The impact of “taxed at slab”

It’s often scary to hear the phrase “taxed at slab” because it means a relatively larger chunk of our profit is taken away by the government.

Many mutual fund categories are now taxed at slab. This has caused enough concern among investors to spur AMCs into creating weird mutual fund schemes. I know of at least Edelweiss Multi Asset and Parag Parikh Dynamic Asset Allocation funds. I am sure more such funds are coming from various AMCs.

But what is the impact of “at slab” taxation on long-term investments? We look at a few tax scenarios of a ₹50,000 per month SIP.

Estimated corpus @ 10% annualised return over 10 years

It should be no surprise, but a 30% tax bill is twice as large as a 15% tax bill and thrice as large as a 10% tax bill.

Screenshot from Groww SIP Calculator (click image to enlarge)

• Pre-tax corpus: ₹1,03,27,601
• Post-tax corpus with 30% tax and 4% cess: ₹89,77,389
• Tax owed is ₹13,50,212.
• 13.07% of the final corpus is owed as tax.
• Post-tax corpus with 20% tax and 4% cess: ₹94,27,460
• Tax owed is ₹9,00,141.
• 8.72% of the final corpus is owed as tax.
• Post-tax corpus with 15% tax and 4% cess: ₹96,52,495
• Tax owed is ₹6,75,106.
• 6.54% of the final corpus is owed as tax.
• (Why 15% tax? Assuming indexation brings down the acquisition cost, the effective tax rate may be 15%. Just an unscientific estimate.)
• Post-tax corpus with 10% tax and 4% cess: ₹98,77,530
• Tax owed is ₹4,50,071.
• 4.36% of the final corpus is owed as tax.

Estimated corpus @ 12% annualised return over 10 years

For the same investment duration, higher return rate results in higher tax owed (as a percentage of the corpus size).

Screenshot from Groww SIP Calculator (click image to enlarge)

• Pre-tax corpus: ₹1,16,16,954
• Post-tax corpus with 30% tax and 4% cess: ₹98,64,464
• Tax owed is ₹17,52,490.
• 15.09% of the final corpus is owed as tax.
• Post-tax corpus with 20% tax and 4% cess: ₹1,04,48,628
• Tax owed is ₹11,68,326.
• 10.06% of the final corpus is owed as tax.
• Post-tax corpus with 15% tax and 4% cess: ₹1,07,40,709.
• Tax owed is ₹8,76,245.
• 7.54% of the final corpus is owed as tax.
• (Why 15% tax? Assuming indexation brings down the acquisition cost, the effective tax rate may be 15%. Just an unscientific estimate.)
• Post-tax corpus with 10% tax and 4% cess: ₹1,10,32,791
• Tax owed is ₹5,84,163.
• 5.03% of the final corpus is owed as tax.

Estimated corpus @ 12% annualised return over 5 years

For the same 12% return, shorter investment duration results in lower tax owed (when looked at as a percentage of the corpus size).

Screenshot from Groww SIP Calculator (click image to enlarge)

• Pre-tax corpus: ₹41,24,318
• Post-tax corpus with 30% tax and 4% cess: ₹37,73,530.
• Tax owed is ₹3,50,787.
• 8.51% of the final corpus is owed as tax.
• Post-tax corpus with 20% tax and 4% cess: ₹38,90,460.
• Tax owed is ₹2,33,858.
• 5.67% of the final corpus is owed as tax.
• Post-tax corpus with 15% tax and 4% cess: ₹39,48,924.
• Tax owed is ₹1,75,394.
• 4.25% of the final corpus is owed as tax.
• (Why 15% tax? Assuming indexation brings down the acquisition cost, the effective tax rate may be 15%. Just an unscientific estimate.)
• Post-tax corpus with 10% tax and 4% cess: ₹40,07,389.
• Tax owed is ₹1,16,929.
• 2.84% of the final corpus is owed as tax.

Conclusions

To recap, these are the objective takeaways from the numbers.

• Tax at 30% is significantly higher than 10% or 20%. (Of course!)
• The higher the rate of return, the higher the taxes owed.
• The higher the investment duration, the higher the taxes owed.

The more nuanced and subjective aspects are interesting to think about. For a 10 year debt SIP, if the tax difference is 8% of the corpus vs 13% of the corpus, the choice is easy for me: I’d pay the tax to keep my debt portfolio clean and simple. This is partly because I take barely any credit risk in my debt portfolio. High tax for a low-risk investment is fine.

Other asset classes are not so straightforward. Am I okay to invest in international equity and not be compensated for the risk (with a lower tax bill)? I don’t currently know what my stance is.

Hopefully, we can all think about these nuances and make the tradeoffs that we are comfortable living with.