How Are STPs And SWPs Taxed?

Introduction

In our earlier articles, we have seen what is SIP, STP and SWP in detail. In SIPs, there is no tax applicable generally as there is no transfer or withdrawal of funds. Instead funds are invested in SIP. However, in case of STP and SWP, there is taxation involved. In this article, we are going to see the Tax implications of STP and SWP.

In case of STP, capital gains tax is applicable as the money transferred from one fund to other fund, is considered as a redemption. Similarly in case of SWP, each withdrawal is treated as a redemption and thus attracts capital gain tax.

Tax Implications of STP & SWP

A. Tax Implications of STP

1. transfer of money [STP] from debt to equity fund

  • This mode of transfer is suitable for the investors who are not confident to invest a lumpsum amount into equity funds due to market volatility. As a result, through STP, these investors first invest the money in debt funds and then transfer it to equity funds of their choice.
  • When you transfer funds out of a debt fund or equity fund, it will be treated as a sale and taxed accordingly. Thus, capital gains tax is applicable on the transferred funds, since it is considered as a redemption.
Tax Implications on STP from Debt Fund to Equity Fund –
  1. Any transfer before 3 years will be Principal + Short-Term Capital Gains (STCG) and in that STCG will be taxed as per your slab rate.
  2. Any transfer after 3 years will be Principal + Long-Term Capital Gains (LTCG) and LTCG part will attract tax at 20% after indexation.

2. TRANSFER OF MONEY [stp] FROM equity TO debt FUND

This mode of transfer is suitable for the investors who are going to achieve their long-term financial goal within 3 years or simply who are approaching their retirement. Thus the STP from equity to debt fund would protect their corpus from possible market fluctuation.

TAX IMPLICATIONS ON STP FROM equity FUND TO debt FUND –
  1. Any transfer before 1 year will be Short-Term Capital Gains (STCG) and it will be taxed at 15%.
  2. Any transfer after 1 year will be Long-Term Capital Gains (LTCG) and it will be tax-free up to Rs. 1 Lakh per annum. Beyond that, it will attract a flat tax of 10%.

B. Tax Implications of SWP

Mutual fund withdrawals are subject to tax depending on the category of the funds you own. Debt funds and equity funds are taxed differently. Systematic Withdrawal Plans (SWP) redemption is as per first in first out (FIFO) method wherein units first bought are assumed to be redeemed first. Hence your costs for the purpose of taxation will be considered as per FIFO method.

In case of SWP, each withdrawal will be treated as a mix of principal and capital gains withdrawal and only the capital gains portion will be taxed. That makes an SWP a lot more tax efficient.

1. SWP FROM Debt funds

SWPs are normally done on debt funds or hybrid funds as they are more predictable compared to equity funds.

TAX IMPLICATIONS ON SWP in DEBT FUND –
  1. If investments are held for 3 years or more, it will be Long-Term Capital Gains (LTCG). LTCG tax on debt funds is 20% with the inflation indexation benefit on the original investments.
  2. If debt mutual fund investments are sold before 3 years, it will be the Short-Term Capital Gains (STCG). And STCG is taxed as per your slab rate.
  3. Example – Suppose, you invested ₹6 Lakhs in Reliance Short Term Fund on 1st Apr, 2015 and started SWP of Rs. 10,000/month from it immediately from 10th Apr, 2015. So, this is how your taxation (Assuming you are in 30% tax bracket) will be –
STCG Tax Implication of SWP on Debt Fund

2. swp FROM equity funds

TAX IMPLICATIONS ON SWP IN Equity FUND –
  1. If you redeem/withdraw your investments in equity mutual funds after 12 months, your investments would qualify for Long-Term Capital Gains tax. LTCG in excess of Rs. 1 lakh are taxed at 10% currently. 
  2. If you sell your equity mutual fund investments before 12 months, you will have to pay a short-term capital gains tax at a rate of 15%.