Understanding Tax Harvesting for Mutual Funds

Tax harvesting for mutual funds involves selling mutual funds at a loss to offset capital gains from other investments, thereby reducing the overall tax liability. This strategy takes advantage of specific tax provisions that permit the adjustment of losses against gains. Additionally, investors can employ a strategy of booking profits up to Rs. 1 lakh and buying back the same or similar investments. Since gains up to Rs. 1 lakh are exempt from taxes, this approach effectively makes profits tax-free, akin to the concept of wash sales.

Common Tax Harvesting Strategies in Mutual Funds

Selling Underperforming Mutual Funds

One such easy way to harvest tax is selling mutual funds that have underperformed. By realising these losses, investors can counterbalance gains from other investments which in turn reduces their taxable income. This practice is often carried out towards the end of the financial year to reduce losses for tax purposes.

Switching Between Mutual Fund Schemes

Another such method involves switching between mutual fund schemes within the same fund house. By moving from a scheme with long-term losses to another scheme, investors can realise these losses against other gains wherein the investor reduces his taxable income while also remaining invested.

Utilising Wash Sales

A wash sale entails selling a mutual fund at a loss and then repurchasing it shortly after. This allows investors to book losses for tax purposes while also maintaining their investment position. Although effective, this strategy must be used cautiously to avoid unwarranted inspection from the tax authorities.

Section 112A

Section 112A deals with Long-Term Capital Gains (LTCG). If the LTCG exceeds Rs. 1 lakh from the sale of listed equity shares, equity-oriented mutual funds, or units of a business trust, a 10% tax is applied without indexation benefits. This tax applies only if the Securities Transaction Tax (STT) was paid during both the transfer and acquisition in specific scenarios. Adding on this is only applicable if the equity shares or funds are sold after being held for longer than a year

Section 111A

Section 111A covers Short-Term Capital Gains (STCG). Gains from transferring equity shares and equity-related instruments held for 12 months or less fall under this section. If the Securities Transaction Tax (STT) was paid during the transfer, these gains are taxed at a flat rate of 15%. If STT was not paid, the gains are taxed according to the individual’s income tax slab rate.

For debt funds, this section is no longer applicable. Debt funds are now taxed at the individual’s income tax slab rates, regardless of the holding period. This means that gains from debt funds will be taxed based on the investor’s total income, rather than benefiting from a separate, potentially lower tax rate for short-term holdings.

Section 73-74 – Loss Carry Forward Provisions

Sections 73-74 permit carrying forward capital losses for up to 8 assessment years to offset future capital gains. This extends the benefit period for tax advantages, allowing investors to utilise these losses against future gains.

Conclusion

Tax harvesting is a valuable tool for managing tax liabilities within a mutual fund portfolio. By understanding and applying the relevant tax provisions, investors can strategically manage their investments to optimise their tax outcomes. As with any financial strategy, it is crucial to execute tax harvesting responsibly and in compliance with the law to reap the full benefits without facing penalties.