You may have started investing in mutual funds few years back without giving much importance to whether you invested in growth option or dividend option (or now called Income Distribution cum Capital Withdrawal option) or regular plans vs direct plans of the same schemes. But now, maybe you want to make changes.
What kind of changes?
- Switch from regular plans to direct plans of mutual funds as you now understand the benefit of investing in direct plans
- Switch from dividend option to growth option as you don’t need to take out money from your investments.
- Or any other similar switch from direct to regular or from growth to dividend plans, etc.
But switching of funds (even within the same scheme of a fund house) does have tax implications. Let’s briefly discuss these in simple terms.
The effects of switching are similar to withdrawal/redemption from one scheme and investing in other scheme. Why? Because if you look at it, then its simply a withdrawal and reinvestment transaction within the fund house (with money not passing through investor’s bank account). So any capital gains (losses) arising from this switch are treated in similar manner as in the case of gains (losses) being taxed on withdrawing money from a mutual fund.
So switching within the same scheme of a mutual fund from growth to dividend option (or vice-versa, i.e. from dividend to growth option) OR from regular plan to direct plan (or vice-versa i.e. from direct plan to regular plan)) is considered a sale and therefore liable to capital gains tax.
And how does the taxation happen exactly?
Its similar to regular manner of taxation of mutual fund capital gains. Here is a short refresher:
- Gains on investment in Equity Mutual Funds held for more than 1 year(or 12 months) is classified as Long Term Capital Gains. The Long Term Capital Gains (or LTCG) on equity funds is taxed at 10% on LTCG exceeding Rs 1 Lac.
- Gains on investment in Equity Mutual Funds held for less than 1 year(or 12 months) is classified as Short Term Capital Gains. The Short Term Capital Gains (or STCG) on equity funds is taxed at 15%.
- Gains on investment in Debt Mutual Funds held for more than 3 years(or 36 months) is classified as Long Term Capital Gains. The Long Term Capital Gains (or LTCG) on Debt funds is taxed at 20% (with indexation benefits). Read more about how indexation reduces taxes in debt funds.
- Gains on investment in Debt Mutual Funds held for less than 3 years(or 36 months) is classified as Short Term Capital Gains. The Short Term Capital Gains (or STCG) on Debt funds is taxed as per the investor’s income tax slab rate. Read more about how debt funds are taxed in India?
So now you have your answer to questions like “When I switch from one fund to another fund, or when I switch from regular plan to direct plan, does it amount to a sell transaction and attract capital gains tax?”
Few points to note:
- Switching technically works only when switching from one fund or plan to other of the same fund house (AMC). If it’s a move from one AMC to other, then it’s a common sell (in existing AMC) and buy (in new AMC) kind of transaction.
- If the AMC itself is merging two schemes or doing any similar reorganization due to which the investor has to switch schemes, then it is not regarded as a sale/purchase transaction and hence, there will be not capital gains arising from it.
- While gains arising from mutual fund switches are taxable, the switching from one plans to another within the same ULIP (Unit Linked Insurance Plan) is not considered as a transfer and hence, not subjected to any capital gains tax. Seems unfair for MF investors but that is how it is as per the current MF taxation rules.