Chapter 5: Taxation on Stock Investments – Part 1

It's that time of the year!

Time to file your taxes.

As you get your documents in order, your financial advisor points out, you now need to pay taxes on your stock investments. And you suddenly wonder if you've taken on a bigger headache!

One thing is for sure; on any income you receive, you have to pay tax as per your income tax slab.

So, it is with your equity investments. For instance, if you sell your shares at a profit, that is more than the purchase price, you benefit from capital gains, on which you may have to pay a tax.

But just then your financial advisor points out some crucial tax benefits and your eyes light up!

Let’s get to know more.

Taxation on gains and losses

Remember, in the previous chapter, we learned that there are two types of equity shares - listed shares and unlisted equity shares.

When you purchase the share of a listed company such as Reliance Industries Ltd on the stock exchange — NSE or BSE — it is referred to as a listed equity share. So, if you have decided to hold onto Reliance Industries Ltd shares for 12 months or more, it is considered as long term capital gain. And lesser than 12 months is short-term capital gain.

But say, you've purchased shares of your best friend's start-up, which is not traded on the stock exchange. Now those are known as unlisted shares, as your friend’s start-up is an unlisted company that operates privately in the market. In this case, for it to be considered as long-term, you will need to hold on for 24 months or more. Similarly, if you sell these shares within 24 months, you will have to pay Short-term Capital gains tax. It is to be noted that any mutual fund that invests 65% of the investible funds in the equity shares of domestic companies is categorized as equity-oriented mutual funds and will be taxed similar to equity shares.

Are there different types of taxation?

There are four types as classified:

  • Long-Term Capital Gain (LTCG)
  • Short-Term Capital Gain (STCG)
  • Intra-day trading (Speculative business income)
  • Dividend Income

The tax treatment for most equity financial instruments is based on the holding period. And the longer you hold onto your investments, lower the tax rates.

What are the tax rates for listed shares?

According to The Income Tax rule, Long-Term Capital Gains (LTCG) up to Rs. 1 lakh in a financial year, from your investments in listed shares is tax-free. Any gains you make above Rs. 1 lakh will be taxed at 10%. On the other hand, if you hold your listed shares for less than year, you will need to pay Short Term Capital Gains (STCG) at 15% which is exclusive of surcharge and cess as applicable. Here surcharge is a tax on tax that is not collected for any particular cause, whereas a cess is also charged on the tax amount but for a specific purpose.

Now what about the unlisted shares?

On equity investments not listed on the stock exchange, the LTCG tax rate is 20% with indexation. On the other hand, you will need to pay STCG tax as per your income tax slab rates.

Wait, what is indexation?

Indexation helps you adjust the purchase cost based on inflation to help you cut down your tax liability.

Every year, the government of India releases the Cost Inflation Index (CII) to help you estimate indexed costs. To know the indexed purchase price of your equity asset, you can use the following formula:

Indexed Purchase Price = Cost of Shares Purchased x CII of the Year of Sale / CII of the Year of Purchase

You can calculate your capital gain by subtracting the indexed purchase price from the sale price.

Let’s look at an example that explains LTCG on listed shares.

Suppose you buy 1000 shares of a company ‘AlphaTech Ltd.’ at Rs. 2000 per share on NSE on 1st April 2019 and sold them at a profit of Rs. 500 per share i.e. at Rs. 2,500 per share on 1st July 2020.

This means your gain is (1000*500) = Rs. 5,00,000.

So, let’s consider this was the only equity transaction you made in a year.

Since you held your investments for more than 12 months, this qualifies as a long term capital gain (LTCG).

Now, how will it be taxed?

Well, the first 1 lakh will be tax-free, and the remaining 4 lakh will be tax at 10% in addition to the surcharge as LTCG tax.

But what if you only sold part of the shares, let’s say like a 100. How much will you be taxed?

In this case, your capital gain would be (100*500) = Rs. 50,000.

And since the amount is less than Rs. 1 lakh, you will not be liable to pay tax on this gain. 

Now let’s look at how STCG works:

So, now let’s say you sell 100 shares of AlphaTech Ltd. after just six months of purchase at Rs. 2,100 per share which means you have a profit of Rs. 100 per share. The profits earned through this transaction will be considered as short term capital gains (STCG), which would be ((2100-2000) *100) Rs. 10,000. 

How will this be taxed?

In this case, you will have to pay an STCG tax of 15% on the gain of Rs. 10,000.

Did you know? 

Albert Einstein found taxes more difficult than theoretical physics. He once said, "The hardest thing in the world to understand is the income tax."

Now, let’s look at the third form of taxation - Intraday trading (Speculative business income)

Intraday trading (Speculative business income)

The income you make from equity trading in intraday trading is regarded as speculative business income. So, this speculative business income gets added to your overall income and is taxed based on your income tax slab rate.

Let's help clear this with an example.

Arun receives a salary to income of Rs. 10 lakh. But in the financial year, he also received short-term capital gains of Rs. 1 lakh.

This makes Arun's total income amount to Rs. 11 lakh and the tax liability should be calculated based on the applicable income tax slab rate.

Also Read: What are Different Types of Taxes in India and Benefits of Paying Taxes

Disclaimer

Before we wrap up this chapter, please be informed that we have considered the tax rates applicable for the financial year 2021-22, but the rates and clauses may change over time. The details mentioned in this chapter is for educational purpose only. We would advise you to consult a tax advisor before making any transaction.

Summary

  • There are four types of taxation on equity instruments: Long-Term Capital Gain (LTCG), Short-Term Capital Gain (STCG), Intra-day trading (Speculative business income), Dividend Income.
  • Long-Term Capital Gains (LTCG) up to Rs. 1 lakh from your investments in listed shares in a financial year is exempted from tax. Any gains you make above Rs. 1 lakh will be taxed at 10%.
  • If you hold your listed shares for less than a year, you will need to pay Short Term Capital Gains (STCG) at 15%
  • The income you make from equity trading in intraday trading is regarded as speculative business income

We’ll cover the fourth and the final type of taxation in the next chapter.

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