What is STP in Mutual Fund?

What is an STP?

The STP route is an extension of the SIP way of investing. While SIPs allow you to invest small amounts of money in a mutual fund at regular intervals, STPs enable you to transfer money already invested in a mutual fund into another fund of your choice. Investors typically park a lump sum in a debt fund, say, an income fund, from which a fixed sum is transferred at periodic intervals into an equity-oriented fund.

So, units equivalent to the transferred amount will be sold from the primary scheme and the same will be utilised to buy units in the new scheme. This switch to the new scheme is carried out at the prevailing net asset value (NAV). Some STPs also allow you to gradually shift investments from an equity fund to a debt fund.

There are two types of STP plans that are offered by fund houses-fixed and flexible. Under a fixed STP, a pre-defined amount is transferred from the primary fund to the other fund or funds each time. On the other hand, in case of a flexible STP, there is no predetermined value; the capital appreciation in the primary scheme is transferred to the other scheme(s).

Some asset management companies (AMCs) also specify a minimum transfer amount that can be switched each time from the primary fund to the others, apart from a certain minimum number of instalments every year. A few fund houses even specify the monthly dates on which investors can activate the STP. For instance, for a monthly STP from a debt scheme to an equity scheme, some AMCs require the investor to have an investment of at least Rs 12,000 in the primary scheme, which can be transferred through a minimum of six installments in a year, with the minimum transfer amount of Rs 1,000.

Doing the math

To understand the transfer mechanism, let us consider an example. Suppose you invest Rs 60,000 in a particular debt scheme (Scheme A) and want to start switching Rs 5,000 from it to an equity fund (Scheme B) every month for a year. You activate an STP at the start of the year, and every month, Rs 5,000 starts flowing from Scheme A into Scheme B. The fund value of Scheme A starts falling to the extent of this outflow, adjusted for gains or losses it makes every month. Meanwhile, the investment value of Scheme B rises by Rs 5,000 every month, in addition to the gains or losses it makes.

As you can see in the graphic ‘How an STP works’, Rs 60,000 is invested in Scheme A at the beginning of the year, which helps buy 600 units. In the next month, some units are sold and the proceeds from these (Rs 5,000, the predetermined amount) is shifted to Scheme B. The balance amount left in Scheme A is higher at Rs 55,420 rather than Rs 55,000 because of the profits made on the investment due to the rise in the NAV. The benefit of the STP is that even if the NAV declines in one fund, it’s possible that it will rise in the other scheme, thus ensuring that you do not suffer a loss.

The STP advantage

1). STP allows you to  average out the purchase cost of your investments and gives you a better chance to earn high returns over a period of time.

2). This especially works in your favour when the markets are either volatile or in a downtrend.

3). STPs also ensure the optimum use of idle money. Instead of idle cash lying in your bank account, any lump sum invested in a debt scheme will fetch higher returns. This means that your money is already growing at a decent rate before you take the STP route and switch a certain amount to a better-yielding equity fund. 

Says Hemant Rustagi, CEO, Wiseinvest Advisors: “STPs are ideal for those who have a lump sum to invest but don’t want to commit all the money at one go. It will also fetch more tax-efficient returns since the amount invested in debt earns higher post-tax returns than the low yield offered by savings accounts.”

STPs can also work as systematic withdrawal plans (SWP), where the money from an equity fund can be gradually withdrawn, but will flow into a debt fund and continue to grow instead of sitting in your bank account.  

As Srikanth Meenakshi, director, FundsIndia.com sums up, “STPs can be used to book profits in the equity fund in a phased manner and investing the same in a liquid fund. This could possibly fetch you a better selling price over time.”

Shortcomings of an STP

1). Every time you transfer your money into another scheme, you may have to bear an extra cost. If such units are sold within a year of investment, you may have to pay a capital gains tax-15% in the case of equity schemes, and as per the applicable tax slab for debt schemes. An exit load (usually 1%) is also applicable if you switch units from the primary scheme into another within a year of investment. In case of a switch from an equity fund, a securities transaction tax (STT) at 0.125%  will be deducted at the time of making the switch.

2). The fact that not all fund houses offer STPs from equity schemes to debt schemes means that one can put one’s investment value at risk. As pointed out earlier, if one doesn’t shift out of equities gradually when an important financial requirement is nearing, goals can be jeopardised.

3). The biggest drawback of an STP is that your choice is limited to the schemes of the same fund house. This prevents you from effecting transfers into multiple schemes of your choice from different fund houses, picking the best of the lot

Income Tax treatment of Leave Travel Allowance (LTA)

The government wants to encourage us to travel more and explore our country, and wants to assist us. That’s why it gives a favourable income tax treatment to allowance given to us for travel. We actually get income tax benefit for tourism! Read on.

Most salaried people get a special allowance for taking vacations, called Leave Travel Allowance (It is also known as Leave Travel Concession or Leave Travel Assistance).

Let’s understand the income tax treatment of LTA / LTC better.

 What is Leave Travel Allowance / Leave Travel Concession (LTA / LTC)?

This is a special allowance that most salaried people get. This allowance is meant for traveling – you are expected to utilize it to spend it for tourism-related travel expenses.It can be given out every year, or once every 2 or 4 years. Many organizations also allow you to accumulate this allowance for 2 years.

 Income tax and LTA / LTC

The LTA / LTC that you get is fully exempt from income tax, provided it satisfies certain conditions. Here are the conditions:

a) The amount is actually spent on travel

You have to actually spend this amount on transportation. The spending can be for you and your family members, but you have to be one of the travelers.Here, family means spouse and children (including adopted children and stepchildren). Parents, brothers and sisters are also included if they are dependent on you.

b) It has to be for transportation

The amount has to be spent on transportation – either air, rail or road. Any amount spent for lodging and boarding is not considered. Thus, food related expenses and hotel expenses are not exempt from income tax.

Also, this exemption is for primary travel between your city of stay and your destination. Other travel expenses like taxi / cab fare, auto fare, etc. can not be claimed as exempt.

c) Travel within India

The travel has to be within India – foreign travel is not considered. The government wants to boost tourism within India, not international travel!

d) Shortest Distance and Cap on claim amount

The amount exempt would be the amount required for travel to your destination by the shortest route, depending on the mode of your travel. If you travel by air, the maximum amount that can be claimed as exempt is the economy class air fare to your destination by the shortest route. If you travel by rail (or road), the maximum amount that can be claimed as exempt is the air conditioned first class (AC I Class) rail fare to your destination by the shortest route.

(Please see the example at the end of the article to understand this better)

e) Proof of travel

Proof of travel needs to be preserved and presented to claim this exemption. The tickets are considered valid proof. If you arrange travel through a hired or rental car, the receipt from the travel agency or car rental agency is considered valid proof. Please note that any non-transport component (like driver allowance) is not considered for income tax exemption.

As per Income tax rules of India, if transport bills for LTA are not provided, the amount will be taxed. E.g. If an employee has LTA allowance as Rs 50,000 in his CTC(cost to company), and he provides proofs of Rs 40,000 (boarding pass, air tickets, taxi vouchers) then income tax will be deducted for rest of the Rs 10,000. Does not matter whats the amount of LTA in an employee’s package, income tax laws only permits domestic air tickets only for LTA claim.

This court order came after a hearing of case between Larsen & Toubro and income tax department of India. Income tax department had argued that employer has to collect proofs from employee for LTA. Rejecting this, the supreme court in its order said: “The beneficiary of exemption under Section 10(5) (of the Income Tax Act) is anindividual employee. There is no circular of Central Board of Direct Taxes (CBDT) requiring the employer under Section 192 to collect and examine the supporting evidence to the declaration to be submitted by an employee(s).”

 LTA / LTC and Block of 4 years

Apart form the above conditions, there is one more condition that causes confusion: The LTA / LTC tax exemption can be claimed only twice in a block of 4 years.

These blocks of 4 years are predefined by the government. These are:

2002 – 2005
2006 – 2009
2010 – 2013

And so on. The current block is 2006 – 2009.

Please note that these years are calendar years, and not financial years.

Example

Let’s understand the concept of “twice in a block of four years” through an example.

If you claim LTA exemption in 2006, then, you can claim it only once more till 2009. Thus, if you claim it again in 2007, you can not claim it before 2010, as you would have already claimed it twice in the block 2006 – 2009.

However, if you do not claim LTA exemption in 2006 and 2007, you can claim it for both 2008 and 2009, and also for 2010 and 2011, as 2010 and 2011 fall under the next block of 4 years: 2010 – 2013. Thus, it is possible to claim LTA / LTC exemption for 4 years in a row!

 Carry forward of LTA / LTC Benefits

What if you can not claim LTA / LTC exemption for some reason?

No need to worry. The exemption doesn’t lapse – it can be carried forward to the next block of 4 years.

The only condition in this case is that the exemption has to be availed in the very first year of this subsequent block.

Thus, in this next block, you can claim a total of 3 exemptions!

 Spouses and LTA

A question that is very commonly asked is: If both husband and wife are eligible for LTA, can both of them claim it?

Yes, they can very much claim LTA individually. The rules of LTA apply individually to each, which means that each spouse can claim LTA twice in a block of four years.

Thus, a family can claim LTA exemption four times in a block of four years if both spouses are eligible for LTA.

The only restriction is that both spouses can not claim LTA exemption for the same journey.

There is no other restriction: The LTA exemption can be claimed for the same family members, or different family members as allowed by the rules (as explained above). The family can in fact also travel twice in the same year, and each spouse can claim exemption for one journey.

(Note: The rules regarding claims by spouses might be slightly different in case of government employees. Please check with your organization / department to know the exact rules applicable if you are a government employee and claim LTC / LTA)

Example

Let’s say you and your spouse are traveling to Bangalore from Mumbai. But instead of going from Mumbai to Bangalore, you go from Mumbai to Hyderabad, and then got to Bangalore. You travel by train in the AC 3 tier category.

The cost of AC 3 tier train tickets are as follows:

Mumbai – Hyderabad: Rs. 800
Hyderabad – Bangalore: Rs. 700
Bangalore – Hyderabad: Rs. 700
Hyderabad – Mumbai: Rs. 800

Thus, you spend a total of Rs. 6,000 for two people.

Now, the shortest route to your destination in this case would be Mumbai to Bangalore. The AC First class ticket costs Rs. 2,350 for this. So, your round trip fare would have been Rs. 9,400 for two people.

The amount exempt from income tax is the lesser of these two. Thus, in this example, even when you haven’t traveled through the shortest route, you can claim income tax exemption for the full amount of Rs. 6,000.

And what about the actual allowance that you get?

Let’s say you get a leave travel allowance of Rs. 10,000. Would it be fully exempt?

No. As we saw, the amount exempt is the lesser of the amount actually spent and the fare by the defined class through the shortest distance.

Thus, the amount exempt from income tax would be Rs. 6,000. The remaining Rs. 4,000 would be taxable, and would be included in your income.

Happy traveling!

Comments are invited.