If you’re rebalancing your mutual fund portfolio in India, be aware that you’ll likely incur tax liabilities, even if you reinvest the proceeds. This applies whether you switch funds within the same Asset Management Company (AMC) or move to a different one.
The Golden Rule: Switching = Redemption = Taxable Event
Under Indian income tax law, any “switch” between mutual fund schemes is treated as selling your existing units and buying new ones. This means any gains you’ve made on the units you’re selling become subject to capital gains tax.
This rule applies across various types of switches:
- Within the Same AMC:
- Changing from a ‘Regular’ to a ‘Direct’ plan (or vice versa).
- Shifting between ‘Growth’ and ‘Dividend/IDCW’ options within the same scheme.
- Moving from one scheme to another within the same fund house (e.g., from an equity fund to a debt fund).
- To a Different AMC: Selling units from one AMC and investing the money in another fund house. While the process might involve the money hitting your bank account first, it’s still treated as a sale and a new purchase for tax purposes.
Understanding Your Tax Bill: Capital Gains
The tax you pay depends on the type of mutual fund (equity or debt) and how long you’ve held the units (the holding period). This determines if your gains are Short-Term Capital Gains (STCG) or Long-Term Capital Gains (LTCG).
1. Equity Mutual Funds:
- Short-Term Capital Gains (STCG): If you sell units held for less than one year, your gains are taxed at 20%.
- Long-Term Capital Gains (LTCG): If you sell units held for one year or more, gains exceeding ₹1.25 lakh in a financial year are taxed at 12.5%. (Note: The first ₹1.25 lakh of LTCG from equity mutual funds in a financial year is exempt. There’s no indexation benefit for equity LTCG).
2. Debt Mutual Funds:
The tax rules for debt mutual funds vary based on their purchase date:
- Purchased AFTER March 31, 2023:
- All capital gains are considered short-term, regardless of how long you’ve held them.
- These gains are added to your total income and taxed at your individual income tax slab rate. No indexation benefit applies.
- Purchased BEFORE April 1, 2023:
- Short-Term Capital Gains (STCG): If held for less than 2 years, gains are taxed at your income tax slab rate.
- Long-Term Capital Gains (LTCG): If held for 2 years or more, gains are taxed at 12.5%, but without indexation benefit.
Key Points to Remember:
- Exit Load: Beyond taxes, your AMC might charge an “exit load” if you sell units before a certain period. This reduces your net proceeds.
- Securities Transaction Tax (STT): This tax is applicable when you sell units of equity-oriented mutual funds.
- ELSS Lock-in: If you’re investing in tax-saving ELSS funds, remember they have a mandatory three-year lock-in period during which you cannot switch.
- Professional Advice is Best: Tax laws can be intricate and change. It’s always a good idea to consult a qualified tax advisor for personalized guidance based on your financial situation.
In essence, rebalancing your mutual fund portfolio is a strategic move, but it comes with tax implications. Factor these into your financial planning!