Your I-T return forms have provisions to classify these incomes as either taxable or tax-free. But declaration of income is a must. So even if mutual fund (MF) investments are largely tax-free, you need to show where you have invested throughout the year and where you have withdrawn from.
Systematic transfer plans
STPs entail that you invest a lump sum amount in a liquid fund and then transfer an amount to an equity fund of your choice within the same fund house. Every time such a transfer takes place, you have to pay tax because it is deemed to be a withdrawn from a liquid fund. Redemption from debt funds before a year are taxed as per your income-tax brackets (10.30%, 20.6% and 30.9%; including surcharge). If they are redeemed after a year, they are taxed at 10% (without indexation) and 20% (with indexation).
Tax experts claim that one way to save paying tax on your STP investments every time you switch is to invest in a daily dividend plan and then ask your fund house to transfer your dividend proceeds to your chosen equity fund. In a daily dividend plan, your liquid fund declares dividends daily in such a way that your net asset value (NAV) is at Rs. 1,000 at all times. In other words, you always enter and exit at a price of Rs. 1,000 and so you don’t incur any capital gains when you exit (switch from a liquid fund to an equity fund).
Save your a/c statements
The key is your account statement. Save your account statement and just submit the same with your income-tax returns.