STP and taxation in mutual funds – Query

Taxation continues to be a complex subject for most investors. Different tax rules apply based on what you choose – Growth vs Dividend or Debt vs Equity. Here’s a specific question on taxation in mutual funds in an STP mode.

A reader sends this query:

Sir I am planning to make STP from SBI Liquid fund to Equity Fund of Rs. 10,000. My question is with every withdrawal in every month how much tax I have to pay. And is there any exit load to liquid fund?

Let’s break down the above query into parts.

One, the investor made an initial investment in a Liquid Fund. I am assuming that it is in the growth option of the scheme. 

Two, he started a Systematic Transfer Plan (STP) into an Equity fund, monthly instalments. A predefined amount or units is redeemed on a monthly basis from the liquid fund and invested into the equity fund.

Questions are:

A. Is there an exit load on the liquid fund?

B. What is the tax to pay on withdrawal / redemption from the liquid fund?

To answer question A, most liquid funds have no exit loads at all. They are meant for short investment periods and an exit load goes against the purpose of the fund.

For the stated liquid fund, there is no exit load. In any case, check the specific scheme information on its website.

What about tax on withdrawals from liquid fund?

A liquid fund is categorised as a debt fund and the related tax laws apply to it.

In summary, if your holding period is less than 3 years, then any realised gains on the liquid fund investment is treated as short term capital gains. You pay taxes as per your marginal tax rate. If you are in 30% tax bracket, and the gain on your withdrawn amount is Rs. 100, then you pay Rs. 30 + surcharge/cess as tax.

If your holding period is more than 3 years, then the realised gains are treated as long term capital gains. Now, you can also take the cost indexation benefit (that is increase the cost of your purchase using the IT department’s stated cost inflation index) and then pay a flat 20% tax on the indexed gains.

As stated in an earlier note, with a 7% CAGR, you pay about 0.6% tax on long term capital gains.

In the specific case here, assuming the investment has been made just now purely for the purpose of STP, short term capital gains tax will apply.

For every instalment, the gains have to be calculated and added to the overall income for the purpose of calculating taxes.

Here is a example table of an STP and calculation of short term capital gains.

As you would note, mutual fund accounting happens on the basis of units and NAV. Redemption are done on First in First out or FIFO basis.

Even if you specify an amount to be transferred via STP, you have to calculate the corresponding no. of units. On redemption, we use the FIFO method to calculate the for the no. of units redeemed and their purchase price. This leads to calculation of capital gains.

If you had made just one purchase into the liquid fund, then it is fairly easy. See table. However, if you are loading your liquid fund too over multiple purchases, then it needs some additional calculations.

Yes, it sounds a little complicated but several software and investment platforms offer this information to you.

Hope you now have clarity on capital gains taxation in mutual funds.