Just like salary, income from investments in assets like property, stocks, mutual funds, art collectibles, etc., are also taxable, the rate dependent on the holding period.
Capital gains from shares
Any profit booked from selling of a capital asset such as shares, is known as capital gains. Capital gains on an investment generally occurs when the selling price of a share is higher than the purchase price. The profit made by selling shares also accounts as ‘income’, and hence, is liable to taxes, called capital gains tax.
For instance, if you bought shares worth Rs 1 lakh and sold them for Rs 1.5 lakh, the Rs 50,000 is considered your capital gain on which tax is applicable depending on your holding tenure.
Holding tenure as deciding factor for taxation of shares
The investment horizon, or the duration for which an investor holds the stock, determines what kind of capital gain it is. Capital gains can be either short-term capital capital gains, or long term capital gains.
Profits made from selling stock held to less than 12 months from purchase are termed short-term capital gains and short-term capital gains tax is applicable on them. For a detailed understanding of STCG tax in India, refer to our article on Short Term Capital Gains Tax in India on the Angel Broking Knowledge Centre.
When the holding period is more than 12 months, the profit is termed long term capital gains, and long term capital gains tax (ltcg tax) is applicable on such gains.
Long-term Capital Gains Tax Rate in India
The long term capital gains tax (LTCG tax) in India was reintroduced in the 2018 budget. The ltcg tax rate in India currently is 10%, levied on profits of over Rs 1 lakh made from selling shares that were held for more than 12 months (LTCG) without any indexation benefits. Indexation benefit is where the price of the asset is adjusted for inflation and the same monetary benefit is passed to the investor.
For example, suppose an individual bought shares worth Rs 5 lakh on 12th September 2019. Until January 2021, the price of the shares jumped to Rs 7 lakh. The investor in this scenario made gains of Rs 2 lakh. If they sell it now (after the 12-month threshold), they will have to pay a 10% tax on the Rs 2 lakh profit made.
Note here that only your profits are taxed and not the full amount you redeem from the sale of shares.
Calculation of long term capital gains tax
Indexation benefits can be claimed by the investor for gains made before January 31, 2018. In this case, long-term capital gains are calculated by subtracting the indexed purchase price of the shares and the brokerage paid on it by the investor from the selling price of the share.
However, as per the latest income tax rules, indexation benefits will not apply on gains made after January 31, 2018. Here, long-term capital gains are calculated by subtracting the actual purchase price of the shares and the brokerage paid on it by the investor from the selling price of the share.
Gains made after January 31, 2018
If an investor bought shares in February 2019 worth Rs 5,50,000 and sold it in January 2021 at Rs 7,00,000, the investor made gains of Rs 1,50,000 on the sale. With indexation benefits, the investor’s gains will be taxed at 10%. Profit over Rs 1 lakh will be taxed at 10%, any gains under Rs 1 lakh will be tax exempt
Hence, while calculating the long-term capital gains tax on profit of Rs 1,50,000, gains of Rs 1 lakh will be tax exempt. The remaining portion of Rs 50,000 will be taxed at 10% bringing the tax liability of the investor to Rs 5,000.
How to Reduce Capital Gains Tax Liability?
There are several ways in which investors can reduce their total tax liability on long term capital gains arising from the sale of equities by taking advantage of various provisions marked out under the Income Tax Act.
As per this method, an investor can book profit in equities and not face any tax liability for it provided the gains made are under a lakh and they are reinvested. The rate at which the shares or the mutual fund units are repurchased becomes the new cost of acquisition. In order to extract the maximum benefit from this method, the investor can repeat the process every year to take advantage of the Rs 1 lakh exemption. Using this method, the taxpayer can save tax up to Rs 10,000 each year. This method can be used in respect of cumulative LTCG liability arising from equity-linked mutual funds and shares.
This method can be better explained with an example. Consider, for example, that an investor purchases 1000 shares of a company at Rs 300. After a period of three years, the price rises up to Rs 550. Let us suppose that the investor decides to sell his shares at this point in time. In this case, the sale price comes to a total of Rs 5,50,000.
The investor will be liable to pay a capital gains tax of Rs 15,000 after a period of three years. It can be calculated as:
Gains from sale of shares= Rs 5,50,000- Rs 3,00,000= Rs 2,50,000
Capital gains over the amount of Rs 1 lakh are taxed at 10%, which brings the LTCG to Rs 15,000. (Rs 2,50,000-Rs 1,00,000= Rs 1,50,000*10%)
By employing the method of tax harvesting, and buying and selling shares every year, the investor, in this case, can save on his tax liability of Rs 15,000.
Let us understand this in detail.
Suppose the price of the share after one year is Rs 310. If the investor sells it at this price, his total capital gains will come to Rs 10,000 (Rs 3,10,000-Rs 3,00,000). As we know already that any capital gains made under a lakh are taxed at 0%. Consequently, his total tax liability will be zero.
Suppose further that the 1000 shares are repurchased at the level of Rs 310.
In the second year, the price of the share rises to Rs 380. In this case, the capital gains comes to Rs 70,000 (Rs 3,80,000- Rs 3,10,000). Once again, the capital gains fall under a lakh and therefore exempt.
The 1000 shares are again repurchased at the level of Rs 380.
In the third year, the share price rises to 460. In this case, the capital gains comes to Rs 80,000 (Rs 4,60,000-Rs 3,80,000). Once again, the capital gains fall under a lakh and are therefore exempt.
This is how an investor can keep selling and repurchasing shares to cut back on his capital gains tax liability. However, one key aspect for equity investors to remember is that the equity market is highly volatile and investors might not be able to repurchase the shares at the price they are expecting.
Setting off and carrying forward losses:
Another manner in which an investor can save on his long-term capital gains tax liability is by setting off gains earned against losses incurred. However, one must keep in mind that short-term capital losses can be set off against long-term capital gains and short-term capital gains, whereas long-term capital losses can only be squared off against long-term capital gains.
Meanwhile, there are no restrictions, per se, in terms of squaring off of capital losses of one asset category against another. For instance, long-term capital loss from the sale of a property can be set off against long-term capital gains from investments in shares or mutual funds.
Additionally, losses- be it short or long term- can be carried forward for the successive eight years, which basically means that losses incurred in this year can be squared off against gains earned in the coming year.
An important caveat for investors to remember is that their income tax returns should be filed within the due date specified under section 139 of the Income Tax Act. If the return is not duly filed, then the capital losses will lapse and the taxpayer will not be allowed to carry it forward.
Capital gains exemptions
Investors who have booked long-term capital gains from the equity market can invest the amount in 54EC bonds also popularly known as capital gains bonds. However, these bonds aren’t as popular with many financial advisors as the returns on these bonds are currently 5% and the lock-in period is five years.
One can also escape their capital gains tax liability by investing the LTCGs in a residential property. Section 54F of the Income Tax Act states that gains arising out of the sale of any assets including gold, securities or commercial property are exempt from capital gains tax liability if the gains are reinvested in buying or constructing a residential house.
How to reinvest your tax return?
Following are some of the advisable investment options available today, to help reinvest your tax returns as per your risk appetite. Let us have a look at them:
1. Equity-based mutual funds
Equity fund managers try to diversify their portfolio across companies and sectors to mitigate risk.
2. Public Provident Fund (PPF)
Backed by the government of India, PPF allows citizens of the country to invest upto Rs.1.5 Lakhs per annum at a 7.1% interest rate changed every quarter. Interest earned from PPF is exempt from taxes. It requires locking in your money with the bank for a period of 15 years.
3. Fixed Deposits (FD’s)
The rate of interest offered on this instrument varies greatly from one banking institution to another but is often at par with that offered by the PPF. The interest earned from fixed deposits is taxable.
4. Debt mutual funds
Debt mutual funds invest in securities such as treasury bills, corporate bonds, commercial papers etc, that generate a set revenue which is not directly affected by the happenings in the global markets. Hence, they offer low but constant returns.
5. National Pension Scheme (NPS)
National Pension Schemes offered by the central government are open to employees from the public and private sectors to invest for their retirement. If you invest money in a pension account at regular intervals, you can receive a certain sum of money from this accumulated sum and receive the remaining as monthly pension payments from then on.
At present, the NPS offers interest rates between 9-12% on the amount. The only drawback is that your money would be locked in for a long period of time and the benefits could only be availed after you turn 60.
6. Savings Bond
A savings bond is a sovereign bond issued by the government of India to meet its borrowing needs. The Reserve Bank of India (RBI) is the issuing authority for savings bonds that authorises select banks and brokers to sell these to the general public on its behalf.
There is a saying that goes, ‘two things are certain in life – death and taxes.’ Any income earned is liable to tax payments in the country but the government also makes provisions to save some amount of tax. Long-term capital gains from shares are taxed at a flat 10% without indexation benefit for profits above Rs 1 lakh. This is nonetheless a better option than paying short-term capital gains tax that is 20% with indexation benefit in India. This also feeds into the thought that holding investments for the longer term bodes well for investors.