Mutual funds offer the option of a systematic transfer plan (STP) to switch investments from one scheme to another within the same mutual fund house. However, the switch from the existing scheme to a new one is treated as a sale and is taxed under capital gain, which must be reported in Form ITR-2 if the transaction happened in a financial year. Further, as mutual fund schemes vary, their taxation may differ. So, let’s understand how the STP works and how it is taxed.

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What Is Systematic Transfer Plan (STP)?

In a Systematic Transfer Plan (STP), the allocated fund can be transferred from one scheme to another based on the investor’s preference and financial goals. STP has several advantages, such as cost averaging, mitigating the risk of market volatility, etc. For instance, investing in equity funds in one go could be risky, so some people invest in a debt fund in a lump sum and then use the STP method to transfer the funds from debt to an equity scheme at a chosen frequency, allowing investors to reap the same benefits as the Systematic Investment Plan (SIP).

Hence, if you have opted for an STP plan in a financial year, it is subject to capital gain tax, and the tax liability will depend on the holding period and whether it was equity or a debt fund.

Equity Funds: These funds allocate over 65 per cent of the funds in shares of companies. If the fund is transferred from one scheme to another within 12 months, it will be considered for Short Term Capital Gain (STCG) and taxed at 15 per cent. On the other hand, if you opt for STP after 12 months from an equity scheme, it will be considered Long Term Capital Gain (LTCG) and will be taxed at 10 per cent without indexation. However, gains up to Rs 1 lakh in a financial year are exempt from tax, but beyond that amount, the LTCG rates will apply.

Debt Funds: Debt funds invest primarily in fixed-income securities, such as bonds, debentures, commercial papers, and other debt instruments, to generate interest income and capital growth. They allocate less than 35 per cent of their portfolio to equities. From April 1, 2023, the indexation benefit has been removed from debt funds, and thus, all gains, irrespective of whether they are short or long-term, are taxed as per investors’ slab rate.

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How Useful Are STPs In Financial Planning?

Sudhir Kaushik, CEO of Taxspanner, a tax advisory firm, says, “The objective of a systematic transfer plan is to move money from one investment to another over time for different return, risk and liquidity. You might have to pay taxes on any profits you make, depending on how long you’ve held the investment.”

So, who should opt for STP? He adds, “STP is an automated method for moving funds from one mutual fund to another. It’s popular among investors who have a large sum saved but want to avoid the risk of trying to time the market. Typically, investors use this strategy to move money from a debt fund to an equity fund”.

So, while opting for STP, remember the taxation aspect and plan your finances accordingly.