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Is SIP investment tax free or not?

Investing through SIP (Systematic Investment Plan) is an excellent way to stay consistent in the course of growing your wealth. It helps you stay disciplined and allows you to invest at regular intervals of your choice, say, weekly, monthly, bi-monthly, quarterly, or even half-yearly.

Let’s understand what SIP is, in a nutshell, before we move on to whether or not they are tax-free.

What is SIP?

Systematic Investment Plan – as the name suggests is an automated plan / investment mode. It allows you to invest a fixed amount in a mutual fund of your choice periodically to grow your financial corpus through the power of compounding. It is a clever, or a rather hassle-free way of investing money in mutual funds to have stable gains in both, good and bad times. It can be put on pause or stopped as and when you like it.

Now… is it tax-free or not?

The taxation of SIP investments depends on the nature and tenure of your investment. The tax treatment of equities varies from that of the treatment of debt. While equity mutual funds are the most tax-beneficial ones, debt funds attract tax on both short and long-term returns.

So no, not all SIPs are tax-free. However, tax benefits are only applicable to the investments made in ELSS funds. What are ELSS funds you ask? They are Equity Linked Savings Schemes that are government-approved tax saving schemes. The investor can claim tax deductions under section 80C of the Income Tax Act, 1961.

Even though not all SIPs are tax deducted, they are highly tax-efficient, which means this model of investing helps the investor save more taxes than a lumpsum investment. 

Know how SIP investments are taxed differently

For SIP you would have to save small amount regularly each month while in SIP you would have to invest a big chunk at once . For example, if you would consider putting ₹12,000 all at once for one year (lumpsum investment), SIP will allow you to invest ₹1,000 every month for a year. Tax is calculated on each investment you make as each investment is considered as a fresh investment. As mentioned above the nature and tenure of your investment also plays a big role in taxation. Be it equity, debt, or balanced/hybrid all of them are taxed differently with regards to the period before redemption.

Tax on SIP Investments in Equity Funds

For instance, suppose the investor had started a monthly SIP in the equity scheme on 1st June 2020. On 2nd June 2021, they wish to redeem the investment.

In this case, only the capital gains on the purchased units from the first installment, the one made on 1st January 2020, will be considered as the Long Term Capital Gain (LTCG) as they were held for more than one year. Tax is exempted on long-term capital gains below ₹1 lakh however, capital gains above ₹1 lakh are taxed at 10%. The remaining SIP installments made will be considered as short-term capital gains since their holding period is less than one year. Thus, 15% tax will be applicable on these units that fall under Short Term Capital Gains (STCG). The ‘first-in first-out’ rule is followed here which means the units purchased first will get redeemed first.

Tax on SIP investments on Non-Equity Funds

However, if the investor had invested through an SIP in a debt or debt-oriented hybrid funds, long-term capital gains will apply on units that were invested for over 36 months and the profit is taxed at a rate of 20% after indexation benefit. For investments below 36 months, the capital gains are treated as short-term capital gains and are added to income and taxed as per the investor’s income tax slab.

The Exception of SIP Investments in ELSS Funds

The tax deduction available with ELSS under Section 80C is up to ₹1.5 lakhs. Now there is a lock-in period applicable to these funds. The units have a lock in period of 3 years. Therefore, the tax will be levied if the investment amount exceeds ₹1.5 lakh and the investor receives capital gains beyond ₹1 lakh. Then, only the Long Term Capital Gains Tax (LTCG) of 10% will be taxed on it.

Let’s take, for example, the investor has made a capital gain of ₹1.5 lakh on their investment in an ELSS scheme. At the time of redemption, LTCG of 10% would be levied only on ₹50,000. The ₹1 lakh in capital gains is exempted from taxation. The payable tax finally would be ₹5,000.

What are other tax-free investment options?

If you are looking for tax-free investment options to save on the tax liability, go in for Public Provident Fund (PPF), Employee Provident Fund (EPF), Unit Linked Insurance Plans (ULIPs), NPS (New Pension Scheme), or Life Insurance. Most of these fall under the Income Tax Section 80C which allows deductions on the returns.

Conclusion

When it comes to tax saving, an investor must bear in mind that not all SIPs are tax-free. However, they can be tax-efficient and the investor should be aware of the tax implications on all their investments. Hence, investing in small installment amounts will result in a bigger corpus in the long run. The returns expected differ based on the type of scheme you opt for. So, stay vigilant of the nature, tenure, and most definitely the objective of the investment.

Tarrakki – Towards prosperity

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