SIP Tax Benefit: Learn the Benefits of SIP Investment
Systematic investment plans or SIPs of mutual funds have emerged as a preferred investment for investors to create wealth or to create a corpus. The beauty of SIPs is that it does not require that investors time the markets. They can adopt a passive approach of disciplined allocation on a regular monthly basis and the SIP takes care of the rest.
SIPs are popular for the discipline and for syncing with your income flows. But there is one more very important attribute to SIPs. They offer the benefit of rupee cost averaging. What does that mean? In a SIP, you allocate a fixed sum on a regular basis. So when the markets go up you get more value and when the markets go down you get more units. Over a period of time, in volatile markets, your cost of acquiring the units comes down, expanding ROI.
Can you explain how SIP would work with an illustration?
Let us take the hypothetical example of an investor who starts with a monthly SIP of Rs. 10,000 in a diversified equity fund on 10th January 2020 and continued the SIP till 10th April 2021. Here is how the SIP would look like.
| Month | SIP Amount | NAV | Units Allotted | Total Units |
|---|---|---|---|---|
| Jan-20 | 10,000 | 12.50 | 800.00 | 800.00 |
| Feb-20 | 10,000 | 12.65 | 790.52 | 1590.52 |
| Mar-20 | 10,000 | 12.75 | 784.31 | 2374.83 |
| Apr-20 | 10,000 | 12.90 | 775.19 | 3150.02 |
| May-20 | 10,000 | 13.25 | 754.72 | 3904.74 |
| Jun-20 | 10,000 | 13.80 | 724.64 | 4629.38 |
| Jul-20 | 10,000 | 13.40 | 746.27 | 5375.65 |
| Aug-20 | 10,000 | 13.55 | 738.01 | 6113.66 |
| Sep-20 | 10,000 | 13.35 | 749.06 | 6862.72 |
| Oct-20 | 10,000 | 13.25 | 754.72 | 7617.44 |
| Nov-20 | 10,000 | 12.95 | 772.20 | 8389.64 |
| Dec-20 | 10,000 | 12.80 | 781.25 | 9170.89 |
| Jan-21 | 10,000 | 12.85 | 778.21 | 9949.10 |
| Feb-21 | 10,000 | 13.25 | 754.72 | 10,703.82 |
| Mar-21 | 10,000 | 13.45 | 743.49 | 11,447.31 |
| Apr-21 | 10,000 | 13.80 | 724.64 | 12,171.95 |
In this case, the investors has accumulated 12,171.95 units of the diversified equity fund with an average NAV of 13.145 (160,000 / 12,171.95). For simplicity, we will not get into time value here. This will be the basis of how the SIP will be taxed.
How will the capital gains be calculated in the case of SIP?
The SIP does not have any special treatment for taxation. It only considers whether the underlying fund on which the SIP is done is an equity fund or a debt fund. Here are the highlights of how SIPs will be taxed.
- SIPs on equity funds will be taxed as LTCG if held for more than 1 year and STCG if held for less than 1 year from the date of purchase. For SIPs, this will apply to each purchase tranche individually.
- SIPs on non-equity (debt and other category) funds will be taxed as LTCG if held for more than 3 year and STCG if held for less than 3 years from the date of purchase. Again in the case of SIPs, this will apply to each purchase tranche individually.
- Long term capital gains on equity funds will be taxed at 10% after base exemption of Rs.1 lakh but without benefit of indexation. Short term capital gains on equity will be taxed at 15%. In both cases, the surcharge and cess as applicable will be levied.
- Long term capital gains on debt funds will be taxed at 20% with the benefit of indexation. Short term capital gains on debt funds will be added to income and taxed at peak rate. In both cases, the surcharge and cess as applicable will be levied.
Can you explain how LTCG and STCG will be calculated for SIPs
As explained earlier, the classification of LTCG and STCG will be done as per the regular treatment of equity funds or debt funds underlying the SIP. However, there is a slight difference. SIPs are not a lump-sum investment hence there are multiple points of acquisition. The question that arises is which NAV to consider for calculation of capital gains. That is where the FIFO method or First In First Out approach is used. The illustration of the equity fund is being again used to understand how FIFO will be applied for capital gains treatment as LTCG and STCG.
| Month | NAV Cost | Units Sold (FIFO) | LTCG / STCG |
|---|---|---|---|
| Jan-20 | 12.50 | 800.00 | LTCG |
| Feb-20 | 12.65 | 790.52 | LTCG |
| Mar-20 | 12.75 | 784.31 | LTCG |
| Apr-20 | 12.90 | 775.19 | LTCG |
| May-20 | 13.25 | 754.72 | STCG |
| Jun-20 | 13.80 | 724.64 | STCG |
| Jul-20 | 13.40 | 746.27 | STCG |
| Aug-20 | 13.55 | 624.35 | STCG |
Here our target is to sell 6,000 units on 25-April 2021. Here you use the FIFO method by selling the earliest units first and the subsequent units progressively later. In the above case, you sell all the units bought between Jan-20 and Jul-20. Out of the total units bought in Aug-20, you sell only 624.35 units to reach your target of 6,000 units. That is how FIFO works.
How about taxation. Since this is an equity fund, 1 year will be the cut-off. Hence the units purchased between Jan-20 and Apr-20 would be treated as long term capital gain (LTCG) as they have been held for more than 1 year. However, units sold of May-20 to Aug-20 will be classified as short term capital gains and taxed accordingly.
Are there additional beenfits if I do SIP on ELSS Funds?
There is a small difference 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.
The difference is in the consideration of the SIP for Section 80C benefits and the applicable lock-in period. All SIP investments in an ELSS fund from April to March (financial year) will be eligible for Section 80C benefits for that fiscal year up to the overall blanket ceiling of Rs.1.50 lakhs.
What about lock-in for each tranche of SIP? The lock-in period will be applicable from the date of the SIP. Thus the April 2020 SIP will have a lock in till April 2023 and the May 2020 SIP will have a lock in till May 2023 and it continues like that.
How are SIPs on debt and other non-equity funds taxed?
The tax treatment explained above for SIP on equity funds will also be applicable in case of SIPs on aggressive balanced funds and arbitrage funds as they hold more than 65% in equity. In case of debt funds, SIPs will follow the FIFO method for SIP units, but the holding period for classification as long term gains will be 3 years instead of 1 year.