I have a query regarding tax implications on STP. For example if somebody is transferring from money market/ ultra-liquid schemes to equity funds what would be tax implication is STP is for a year and if it is for more than a year say 5 years (60 Months)? - Debasish Bose
Money withdrawn through STP is considered as redemption in one fund and purchase in another fund. Thus, if you do a STP from a liquid/debt fund (growth option) before completing three years, you will have to pay short term capital gains tax according to your tax slab.
If you do an STP from a dividend re-investment option or dividend option, the STP will be tax free in your hands. However, the dividends will attract dividend distribution tax (DDT) at 28.84%. Opting for dividend re-investment option makes sense for those who fall in the highest tax bracket of 30%, since 28% DDT is less as compared to paying 30% tax.
Investors who fall in lower tax bracket can opt for growth option in debt funds if they wish to do STP to an equity fund.
Some financial advisors say that it is better to opt for growth option if you are planning to do STPs. Suppose your investment value in a debt fund is Rs. 1 lakh and the fund declares 30% dividend on face value of Rs. 10. You would receive Rs. 15,000 (Rs. 3*5000 units) and your investment value would fall to Rs. 85,000. If you have opted for dividend payout you would not be left with enough funds in your scheme to fund your STP. The STPs would stop if you don’t have enough funds in your scheme.
Alternatively, you can invest in arbitrage funds, which are treated as equity funds for taxation, and do STP from there. Though arbitrage funds are treated as equity funds, they are less risky as they invest in stocks and their futures simultaneously to hedge the portfolio. If you do an STP before 12 months, it will attract a lower short term capital gains tax of 15%. You can also invest in monthly dividend option of arbitrage funds. Since arbitrage funds are treated as equity funds for tax purpose, they are not required to pay DDT. Also, arbitrage funds usually have a lesser exit load period of 1-3 months, which will save your exit load costs if STP is done after the exit load period getting over. However, you cant switch or redeem any day you wish to as arbitrage funds permit SWPs, STPs and redemptions only on specified dates.