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Divide and Rule!

Though the Finance Minster has been quite liberal in his tax policies towards investments, you can still do your own bit to further cut down the taxman's share. Here's one way which can prove useful to save some tax outgo

Though the Finance Minster has been quite liberal in his tax policies towards investments, you can still do your own bit to further cut down the taxman's share. Here's one way which can prove useful to save some tax outgo.

In the US, an investor has an option to choose which units he wants to redeem. Consider an example where an investor has been investing in the same fund for the last five years. Now, he is in need of some money, and wants to redeem a part of his holdings. In the normal circumstances, the units which were bought by him at the earliest will be redeemed, i.e., on the basis of first in-first out (FIFO) method. However, a careful analysis reveals that he may have to pay higher capital gains tax if he treats the earliest units as sold. Therefore, he can choose the specific units out of his investments in the fund which he wants to sell in order to minimize his tax liability.

In case of an Indian investor who invests in an equity fund, this would lose much of its relevance since the long term capital gains on an equity fund are exempt from tax. However, such a choice will still hold relevance for debt funds. But unfortunately, Indian investors are not provided with the flexibility to choose the units which they want to redeem, and first in-first out will compulsorily apply. So, is there a way out?

Sure there is! By maintaining different folios for your investments, you can distinguish between the investments made at different time periods, and hence have the flexibility to redeem the units which are most beneficial from cost point of view. This means that every time you invest in a fund in which you already have investments, you can open a new account (folio) rather than making further purchases in your existing account. Thus, at the time of redemption you will have the flexibility to redeem the units from the account which turns out to be least costly.

This can work for an investor following systematic investment planning. Suppose a person wants to invest in an income fund systematically over the next two-three years. Rather than creating an SIP for the entire time duration, he can create an SIP of, say six months, at a time. After six months, he can create a new SIP for another six months under a different folio. This way, even an SIP investor can break his investment under different folios to avail the flexibility.

However, note that while redeeming, give due consideration to the load structure as well, apart from the tax liability. Since most income funds have an exit load, redeeming the most recent investments can burden you with exit load. Therefore, you should carefully analyse the costs, associated with redeeming a particular folio, and choose the one which turns out to be least expensive.