Tax implications on a Mutual Fund & SIPs | Motilal Oswal
Tax implications on a Mutual Fund & SIPs | Motilal Oswal

Tax implications on a Mutual Fund and SIPs (Systematic Investment Plans)

Over the last few years, systematic investment plans (SIPs) of mutual funds have emerged as a preferred investment and wealth creation vehicle for small and mid-sized investors. But the big question is how to calculate the tax on SIP. You need to understand the tax implications of SIP from the point of view of the purchase and the sale side of the transaction. The SIP tax calculator below will better explain how tax is calculated on your SIP and the tax implications of your Mutual fund SIP (both equity and debt)..

SIP Tax Calculator with live illustration of equity fund.

 Let us assume that an investor Rakesh has started a monthly SIP of Rs.10,000 in Alpha Equity Fund on 1st January 2016 and continued the SIP till 01st April 2017. Here is how the SIP tax calculator will look like.

Month    SIP Amt    NAV    Allotted  Total Units
Jan-16    10,000    12.50    800.00    800.00
Feb-16    10,000    12.65    790.52    1590.52
Mar-16    10,000    12.75    784.31    2374.83
Apr-16    10,000    12.90    775.19    3150.02
May-16    10,000    13.25    754.72    3904.74
Jun-16    10,000    13.80    724.64    4629.38
Jul-16    10,000    13.40    746.27    5375.65
Aug-16    10,000    13.55    738.01    6113.66
Sep-16    10,000    13.35    749.06    6862.72
Oct-16    10,000    13.25    754.72    7617.44
Nov-16    10,000    12.95    772.20    8389.64
Dec-16    10,000    12.80    781.25    9170.89
Jan-17    10,000    12.85    778.21    9949.10
Feb-17    10,000    13.25    754.72    10,703.82
Mar-17    10,000    13.45    743.49    11,447.31
Apr-17    10,000    13.80    724.64    12,171.95

Through the SIP, Rajesh has accumulated 12,171.95 units of Alpha Equity Fund with an average NAV of 13.145. Assume that Rajesh decides to sell 6000 units of Alpha fund on April 15th, 2017 at a NAV of Rs.13.90. His profit will not be calculated with respect to the average cost, but it will be calculated on a FIFO basis. FIFO (First In - First Out) assumes that the units bought first were sold first and so on progressively. Here is how the capital gains table in his case will look like on FIFO basis.

Month     NAV       Units     Profit       LTCG 
                              Sold      / Loss     / STCG

Jan-16    12.50    800.00    1,120.0    LTCG
Feb-16    12.65    790.52    988.15    LTCG
Mar-16    12.75    784.31    901.96    LTCG
Apr-16    12.90    775.19    775.19    LTCG
May-16   13.25    754.72    490.57    STCG
Jun-16    13.80    724.64    72.46      STCG
Jul-16     13.40    746.27    373.14    STCG
Aug-16   13.55    624.35    218.52    STCG

The above table shows how units are progressively sold to reach 6000 units under the FIFO method. The profits made on the units purchased in the months of January to April 2016 will classify as long term capital gains (LTCG) as they have been held for over 1 year. Hence, the profit for the first four months allocation (marked in yellow) will be entirely tax-free in the hands of Rakesh. However, the units allocated for the months of May to August 2016 have been held for less than 1 year and hence they will classify as short term capital gains (STCG). Hence tax of 15% will be payable on these allocations (shaded in green). The SIP tax calculator is based on the premise that all tax calculations will be based on FIFO and LTCG and STCG will be calculated accordingly. The tax implications of SIP will be based on the holding period from the month of allocation.

Special points to remember when it comes to SIP on ELSS funds..
There is a small difference you need to understand when it comes to SIPs on ELSS. Remember, ELSS is a tax saving fund with a mandatory lock-in period of 3 years. The tax treatment is exactly like any equity fund wherein the gains are LTCG if held for more than 1 year and STCG if held for less than 1 year. However, the difference lies in the consideration of the SIP for Section 80C benefits and the applicable lock-in period. All the SIPs from April to March (financial year) will be eligible for Section 80C benefits during the year and qualify for overall deduction up to Rs.150,000 from total income. However, the lock-in period will be applicable from the date of the SIP. Thus the April 2016 SIP will have a lock in till April 2019 while the May 2016 SIP will have a lock in till May 2019 and so on.

Tax treatment on SIPs on debt and other non-equity funds..
The tax treatment explained for equity funds will also be applicable in case of balanced funds and arbitrage funds as they are treated as equity funds for tax purposes due to their equity component in excess of 65%. However, in case of debt funds the SIP will still follow the FIFO method in case of sale of SIP units. The only difference here is that holdings up to a period of 3 years is classified as short term capital gains and taxed at your peak rate. Any holding beyond 3 years will be classified as long term capital gains and still be taxed at a concessional rate of 10% (or 20% with indexation benefits).

Tax implications of SIP are very important since these are critical financial planning instruments. Understanding how to calculate tax on SIP pertaining to equity and debt funds can go a long way in helping you better understand the concept of effective returns. At the end of the day, it is what you earn after paying taxes that matter to your wealth!

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