Most of us understand the merits of systematic investment plan (SIP) quite well. Apart from helping you with rupee cost averaging SIP also evens out the fluctuations in the market and ensures you get a more attractive buying NAV. A slight variant of the SIP is the STP or the systematic transfer plan. In an STP you consistently transfer funds on a regular basis from one kind of fund to another. Thus you get the rupee cost averaging benefit of an SIP. However, since STP involves shifting from one fund to another, the tax implications of STP assume a lot of importance. It is the aspect of systematic transfer plan taxation that actually decides how you must structure your asset shift. Let us look at the STP tax implications under different scenarios by focusing on 3 practical scenarios..
An STP from liquid/debt funds to equity funds..
Let us understand the setting for this scenario with the example of Rajesh Jain who has just received a lump-sum of Rs.20 lakhs from the sale of his apartment in Nasik. Rajesh is of the view that equity markets are attractively valued and therefore he should invest the entire corpus in direct equities or equity funds. Since he is an engineer and does not track stocks regularly, he prefers the safety of mutual funds investment.
However, his financial advisor counsels him to opt for a systematic transfer plan (STP) instead. How will this transfer plan help Rajesh? To begin with he can invest the entire corpus in a liquid fund or a liquid-plus fund. Then on a monthly basis the amount can be transferred into an equity fund via a structured STP. So Rajesh gets the benefit of rupee cost averaging in a volatile market and his idle funds earn higher returns in a liquid-plus fund compared to a savings bank account. The big consideration is taxation. If he structures it as a growth plan then he pays 30% tax on each STP and if he structures the liquid-plus fund as a dividend plan then the fund deducts 28.33% as dividend distribution tax (DDT). From that perspective a dividend plan may be slightly more tax-effective.
An STP from liquid funds to long term debt funds..
This is another cast study for an STP. Returns on liquid funds tend to remain stable over longer periods of time but the returns on a debt fund can fluctuate sharply with movement in interest rates. Let us assume that you expect the interest yields to be volatile in the next 1 year. Hence you are averse to committing all your funds to a debt funds and would prefer to adopt a phased approach. The answer once again could be an efficient STP.
One way would be to invest the funds in a liquid or liquid-plus fund and then structure a STP to regularly transfer funds into the debt fund. This way the phased approach ensures that your NAV gets spread and you are able to play the volatility in interest rates much better. In terms of tax treatment you will face 28.33% DDT on dividends declared on the liquid funds. Transferring out of liquid and liquid-plus funds is profitable because normally these funds do not attract exit loads and thus the effective cost of STP is much lower.
An STP from equity funds to ELSS funds..
This is normally a kind of STP that is not used too often considering that equity, by definition, happens to be more volatile and predictable in the short to medium term. In case you are having profits on your equity fund you may want to systematically transfer your money into an ELSS fund on a regular basis. If you equity fund has been held for more than 1 year then it is long term capital gains and is entirely tax free. However, you need to be cautious about doing STP on equity funds when held for less than 1 year. The redemption attracts 15% STCG tax and that adds to your cost. Also most equity funds will charge you exit load if redeemed within 1 year.
Normally, in any STP the basic consideration is that the STP-out fund should be a low volatility fund. Hence liquid to equity is fine; liquid to debt is also fine but equity to debt or equity to ELSS means that you are opening yourself to price volatility. That is not a great idea for an STP structure. The STP offers an elegant structure to convert a lump-sum investment into a regular SIP. However, select the in-asset and out-asset carefully. Apart from returns, risk and volatility, the exit loads and the tax implications also matter a lot! You need to understand STP tax implications for your STP to be really effective.
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