Switching from Regular to Direct – Mind the tax

Switching from Regular to Direct - Mind the tax 1

Direct plans have been a part of the Indian mutual fund industry from Jan 1, 2013. It won’t be wrong to expect that all those who wanted to switch from regular plans to direct plans would have done so. Interestingly, a recent question in Quora indicated that people are still considering the big switch. In this short article we look at the ways to do the switch with the optimal tax outcome.

First things first

While a lot of arguments are made for regular plans, it is quite clear that paying for mutual funds advice and then investing in direct plans is advantageous to the investor. You can read more here: Regular Funds – Pay more for ‘free’ advice

  • First decide how you are going to make future direct plan investments. Please note that I did not mention which funds; I mentioned the choice of online/offline platform that you would use.
  • Set up your account on the portal. If you use SIPs, start the SIPs in direct plans. Even if you plan to use a different online portal, it would be very helpful to set up the account with MF Utility. You can read this article for the procedure to get this done. How To Apply Online For a MF Utility Account
  • Now go and stop the current SIPs in regular plans. Typically the mechanism you used to invest earlier can be used to stop the SIPs. You may have to call your AMC if all else fails. Be prepared to do this using physical forms.

The above procedures would take care of your future investments. We can then look at the current investments.

Simple options

While the switch seems like a single transaction, it is actually a redemption from the regular plan and re-investment in the direct plan. So exit loads and taxes would apply.

Note: A switch from one equity to another equity can be made in one shot without any regard to the current market conditions.

  • Avoiding exit loads is as simple as waiting for the time to elapse – usually a year for most equity funds. A lot of mutual funds also waive exit loads in case of a switch from regular to direct plan.
  • Till Apr 2018, mnimizing taxes was simple too. You just needed to wait till the units are a year old and then switch them..
  • If you have a small existing corpus, say less than 2 to 3 lacs, you can switch out the units after 1 year without much regard to the capital gains taxes. (The next section would explain why.)

Important features of LTCG on equity

  •  The budget announcement on Feb 1, 2018 re-introduced long term capital gains on equity. A concession was made for the gains made till the previous day.  Typically capital gains =  Selling price – costs involved in selling – costs involved in buying – ‘Buying Price’.  The grandfathering clause means that the ‘Buying price’ can be the higher of the two: The actual purchase price or the value as om Jan 31, 2018. In short, the rules grandfather the gains made till Jan 31 2018.
  • The rules also allow 1 lac LTCG per year without taxes. This has led to (good) advice for people to book this amount of capital gains every year.  That is, even if you plan to hold a particular fund for five years, sell enough units to result in 1 lac of capital gains, and buy the units again. You would reset the purchase price to a higher value.  There is a chance that the fund/stock can rocket up in the short gap between redemption and re-purchase, but this is a very small chance.

Tax efficient ways to switch from regular to direct

  • If your funds are doing better than the value as of Jan 31, 2018, do enough switches to use up the 1 lac per year allowance.
  • If your funds are near the Jan 31 values (or even slightly below) you can switch them out in one go.
  • If your funds are well below the Jan 31 values, you may want to switch them and carry forward the capital losses, or adjust them against other capital gains.
  • If your corpus is quite large, say greater than 30 lacs, you may want to do the switch in one year so that you don’t miss out on the additional returns from direct funds. The trade-off will depend on three factors:
    • Your current corpus in regular plans
    • Your capital gains as of Jan 31, 2108
    • Your funds’ difference in returns between regular plans and direct plans

Switching from regular plans to direct plans is a very important and beneficial step for investors. Just ensure that you do it in a tax-efficient way.


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