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Common Tax Harvesting Strategies in Mutual Funds

Submitted by admin on November 18th, 2024

Selling Poor Performing Mutual Funds

The most straightforward way of tax harvesting is selling mutual funds that have underperformed. By realizing these losses, investors can counterbalance gains from other investments which in turn reduces their taxable income. This practice is often carried out toward the end of the financial year to reduce losses for tax purposes.

Switching From One Mutual Fund Scheme to Another

Another of these strategies is known as shifting between various schemes that one fund house offers. Here, one can shift from a scheme that has incurred past losses to another scheme where these losses are actually realized against other gains. This will assist an investor in reducing his taxable income while still remaining invested.

Using Wash Sales

A wash sale is the act of selling a mutual fund at a loss, after which it is bought again in the same window period. In this manner, investors get to expense the losses for tax reasons and still enjoy the same investment position. Though a useful strategy, its application must be done with caution to avoid unwarranted scrutiny by the tax department.

Indian Tax Provisions on Reaping

To assume tax harvesting within the legal framework, it is important to understand the applicable Income Tax rules in India as follows:

Section 112A

Section 112A refers to Long Term Capital Gains (LTCG). LTCG exceeding Rs. 1 lakh on account of sale of listed equity shares, equity oriented mutual funds, or units of a business trust is taxed @ 10% no indexation benefits are available. This tax is applicable only in case the Securities Transaction Tax was paid both during the transfer and acquisition in certain instances. Accruing on this is relevant only if the equity shares or units are sold after the holding period exceeds one year

Section 111A

Short term capital gains Section 111A applies to STCG. This section taxes income from the transfer of equity shares and any other equity-oriented security held for a total duration of 12 months or less. If STT was paid while transferring, the gains are subjected at a flat rate of 15%. However, if no STT was paid, then the gains are taxed according to the slab rate of the individual’s income tax.

For debt funds, this provision is no more applicable. Debt funds are now taxed at the individual’s income tax slab rates irrespective of the holding period. Hence, for debt funds, the gain would be taxed and not benefit from the separate much lower tax slab that short term holding gets.

Section 70 – Set off of Losses

It provides for the setting off of losses arising from one source against income arising from another from the same head; it’s really important for tax planning and tax-loss harvesting strategies. Certain key points: the losses can be set off against both short term and long-term capital gains for short-term capital, whereas long-term capital losses can only be set off against longterm capital gains.

Some losses, such as losses from speculation, can only be claimed as set off against specific incomes.

Sections 73-74: Loss Carry Forward Provisions

Sections 73-74 permit carrying forward capital losses for up to 8 years so that they may be absorbed against future capital gains. It thus extends the benefit period of tax disadvantages wherein investors can use such losses against future gains.