How the systematic investment plan taxation works?
Systematic Investment Plan (SIP) is the most preferred method for making investments by retail investors. Often there is confusion about what are the tax implications of SIP and how they are taxed.
WHAT IS A SIP?
SIP is a method of investing at the fixed intervals. This interval may be daily, weekly, fortnightly, monthly or even quarterly. Under SIP, a fixed sum of money is debited in your designated bank account and corresponding applicable number of units are purchased in your name, based on the Net Asset Value (NAV) of the scheme of your choice. The SIP route is generally adopted for the purpose of making investments in equity, in order to tide over volatility in the equity market as well as to help the people automate their investments process over long periods of time.
WHEN AND HOW OF TAX ON SIP
There is no tax implication at the time of making the investment nor are you liable to pay any tax in respect of appreciation in NAV of the units acquired at the end of a financial year. The liability to pay tax arises only when you sell the units either through the stock exchange or redeem them from the fund house.
For the purpose of taxation, each and every transaction of an SIP is treated as separate investment and the profits are computed at the time of sale/redemption based on the FIFO (First in, First Out) method. Under the FIFO method, the units which were bought earlier are treated as having been redeemed or sold first. In case you have more than one demat account, where your mutual funds units are parked, this method of identifying the units sold is applied for each of the demat account separately.
TAX LIABILITY COMPUTATION
The tax liability on the profits on sale/redemption depends on the period for which you held the units. In case of equity oriented schemes if the investment is held for less than 12 months on the date of sale/redemption, they are treated as short term capital gains (STCG), else they are treated as long term capital gains (LTCG) for taxation purposes.
While calculating the profits on units bought under SIP, profits/loss is computed with reference to each lot of the units purchased through that particular SIP. The difference between the total cost of the units sold and the sale/redemption price of the units comprised in each SIP investment is treated as capital gains.
No benefit of indexation is available in respect of LTCG on equity scheme unlike for other long term capital assets. For units acquired through SIP prior to 31st January 2018, the NAV on 31st January 2018 is taken as cost for units sold/redeemed after 12 months. So effectively any appreciation in the NAV of the scheme upto 31st January 2018 has become exempt in your hands. However, in case the actual cost of the SIP purchases is higher than the NAV on 31st January 2018 as well as the sale/redemption price, the difference is treated as capital loss and is allowed to be set off against other qualifying capital gains.
The STCG on equity units are taxed at flat rate of 15%. There is no tax liability for initial one lakh of LTCG on equity investments in equity oriented schemes and listed equity shares taken together. LTCG beyond one lakhs rupees are taxed at flat rate of 10%. Likewise, STCG on units other than equity oriented scheme are added to your regular income and gets taxed at the slab rate applicable to you but such LTCG are taxed at flat rate of 20% after indexation.
For listed securities other than units you have an option to pay tax either at 10% on LTCG without indexation or at 20% with indexation. In case you are a resident individual for tax purposes and your total income excluding the capital gains on equity schemes is less than the basic exemption limit applicable to you, your taxable capital gains shall be reduced by the short fall in the exemption limit and only the balance of such capital gains shall be taxed at the flat rates. This benefit is not available to non-resident taxpayers.
Likewise, if you are a tax resident and your total taxable income including capital gains of all nature does not exceed Rs. 5 lakhs in a year, you are entitled for a rebate under Section 87 A of Rs. 12,500/- which can be set off against any your taxability of any nature except tax payable on LTCG on equity products which are taxed at 10% as explained and you have to still pay tax on LTCG on equity products at 10% beyond initial one lakh on which no tax is payable.
Author-Balwant Jain
(As published in IPRU Insights)
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