Types of Taxes: Capital Gain Tax, Dividend Tax and Interest Tax

Now that you understand how to get started with investing in the stock market, it is time to know about taxes. 

Understanding taxes is essential to maximising our investments. In simple terms, taxes are certain charges imposed on your investment gains. This chapter breaks down these charges, making it easy to grasp and ensuring you're well-informed about how taxes can affect your investment decisions. Let's dive into this topic together, ensuring you have the knowledge to make smarter investment choices while staying within the rules.

What Are Capital Gains?

Capital gains refer to the profit or gain an investor earns when selling an asset, such as stocks, real estate, or other investments. It is calculated by deducting the cost of the investment from the selling price. 

Let us consider an example to understand capital gains better. Suppose you bought 100 shares of Mix and Match Company in October 2022 for ₹1,500 per share, totalling an investment of ₹1,50,000 (1,500*100). Now, in January 2024, the market price of the share has risen to ₹5,000 per share. You decide to sell your 100 shares.

Here's how to calculate your capital gain:

• Selling price: 100 shares * ₹5,000/share = ₹5,00,000
• Cost price: 100 shares * ₹1,500/share = ₹1,50,000
• Capital gain: Selling price - Cost price = ₹5,00,000 - ₹1,50,000 = ₹3,50,000

In this example, you earned a capital gain of ₹3,50,000 on your investment in Mix and Match Company. Remember, this is just a hypothetical example, and actual returns may vary based on market conditions and the specific stock you choose.

Types of Capital Gains Assets

• Short-Term Capital Assets (STCA)

An asset held for 36 months or less is called a STCA. The holding period for each asset determines whether it is STCA or not. 

Holding Period for STCA:

Immovable properties (land, buildings, houses): 24 months or less (sold after March 31, 2017)
Specific assets (listed below): 12 months or less (transferred after July 10, 2014).
- Equity or preference shares in listed companies.
- Securities traded on recognised stock exchanges (debentures, bonds, government securities).
- Units of UTI (quoted or unquoted).
- Units of equity-oriented mutual funds (quoted or unquoted).
- Zero coupon bonds (quoted or unquoted).

• Long-Term Capital Assets (LTCA)

Most assets qualify as long-term capital assets (LTCA) if held for more than 36 months.

Holding Period for LTCA:

• Land, Buildings, Houses: These qualify as LTCA if held for 24 months or more, effective from April 1, 2017.
• Specific Assets: Certain investments become LTCA after 12 months:
  - Listed equity/preference shares.
  - Listed securities (debentures, bonds, government bonds).
  - UTI units (quoted or unquoted).
  - Equity-oriented mutual fund units (quoted or unquoted).
  - Zero coupon bonds (quoted or unquoted).

What Is the Capital Gain Tax?

The tax charged on capital gain is known as the capital gain tax. You are liable to pay the capital gain tax when:

• You have sold an asset that is a capital asset, such as properties, securities, etc. 
• You have made profits from the sale.
• The sale is made in the previous year (the year before the assessment year).

Tax Type	Condition	Applicable Tax
Long-Term Capital Gains Tax (LTCG)	Sale of: - Equity shares - Units of equity-oriented mutual fund	10% over and above ₹1 lakh
	Others	20%
Short-Term Capital Gains Tax (STCG)	When Securities Transaction Tax (STT) is not applicable	Normal slab rates
	When STT is applicable	15%.

Considering our previous example, since you held the shares for more than one year, your capital gain would be considered long-term, and as the gains are above ₹1 lakh, the gains are liable for long-term capital gains tax of 10%. 

What Is a Dividend Tax?

A dividend tax is a levy imposed by a government on dividends paid by companies to their shareholders. 

Before April 2020:

• Companies paid a dividend distribution tax (DDT) instead of shareholders paying tax on received dividends.
• Shareholders received dividends tax-free.

After April 2020:

• DDT was abolished. Now, shareholders pay taxes on dividends (at slab rates).
• Companies/mutual funds deduct Tax Deducted at Source (TDS) at 10% on dividends exceeding ₹5,000. This TDS gets adjusted against your total tax liability when filing an ITR. However, during COVID-19, the government reduced the TDS rate to 7.5% for distribution from May 14, 2020 until March 31, 2021.
  For example, Mr Ram received a dividend of ₹6,000 from an Indian company on June 15, 2020. Since his dividend income is more than ₹5,000, the company will deduct a TDS @7.5% on the dividend income of ₹450. Mr Ram will receive the balance amount of ₹5,550. Further, the dividend income is Mr Ram’s taxable income taxed at the slab rates applicable for FY 2020-21 (AY 2021-22).'
• In the case of Non-Resident Individuals (NRIs), TDS must be deducted at the rate of 20%, subject to the DTAA (Double Taxation Avoidance Agreement), if any. To avail of the benefit of lower deduction due to the beneficial treaty rate with the residence country, the non-resident has to submit documentary proof such as declaration of beneficial ownership, Form 10F, certificate of tax residency, etc. 

What Is Interest Tax?

When you invest across various instruments or keep your savings in a bank account, you typically receive interest, known as interest income, which is liable to taxation under the Income Tax Act. The tax on interest income varies based on the source of the interest, such as the financial instrument used and any applicable deductions.

• Interest from FDs and RDs: Fixed and recurring deposits are popular investments with taxable interest under Section 194A of the Income Tax Act. If your interest exceeds ₹40,000 (₹50,000 for senior citizens), the issuer deducts TDS at 10%. Submitting Form 15G or 15H can avoid TDS if you declare non-taxable income.
• Interest from Savings Accounts: Interest earned in savings accounts is taxed based on applicable slabs; however, it isn't subject to TDS under Section 19A. Deductions under Section 80TTA and 80TTB for seniors apply, capping taxable interest at ₹10,000 or ₹50,000, respectively.
• Interest from Public Provident Fund (PPF): PPF offers tax-exempt interest income (EEE status) under Section 10(11). Both principal and interest are tax-free, making it a popular low-risk investment. The investment amount is capped under Section 80C.
• Interest from Bonds: Bond interest is taxable based on slab rates unless the bond is tax-free. Tax-free bonds enjoy full exemption. Other bonds require adding interest to 'Income from Other Sources,' taxed at slab rates. 

By now you must have understood that taxes are not the same for every investment. Therefore, in the next chapter, you will learn about taxes on specific investments.