Is SIP Tax Free or Not?

SIP, a popular mode of investing in mutual funds, provides a safe way of building wealth over time. However, a lot of investors often ask if SIPs attract taxes. As taxes can decrease your returns, it is necessary to know whether they can come into the picture or not.

Is SIP Investment Tax-Free?

As mentioned earlier, whether an SIP is tax free or not depends on your country of investment. Here’s what the scenario looks like —

The UAE 

In the UAE, there is no personal income tax. So whether you earn through a salary or make profits through mutual fund investments, you won’t have to pay taxes. 

All in all, as an investor, you can enjoy tax-free SIP investments in the UAE.

India 

India is a great investment destination. For context, Nifty 50, the market index of the country’s top companies on the National Stock Exchange (NSE), has delivered a compound annual growth rate of around 15% over the last 20 years. 

At the same time, India’s market also brings tax liabilities. The exact rate, however, depends on the nature of the fund you are investing in and the holding period.

SIP Calculator

Tax on SIPs in Mutual Funds — How Does it Function?

While we now know the answer to our query of whether SIP is tax free or not, let’s take a closer look at the taxes applicable to investments in India — 

1. Holding Period 

If you sell your mutual fund investment within 1 year, it will be taxable under Short-term Capital Gains (STCG) Tax. STCG tax rates differ as per the type of mutual fund you choose, but, going by the recent 2024 budget, these rates can be as high as 20%.

Investments held for more than 1 year are taxed under Long-term Capital Gains (LTCG). The LTCG tax rate has recently been updated to a maximum of 12.5%.

Key Point

If the LTCG profit in a financial year is up to ₹1.25 lakh, you will not have to pay taxes on it. This can reduce the burden of taxes from long-term investments.

2. Type of Mutual Fund

Equity Funds (Stocks):

• Short-term capital gains (STCG): If you redeem your equity mutual fund units within 1 year of investment, the profits fall under the category of short-term capital gains. They are taxed at 20%.
• Long-Term Capital Gains (LTCG): If you hold the equity mutual fund units for 1 year or more, the gains are known as long-term capital gains. As of recent tax laws, LTCG of up to ₹1.25 lakh is tax-free. Any gains above this mark are taxed at 12.5% without indexation benefit.

Debt Funds (Bonds)

SIPs in debt funds are taxable and Capital gains made after April 1, 2023 are treated as STCG, irrespective of the holding period. Besides, indexation benefits will not be available to them. But for debt fund SIP investments prior to the said date and holding period of more than 3 years, the fund will get an indexation benefit. 

How to Invest in SIPs in a Tax-Efficient Manner?

As we have seen so far, the question of ‘are SIPs tax free?’ varies significantly as per the country. However, there are several key strategies and tips that you can adopt to make your investments more tax-efficient —

1. Choose the Right Fund

When selecting a fund for your SIP, it’s important to assess your tax bracket and investment timeline. Decide between equity and debt funds based on your risk tolerance, investment goals, and the tax impact based on your holding period. Whether your SIP investment is taxable or not (and how much is the tax rate) will depend on whether you are investing in equity or debt funds. 

2. Invest for the Long Term

Holding your SIP investments for the long term, say more than 1 year for equity funds, generally results in Long-Term Capital Gains (LTCG). This type of taxation brings lower rates compared to Short-Term Capital Gains (STCG). 

In fact, the power of compounding also works best over the long term. Thus, to grow your investments exponentially and enjoy lower tax rates, it’s advisable to stay invested for the long run.

3. Invest in ELSS (Equity-Linked Savings Schemes)

ELSS funds are quite popular as tax-saving investments. Not only do these funds give you the necessary tax benefits under Section 80C of the Income Tax Act (up to ₹1.5 lakh in the old tax regime), but they also present good returns over a long-term period. 

ELSS funds provide numerous opportunities to enjoy attractive tax benefits and significant capital appreciation.

4. Tax Harvesting

Tax harvesting is a technique to optimise your tax returns. It is a strategic selling of some investments, which lets you reduce the taxable gains arising due to such investments with the exemption limits available. You can minimise tax by understanding the managed timing and amount of gains and losses