which you are offsetting. Long-term capital losses can only be offset by long-term capital gains. You can have a capital loss on stocks or any other asset class, and losses can be carried forward for eight years.

The objective of optimizing investments is to generate returns without taking too much risk. Execute your investments within your risk appetite and try to generate “alpha”, i.e. relatively higher returns, within your parameters.

Joydeep Sen is a business trainer and author.

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