Systematic Withdrawal Plan (SWP) and Systematic Transfer Plan (STP) are mutual fund facilities which offer solutions to different investment needs.
SWP provides fixed cash-flows to investors.
STP enables investors to transfer fixed amounts at regular intervals (e.g., weekly, monthly, etc.) from one scheme (usually low volatility scheme) to another scheme (high volatility).
In this article, we will discuss the updated taxation of SWP and STP.
SWP and STP transactions involve redemptions for tax purposes
It is important for investors to understand that both SWP and STP transactions are treated as redemptions for tax purposes.
Each SWP instalment is a redemption; the AMC redeems a certain number of units based on prevailing NAV to generate cash-flows.
STP is a series of switches — from one scheme to another — and for tax purposes, a switch is considered redemption and re-investment.
Any redemption may lead to capital gains tax incidence depending on whether you made a profit or loss on the redemption of units.
What is a capital gain?
Capital gain = Appreciation in value = (Redemption Value – Purchase Value) of the mutual fund units redeemed.
Capital gains are taxed only when realized — i.e., when units are redeemed.
Unrealized gains (holding units without redemption) are not taxed.
How is capital gains calculated?
Earlier, indexation benefit was allowed for non-equity funds.
Now, indexation benefit is removed for all new investments post 1 April 2023.
Thus, capital gains are simply:
Capital gains = (Redemption NAV – Purchase NAV) × Number of units redeemed
No indexation applies anymore for non-equity mutual funds.
What is capital gains tax?
If redemption of units through SWP or STP leads to capital gains, then it will result in a capital gains tax incidence.
This means you may have to pay tax on the gains you realize.
The amount of tax you pay depends primarily on two factors: the holding period of the units (i.e., how long you held the units before redeeming them) and the type of scheme in which you invested (equity or non-equity).
From a taxation perspective, mutual fund schemes are categorized into two types – equity funds and non-equity funds.
Capital gains taxation rules are different for equity and non-equity mutual funds.
In the case of equity funds, if you redeem your units within 12 months of purchase, the gains are treated as short-term capital gains (STCG).
Short-term capital gains on equity funds are taxed at a flat rate of 20% plus applicable cess and surcharge.
If you redeem your units after 12 months, the gains are considered long-term capital gains (LTCG).
Long-term capital gains on equity mutual funds enjoy a tax exemption up to ₹1.25 lakh per financial year.
Any LTCG above ₹1.25 lakh in a financial year will be taxed at 12.5% plus applicable cess and surcharge.
In the case of non-equity funds, if you redeem your units within 36 months of purchase, the gains are treated as short-term capital gains.
Short-term capital gains on non-equity funds are added to your income and taxed as per your applicable income tax slab rate.
If you redeem non-equity fund units after a holding period of 36 months, then the gains are classified as long-term capital gains.
Unlike earlier, where investors could benefit from indexation to reduce their tax liability, now long-term capital gains on non-equity mutual funds are taxed at a flat rate of 12.5% without the benefit of indexation.
There is no exemption threshold for long-term capital gains in non-equity funds; the entire gain amount is taxable.
Therefore, the tax treatment of your SWP or STP transactions will be determined based on the type of mutual fund, your holding period, and whether the gains are short-term or long-term under the new tax regime.
Equity and non-equity funds
Equity funds, from a taxation point of view, are mutual fund schemes where at least 65% of the portfolio is invested in domestic equities.
These include not only funds categorized strictly as equity funds under SEBI regulations but also certain types of hybrid funds where the average equity allocation exceeds 65%, such as aggressive hybrid funds, arbitrage funds, equity savings funds, and balanced advantage funds.
Exchange-traded funds (ETFs) and index funds with underlying Indian stocks are also considered equity funds for taxation purposes.
It is important for investors to verify the nature of their funds because the tax treatment depends on whether the scheme qualifies as an equity fund.
Non-equity funds, from a tax perspective, are those mutual fund schemes that have less than 65% allocation to equities.
These typically include debt mutual funds, conservative hybrid funds, and international funds.
Fund of Funds (FoFs), regardless of the asset classes of the underlying funds, are treated as non-equity funds.
Similarly, gold ETFs and gold FoFs are also classified as non-equity funds for taxation purposes.
If there is any confusion about the classification of a scheme in your portfolio, it is advisable to consult your mutual fund distributor or financial advisor.
Capital gains taxation
or equity funds, if you redeem your units within 12 months from the date of investment, the gains are treated as short-term capital gains (STCG).
These short-term gains are taxed at a rate of 20% plus applicable cess and surcharge under the new regime.
If you redeem your units after holding them for more than 12 months, the gains are treated as long-term capital gains (LTCG).
Long-term capital gains up to ₹1.25 lakh in a financial year are exempt from taxation.
If your gains exceed ₹1.25 lakh in a financial year, then the excess amount will be taxed at the rate of 12.5% plus applicable cess and surcharge.
For non-equity funds, if you redeem your units before completing 36 months from the date of investment, the gains are treated as short-term capital gains.
Short-term capital gains in non-equity funds are added to your gross income and taxed according to your individual income tax slab rate.
If you redeem non-equity fund units after a holding period of more than 36 months, then the gains are classified as long-term capital gains.
Long-term capital gains in non-equity mutual funds are now taxed at a flat rate of 12.5% without any indexation benefit, irrespective of the quantum of gains.
Summary of capital gains taxation
Type of Fund | Holding Period | STCG Tax Rate | LTCG Tax Rate
Equity Funds | <12 months | 20% + cess | 12.5% (exemption up to ₹1.25 lakh/year)
Non-Equity Funds | <36 months | As per income tax slab | 12.5% (no indexation benefit)
How will your SWP be taxed?
Let us understand SWP taxation with the help of an example.
Suppose you invested ₹50 lakhs in an equity mutual fund on April 1, 2024, with the purchase NAV of ₹100.
You have set up an SWP to withdraw ₹50,000 every month.
Assuming an annualized return of 10% on the fund, and ignoring exit loads and surcharges for simplicity, the withdrawals made during the first 12 months will be subject to short-term capital gains tax at the rate of 20%.
From the second year onward, when the units redeemed would have completed a holding period of more than 12 months, the gains on withdrawals will be subject to long-term capital gains tax.
Long-term capital gains up to ₹1.25 lakh in the financial year will be exempt from tax.
Any gains above this threshold will be taxed at 12.5%.
How will your STP be taxed?
Let us now understand STP taxation through another example.
Suppose you invested ₹10 lakhs in a debt mutual fund on April 1, 2024, and you set up a monthly STP of ₹1,66,667 to an equity mutual fund for the next 6 months.
The purchase NAV of the debt fund was ₹100 and it earns an annualized return of 5%.
Every switch or transfer from the debt fund to the equity fund is considered a redemption from the debt fund.
Since the holding period of the debt fund units is less than 36 months at the time of each transfer, the gains will be treated as short-term capital gains and taxed as per your applicable income tax slab rate.There is no benefit of indexation available.
For the transferred amount, each new purchase into the equity fund will have a fresh purchase date for tax purposes, and taxation on the equity fund units will depend on their respective holding periods at the time of redemption.
Conclusion
When filing your Income Tax Returns (ITR), it is extremely important to review all your mutual fund transactions carefully, including SWP and STP activities.
You must check all the redemptions made during the financial year and calculate the applicable short-term or long-term capital gains tax.
You can obtain your capital gains statements online through the respective Registrar and Transfer Agents (RTAs) like CAMS and KFinTech or through your mutual fund distributor.
You must disclose all your capital gains, including those arising from SWP and STP transactions, accurately in your income tax returns and pay the due taxes.
In case of any confusion or doubt, it is strongly recommended to consult a professional tax consultant or financial advisor.
Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.