In 2004, the government introduced the Securities Transaction Tax to curb the problem of capital gains tax evasion by ensuring that a small tax is collected on every securities transaction, whether or not the investor reports capital gains. Generally, the STT tax is associated with stock investments. Still, it also applies to equity-oriented mutual funds when investors sell their units.
Here, we’ll understand what a security transaction tax is, how it compares with other mutual fund taxes like capital gains tax, and how a mutual fund planner can help you minimise the impact of these taxes.
What is Securities Transaction Tax (STT)?
Securities Transaction Tax or STT, is a type of direct tax levied by the Government of India on the sale or purchase of securities. This tax is fixed and is paid even if the investor makes a loss on the investment.
STT is governed by the STT Act, which borrowing from the Securities Contracts (Regulation) Act, defines the word ‘securities’ as marketable securities such as shares, bonds, debentures, or derivative instruments traded on recognised stock exchanges.
It also includes units of equity-oriented mutual funds and other equity instruments offered by the government. The exact security transaction tax rate varies from security to security.
The STT tax was introduced in 2004 in an effort to stop investors from evading capital gains tax. With STT the government can collect tax any time a transaction is made which curbs this problem.
For example, if you sell your equity mutual funds units on the exchange or redeem them from the fund house, STT is automatically deducted at a fixed rate, thus the tax is collected regardless of whether you make a profit or loss.
Here are some features of STT:
- STT collection works similarly to TDS or TCS. It is collected by recognised stock exchanges, mutual fund houses, or lead merchant bankers. The collected tax must be deposited with the government by the 7th of the following month.
- STT rate depends on the kind of security being traded. For example, the purchase of a delivery-based equity share is charged at 0.1% on the sell side, while the buyer pays no STT. Similarly, for equity-oriented mutual funds, the STT is 0.001% on sale through the exchange or redemption from the asset management company.
- Off-market transactions do not attract STT.
- STT is not levied on unlisted securities and debt mutual funds either.
Now that it’s clear what is STT in a broad sense, let’s see how it applies to mutual funds specifically.
How STT Applies to Mutual Funds?
Only equity-oriented mutual funds, such as ELSS, flexicap, small-cap, and sectoral funds attract STT. No STT is applicable on the sale and purchase of debt-oriented funds. When an investor sells their units on a stock exchange or redeems them by selling them back to the fund house, STT is charged at 0.001% of the total value at which the units are sold.
The STT in mutual fund transactions is always borne by the seller of the units whether they sell their units on the stock exchange or redeem them through the fund house. In the case of units that can be traded on the market, like exchange-traded funds or closed-ended funds, the seller pays 0.001% STT on the sale price.
Similarly, in the case of redemptions from the AMC, the fund house deducts 0.001% STT from the investor’s proceeds before payout, like a TDS. This is charged regardless of whether the investor made any profit from the investment.
Security Transaction Tax Rate for Mutual Funds
Equity-oriented mutual funds, which means funds that invest at least 65% of their assets in equities, are the only category of mutual funds where STT is charged. There are two ways the units of such funds can be sold – They can either be sold on the stock exchange, like the units of a closed-ended fund or an ETF, or they can be sold back to the AMC and redeemed. In both cases, the security transaction tax rate is the same at 0.001% of the price at which units are sold.
As far as debt mutual funds are concerned, there is no STT tax. However, an important thing to keep in mind is that STT in mutual fund investment is levied every time units are sold, whether or not one makes capital gains. If you are selling your units on an exchange, you’ll automatically pay an STT. Similarly, when redeeming units with the fund house, the AMC will deduct the applicable STT and then credit you the funds.
STT vs. Other Taxes in Mutual Funds
1. Dividends and Capital Gains Tax
Other than STT, there are two major taxes levied on mutual fund investments: Capital gains and dividends. Previously, dividends were subject to the Dividend Distribution Tax, where the fund houses deducted the tax on dividends before paying them out to the investors. However, since the DDT was abolished, dividends are taxed in the hands of investors. They are categorised as income from other sources and taxed according to the investor’s tax slab. If the total dividend income in a financial year exceeds Rs. 5,000, the fund house is mandated to deduct a 10% TDS under Section 194K of the Finance Act.
Capital gains, on the other hand, have a different taxation structure. Depending on the holding period of the funds, capital gains are categorised into two –
- Short-term capital gains, or STCG, and
- Long-term capital gains, or LTCG
For equity-oriented mutual funds: If an equity fund investment is held for less than 12 months, the gains made from selling or redeeming the units are considered STCG. On the other hand, gains made on selling the investment after holding it for more than 12 months are considered LTCG.
For debt-oriented mutual funds: If a debt fund investment is sold within 36 months of purchase, the gains are classified as STCG and are taxed as per the investor’s income tax slab rate. If the investment is sold after 36 months, gains are classified as LTCG.
Capital gains tax can make a significant dent in your post-tax returns, which is why it’s always a good idea to get input from a tax consultant, who can ensure your tax outgo is minimal and your portfolio remains aligned with your financial goals.
2. Capital Gains Tax on Equity Mutual Funds
Equity mutual funds are funds where at least 65% of the fund’s assets are invested in equities. When units of an equity fund are sold or redeemed within 1 year of purchase, an STCG tax is charged at the rate of 20%. If the units are sold or redeemed after being held for more than 1 year, LTCG tax is charged at 12.5% without indexation benefit. Compared to STCG, not only is the LTCG rate lower, but investors also get an exemption on LTCG up to Rs. 1.25 lakh per financial year.
3. Capital Gains Tax on Debt Mutual Funds
Debt mutual funds invest at least 65% of their assets in debt-related instruments like bonds, T-bills, CDs, CPs, and more. STCG tax is levied upon selling the fund’s units within 3 years of purchase, and gains are added to the investor’s income and taxed according to their slab rate.
If sold after 3 years, the tax treatment depends on when the investment was made. For investments made on or after 1st April 2023, gains are added to income and taxed as per the investor’s tax slab without an indexation benefit. For older investments made on or before 31st March 2023, gains are taxed at 20% with indexation.
How STT and Capital Gains Tax Differ
- Capital gains tax is only levied on the profit made while STT is levied on the total transaction value, regardless of profit or loss.
- STT does not apply to debt or debt-oriented mutual funds, whereas capital gains from any mutual fund investment are taxable.
- The security transaction tax rate is fixed at 0.001% of the total transaction value at the time of selling, whereas the capital gains tax depends on the investment’s holding period and type (equity or debt).
A mutual fund investment planner can help you minimise the impact of capital gains tax. They can assess your financial situation and risk tolerance and recommend suitable options that help you get closer to realising your financial dreams. While STT is an unavoidable part of equity funds, investments can be planned in such a way that reduces capital gains tax liability and maximises post-tax returns.
How to Minimize the Impact of STT?
Since STT charges are fixed, they are automatically deducted at the time of transaction so there is no way to avoid them. Generally, this isn’t a major concern for mutual fund investors since equity mutual funds are held for the long term. STT, however, can add up for investors that trade frequently on the stock exchange, like intraday traders.
For equity mutual funds, the STT rate is minimal at 0.001% at the time of selling which is noticeable only when the redemption amount is large. Other aspects, such as capital gains, exit loads, and expense ratios are a bigger cause for concern for such investors. In any case, if you want to increase the profitability of your investments, you should consider taking professional advice. Experts offering tax consultation services can help you minimise the impact of STT and other taxes on your portfolio significantly.
Conclusion
STT, or Security Transaction Tax is a type of direct tax levied on the sale or purchase of securities like stocks, derivatives, and equity-oriented mutual funds on recognised stock exchanges. It is a fixed percentage of the transaction value and is charged automatically, whether the investor makes a profit or loss. Different securities have different stt tax rates.
The STT in mutual fund investments is only levied on funds focused on equities. When selling units on the stock market, the investor has to directly pay the STT, while redeeming units through the fund house leads to the AMC deducting the STT before crediting the redemption amount to the investor. This tax is set at 0.001% on the total sell price for equity mutual funds.
