Assume that Patel had accumulated Rs 500,000 over the past four years in the balanced fund until January 31, 2018. For computation of LTCG, the investor has to take the fund value as on January 31, 2018, and calculate the gains made after that. Assume that his fund grew 5 per cent since then. If he redeems now, the gains he made since January 31, 2018, will be Rs 25,000.
If Patel doesn’t have any other equity gains, the entire Rs 25,000 will be tax-free as it’s below the exemption limit of Rs 100,000. But if the fund declares Rs 25,000 as dividend, there will be mandatory 10 per cent dividend distribution tax (DDT) on it. “In the future, an investor can do a systematic withdrawal plan over a few years keeping the overall equity gains below Rs 100,000, and he will not need to pay any LTCG,” says Rao. Investment
advisors also point out that the sooner investors shift, the better it is as a majority of equity funds have single-digit returns since January 31.
Systematic withdrawal is more tax efficient not only for equity investments
but also in the case of debt funds. The latter attracts a 28.33 per cent (including cess and surcharge) DDT.
While in equity funds, LTCG
applies after a holding period of one year, in debt funds, withdrawal before three years is taxed as short-term capital gains (STCG). The gains are added to the income of the investor and taxed based on his income tax slab. If an investor tax slab is 20 per cent or lower, he will still end up paying much higher tax if he opts for the dividend option in a debt fund.
Dividend option in debt funds only works for those in the highest tax bracket, who want some cash flow from the first year of the investment.
“If an investor is in the highest tax bracket (33.99 per cent including cess and surcharge), he still ends up saving 5.7 percentage points on returns,” says Malhar Majumder, partner and consultant at Positive Vibes Consulting and Advisory. To make withdrawal more tax efficient, Majumder says the best option is to start the systematic withdrawal plan after three years of investment.