Business

Tax Harvesting in Mutual Funds

Written by Eric · 2 min read >
Tax Harvesting in Mutual Funds

Introduction

If you are a working individual in India, you must be familiar with the bane of paying taxes. No one likes giving a major chunk of their hard-earned money to taxes. Yet, many assets are taxable in today’s economy – from our incomes to the goods & services we buy and even on the profitable returns from our investments in mutual funds. Even though the latter has only been liable since 2018, it is still a bane. However, in this article, we will discuss how one can save on these taxes liable on the returns from mutual funds and even eventually increase post-tax profits.

Sounds impossible? It isn’t. It is made possible through a process known as tax-loss harvesting. It is a useful way of making higher post-tax gains and even indirectly increasing one’s capital accumulation, specifically as a beginner investor.

What is Tax Loss Harvesting?

The logical order of things is that profitable capital returns are made whenever a trader invests in equity funds. These returns on the capital are taxable depending on how long one had invested in the said fund. This is where tax-loss harvesting decreases the taxable amount from the gains made from such investments.

This is done by selling one’s stocks (number of equity funds invested in) at a price lower than their market value to decrease the taxability of capital returns from the said stocks.

Initially, long-term returns on capital made from these equity funds were not taxable, but after the changes in the Union Budget in 2018, these returns are now taxable.

This means that beginning from 2018’s financial year – April 1st, any long-term returns made on the capital of over INR 100,000 will be taxable at the rate of 10 percent without keeping any sort of price adjustments in the account.

For short-term returns made on the capital, the rate of taxation is 15 percent.

Through tax mutual fund tax harvesting, one can save on the taxable amounts of both – short-term and long-term returns made on capital. It is more beneficial on short-term capital returns as they are more taxable than the long-term ones made on capital.

It is done by selling off a fund whose asset value is consistently declining in the market. This is when the stock has lost most of its appeal, and the chances of a bounce-back of the asset value are low. After the loss is experienced, one can offset it against the returns on capital that they have made in a specific period.

How does it work?

A lot of traders take advantage of tax-loss harvesting after each financial year when they are in the process of filing their tax returns. However, an educated investor can take full advantage of this throughout the year in an ordered fashion to maintain their returns on capital at a comparatively decreased value.

For instance, let us take a case where in a particular financial year, one’s portfolio made long-term returns on capital of rupees 1.5 lakhs and short-term returns on capital of rupees 1 lakh, with the losses on short-term capital being fifty thousand rupees.

So, without using the process of tax-loss harvesting, the tax liability would be – [(INR 100,000 x 15%) + (INR 150,000-INR 100,000) x 10%], which is equal to INR 20,000,

Whereas, taking advantage of tax-loss harvesting, the tax liability would be – [ ((INR 100,000 – 50,000) x 15%) + ((INR 150,000 – 100,000) x 10%)] which would equal  INR 12,500. Read more about Japan’s Soft-Bank overseas business chief exits in the latest churn.

These calculations may initially seem very confusing and complicated, but one can get assistance and guidance on managing these as well. This clearly shows that for the same amounts, over 8000 rupees were saved by using the process of tax-loss harvesting. This amount saved can be used to buy another more profitable and lucrative fund. This will help in maintaining the initial asset allocation of your portfolio. Plus, this would help keep your portfolio’s profile of risks on return stable.

Tax-loss harvesting could not only be done to save taxes but also to diversify one’s portfolio to get higher gains eventually. It will not reduce the losses incurred but will help you save on those taxes.

An example of a good fund to invest into avail of the full benefits of tax loss harvesting is ELSS mutual funds.

Conclusion

You should educate yourself before investing in certain funds to avail yourself of the full benefits of tax-loss harvesting. Here is a list of debt funds for you to look at and decide for yourself. The process of tax-loss harvesting can be a very beneficial tool to help with your finances as well as your investment portfolio.

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