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Taxation on equity investments

Rohan, age 35 years, is an executive working in a MNC firm. In the last few years, he has started earning his second income from equity investment. But he always thinks that tax treatment of the equity investment is complex and he remains puzzled at the time of tax filing. Similar to Rohan, equity taxation seems complex to many. Today, we will simplify the equity taxation for you.

You can broadly categorize the equity investment in two parts:

  1. Direct investments into shares and
  2. Investment through the equity oriented mutual funds

Equity shares can be of two types: listed equity shares and unlisted equity shares. Purchasing the share of TCS on the stock exchange like NSE or BSE is an example of a listed equity share. What if you want to buy the shares of your favourite IPL franchise CSK, which does not trade on the exchanges? You can trade in the shares of these unlisted companies privately in the market.

Any mutual fund that invests by way of equity shares in domestic companies to the extent of more than 65% of the total proceeds of such fund is categorized as an equity oriented fund from a tax perspective.

We can classify the gain from equity investments in the following categories:

  1. Long-Term Capital Gain (LTCG)
  2. Short-Term Capital Gain (STCG)
  3. Intra-day trading (Speculative business income)
  4. Dividend Income

Let’s take a deep dive into it and start with capital gain taxation.

Capital gain taxation

When you sell your shares at a price more than your purchased price then the difference will be considered as a capital gain. Otherwise, it will be a capital loss. If you are holding shares at a profit, i.e. have unrealized profit, then there is no capital gain. You are liable to pay taxes on the capital gain, but what about the capital losses? Interestingly, you can also use losses to adjust your capital gains. Or you can carry forward your capital losses to set off the capital gains in the future years. Sounds interesting...?

A capital gain or loss can be divided into two parts depending on your holding period. For listed shares, a holding period of 12 months or more is considered as long term and less than 12 months is considered as short term. For unlisted shares, the period of holding should be 24 months instead of 12 months. But why is my capital gains tax linked to the holding period? Tax treatment of most of the financial instruments depends on the holding period. Tax rates are lower for the long term.

Tax rate

Listed shares: As per Income Tax Act, no tax is required to be paid on long term capital gain (LTCG) of upto Rs. 1 lakh from equity investment in a financial year. Any gains exceeding 1 lakh in a financial year are taxed at 10%. It means you can book an LTCG up to Rs. 1 lakh every year even if you don’t require money. You can purchase those securities again if you wish to stay invested in them.

Short term capital gain (STCG) are taxed at the rate of 15%.

Unlisted shares: The LTCG tax rate is 20% with indexation benefit. Indexation helps to adjust the acquisition cost as per the inflation and reduce your tax liability. STCG is taxed as per the income tax slab rates.

Equity mutual funds are taxed similar to listed equity shares.

Tax Calculation

We understood the tax rate, but how to do the tax calculations? Let’s understand this with a few examples.

LTCG example:

Suppose you bought 1000 shares of ABC ltd @ Rs.2000 on NSE on 1 Apr 2019 and sold them at Rs. 2500 on 1 Jul 2020. Your gain in this case is (2500-2000) *1000 = 5,00,000. Assume that this is the only equity transaction you have in a year. As the holding period is more than 12 months, it is qualified for a long-term capital gain. First Rs. 1 lakh is tax-free, so the applicable tax rate is 10% on the remaining gain i.e. you need to pay tax at the rate of 10% on Rs. 400,000 plus applicable surcharge and cess.

But If you have bought only 100 shares of ABC Ltd., do you still need to pay LTCG tax? Your capital gain would be (2500-2000) *100 = 50000. Your LTCG, in this case is less than Rs. 1 lakh, so there is no tax liability on this gain.

STCG example:

You sold 100 shares of ABC Ltd. after six months of purchase @ Rs. 2100. What would be your tax liability in this case? As your holding period is less than 12 months, it is considered a Short Term Capital Gain(STCG). The STCG, in this case, is (2100-2000) *100 = Rs. 10,000. You need to pay   tax at the rate of 15% on the gain of Rs. 10,000 plus applicable surcharge and cess

Intraday trading (Speculative business income)

Intraday trading is tempting as leverage helps you to earn a higher return on your capital. But did you know intraday trading attracts a higher tax rate? As per Income tax, profits earned by trading equity or stocks for intra-day or non-delivery are categorized under speculative business income. The gain on this type of income is added to your income and taxed as per your tax slab. So, if you earn Rs. 10 lakh p.a. and earn Rs. 2,00,000 in intra-day trading, then your total taxable income becomes Rs. 12 lakhs and is taxed as per the applicable income tax slab rate.
Also, the loss from speculative business can be set off against income from same head and loss if any can be carried forward for four assessment years immediately succeeding the assessment year in which the loss was first computed.

Dividend taxation

Many of us have invested in high dividend-yielding stocks and are earning tax-free returns. But is it still lucrative to invest in these stocks due to a change in dividend taxation? Until FY 19-20, if the total dividend income in the year is less than Rs. 10 lakhs, the dividend is tax-free in your hands. If dividend income is more than Rs. 10 lakhs, it was taxable @ 10%. From FY 20-21, all dividends in the hands of investors are taxable as per slab rates. In other words, dividend income will be added to your income and taxed as per your income tax slab.

Carry forward and set off of capital loss

As we have discussed in the beginning, losses could also be useful in equity investments to reduce your tax liability.

As per income tax rules, any loss under the head capital gains can be set off with income against that head only. It cannot be set off against any other income head like salary, business income, etc.

Long-term capital losses can be set off only against LTCG and short-term capital losses are allowed to be set off against both LTCG and STCG. If you are unable to set off your entire loss in the same financial year Then, both short-term and long-term capital losses can be carried forward for eight assessment years immediately following the assessment year in which the loss was first computed.

Conclusion

It is recommended to pay taxes on time, but you can optimize your tax liability by using the tax benefits offered by the government. By understanding the taxation on different instruments, you can make the right investment decisions to maximize your post-tax return.

This material has been prepared for informational purposes only. You should consult your tax advisor before engaging in any transaction.

Disclaimer: The contents herein above is for informational purpose only and shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon.

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