When we switch from one fund to another fund we don’t realize a single rupee profit. Assume if I switch 10L from HSBC Small-cap to HSBC Value-Fund. Why I have to pay 12.5% or 20% LTCG or STCG Taxes? Not a rupee hit my bank account..
While the process might seem invisible to you, the underlying financial transactions involved in switching funds result in capital gains, which are taxable. This is why you’re liable to pay LTCG or STCG even though no physical money has moved from your bank account.
The Illusion of No Money Movement
While it’s true that no physical cash changes hands when you switch between funds within the same fund house, a significant financial transaction occurs behind the scenes:
- Redemption: Your units in the HSBC Small-cap fund are essentially sold. This is considered a redemption.
- Purchase: The proceeds from the redemption are then used to buy units in the HSBC Value Fund. This is a new investment.
Tax Implications
Even though the money is staying within the same fund house, these two separate actions trigger tax implications:
- Redemption: When you redeem your units, you realize a gain or loss compared to your purchase price.
- Purchase: The money you reinvest in the HSBC Value Fund becomes your new cost basis for calculating future capital gains.
Timing is Key
Whether you pay Short-Term Capital Gains Tax (STCG) or Long-Term Capital Gains Tax (LTCG) depends on how long you held the units in the HSBC Small-cap fund:
- STCG: If you held the units for less than a year, you’ll pay STCG
- LTCG: If you held the units for more than a year, you’ll pay LTCG.
Note: The exact tax rates for STCG and LTCG can vary based on your income tax slab and other factors. Disclaimer: Please do ask tax related advice from any charted accountant. They are capable of giving detailed tax advisory as per your tax slab. This is published just to make complication simpler to understand by layman.