Clearing the tax confusion for SIP investments

Arnav Pandya

One of the best ways to invest in equity oriented mutual funds is through the Systematic Investment Plan (SIP) route whereby a regular sum of money is invested each month on a fixed date. This gives various benefits including that of regular investment as well as rupee cost averaging and hence experts and financial planners prefer this route. This however often leads to some confusion when it comes to calculating the tax on the gains earned on the investment.

Nature of capital gains

When it comes to equity oriented funds one of the main benefits of the investment is that long term capital gains have a zero rate of tax which means that the entire amount after deduction of the securities transaction tax is available for further use for the investor. In such a situation the twelve month or one year time period is a very important one when the investment becomes a long term capital asset.  Many investors end up making a mistake on this front because they behave as if there is a single shot or lump sum investment made into the fund when they make the actual calculations.

This means that for the purpose of the calculation of the time period for investments through SIPs they consider the first investment and then look at the time period that has elapsed since then. Consider the situation where an investor started a systematic investment plan from the 5th of January 2011 for a period of 12 months. Now in the middle of January 2012 they feel happy that the time period of one year for the investment to be classified as a long term capital gains has passed and believe that the gains when they occur will be tax free in their hands.

This is not completely true because of the fact that the one year time period has passed only for the first investment in the entire series of investment that took place during the past year. So while a year has passed for the investment made on January 5, 2011 it is still not complete for the investment made on February 5, 2011. This means that for the remaining 11 investments there is a lower time period that has passed so all the gains from this would be considered as a short term capital gains and there would have to be a 15 per cent tax that has to be paid on the figure calculated here.

Calculation

While the actual nature of the classification is one thing there is also another element that needs attention because there has to be adequate records available for the purpose of the actual calculation of the gains. The final figure that the investor will have depends upon a proper working of the available information.

In  a normal lumpsum investment this is not a big problem due to the  fact that there will have to be  a comparison of the cost involved based on a single investment on a single day and the sale price to arrive at the final gains or losses that have  actually been earned. On the other hand when it comes to the systematic investment plan there has to be a look at the individual cost for each of the transactions and then this will have to be compared to the sale price to arrive at the final capital gains that have actually been earned. In such a situation the availability of the records becomes a critical factor.

The calculation becomes even more complicated when there is a debt mutual fund investment because even the long term capital gain earned here will be taxable. Now if this is held for a few years then the investor will need to have the cost price of the entire investment ready with them along with the correct dates so that the right amount of gains can actually be calculated. A working with the use of the cost inflation index would also be necessary so this highlights the requirement of the dates. When this is available the process becomes smoother and easier to complete.

Arnav Pandya can be contacted at arnavpandya@hotmail.com .