I have been investing in mutual funds for at least 8 years. I now want to shift it to direct plans. Does it make sense? What will it mean in terms of tax?
In 2012, SEBI asked asset management companies (AMCs) to introduce direct plans for all schemes. Since January 2013, every mutual fund has two options: regular plan and direct plan. The same category, same scheme, same fund manager, same portfolio, the difference being the expense ratio charged to investors.
The regular plans are sold by mutual fund distributors. The expense ratio is higher because of the commission paid by the AMC to them.
The expense ratio on direct plans is less than that levied on regular plans and therefore offers a higher return than the regular plan. The expense is charged to the overall investment corpus and hence the impact over long investment horizons would be sizeable. Consequently, moving to direct plans certainly makes sense.
The tax aspect
Capital gain is simply calculated as the difference between investment amount (purchase value) and current market value (sale value) of your investments. It could be short-term capital gain (STCG) or long-term capital gain (LTCG), depending on the holding period.
Capital gains in the case of equity mutual fund units held for more than 12 months are considered as long term. STCG for equity funds is 15% and LTCG is 10%.
Debt mutual funds held for more than 36 months are considered as long term. The tax rate on STCG on debt funds is as per the income tax slab of the investor. LTCG will be taxed at 20% with indexation.
(The above rates have not included surcharge and cess).
What you need to be aware of
- Switching from regular to direct plans is currently treated as a redemption. Hence, the proceeds are subject to tax. Depending on the time frame held, you will be taxed on STCG or LTCG. Considering that you have been investing for 8 years, the bulk of your investments under regular plans are likely to be subject to the more favourable tax, which is LTCG.
- The reinvestment would also reset the cost of the funds to the prevailing net asset value (NAV) at re-entering the fund. Consequently, the capital gains at the end of your investment horizon would accordingly be lower, leading to a lower tax outgo at the end of your investment horizon.
- The other expenses you have to look out for is exit load, if applicable and stamp duty charge on entry.
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