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How are redemptions from ultra-short-duration funds taxed?

Dhirendra Kumar explains the taxation rules that apply when you redeem your investments in ultra-short-duration funds

How are redemptions from ultra-short-duration funds taxed? Are we liable to pay tax if we are only using it for the purpose of STP (systematic transfer plan)? Further, I wanted to know if the tax amount is automatically deducted by the fund company?
- Rohit

An ultra-short-duration fund is taxed exactly like a debt fund. If held for more than three years, the gains will be indexed and the indexed gain will be taxed at 20 percent, but if redeemed within three years, via an STP or not, the gains will be taxed as per the individual's tax slab. This is because an STP is nothing but a redemption. But don't worry about the taxes here because the whole idea of an STP is that you reduce the risk of catching a market high. The idea is not to maximize the return.

So even if you pay taxes on the small gains (small because this is not a long-term investment), the gains will be on a pro-rata basis. So the return in the first month will be hardly anything. So don't worry about the taxes. Your focus should be to reduce the risk of investing in the market at one go at an inopportune time. So it's a risk management mechanism.

To answer the third part of the question, no, taxes are not deducted automatically by the fund company because taxes are subject to your marginal rate of tax. So fund companies don't deduct any capital gains tax before redemptions. Thus you'll get the entire amount from the fund.