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Introduction to Income Tax Rules and Regulations

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Do you actively invest in shares but are unaware of the tax rules and regulations governing the stock market? 

Then, it’s time you understand the share market taxation horizon to maximise your financial gains while maintaining all legal compliances.

The income from the sale and purchase of shares in the stock market are taxable and fall under ‘capital gains.’ In other words, buying and selling shares requires you (the investor) to pay an income tax. The tax you have to pay is based on the holding period. Here, the holding period is the time for which the investor holds the shares or the time between buying and selling.

But what about the enforcement and regulation of these taxes? Investors must comply with not just tax laws but also all rules and regulations set forth by concerned authorities.

To protect the well-being of investors and traders in the domestic market, the regulation of stock market taxes falls under the purview of several authorities. These are the Income Tax Department, the Securities and Exchange Board of India (SEBI), the Central Board of Direct Taxes (CBDT), and the Ministry of Finance.

What Are the Taxes Applied to the Stock Market?

Buying or selling stocks is not just about how much you gain or lose because regulatory authorities will also monitor how you carry out your stock market transactions. 

And this is where capital gains tax comes in. 

If you buy a stock and its price goes up and then sell it at a higher price, the extra money you make is called capital gain. This capital gain is taxable, which means you have to pay a portion of your profit as tax to the government.

For example, imagine buying a lemonade for 100  and selling it for 200. You made 100 extra. This extra 100 is like a prize called "capital gain." But, you must give some of it, say 20, as tax to the government. So, you keep 80 of your prize.

Income under capital gains is further classified into short-term and long-term capital gains.


Short-term capital gain: If you buy a stock and sell it within one year, the profit you make from that sale is a short-term capital gain. The exception being ELSS mutual funds, which consider 3 years as short-term.

Long-term capital gain: If you hold a stock for more than a year before selling it, the profit from selling it is called a long-term capital gain. The tax on long-term capital gains is usually less than on short-term profits.

Now, what about dividends?

All the income you receive as dividends is also taxable; the government will deduct a portion of your dividend income as tax. Think of getting extra cookies because you shared your snacks. If you get 5 extra cookies as a "thank you," the government asks for 1 cookie as tax. So, you get to keep 4 cookies for yourself.

Types of Taxes You Pay While Investing in the Stock Market

If you’re into stock market investments, here are the various types of taxes you should be informed of to avoid any compliance issues:

  1. Securities Transaction Tax (STT)

The STT is deducted on transactions involving stocks, equity mutual funds, and derivatives. You must pay the securities transaction tax every time you buy or sell securities. The STT rate depends on the transaction. For example, the STT rate is 0.1% of the transacted value for delivery-based transactions. So, if you buy or sell securities worth 10,000, you must pay STT of 10.

  1. Goods and Service Tax (GST)

Although GST does not directly apply to stock market transactions, it indirectly affects trading-related services, like brokerage. So, investors must pay GST on the brokerage fees their brokers charge to carry out transactions. 

  1. Dividend Distribution Tax (DDT)

Dividends paid out to shareholders by domestic companies were non-taxable until AY 2020-21. Since the DDT was abolished by the Finance Act of 2020, a regular tax structure applies to shareholders. Thus, dividends received on or after April 1, 2020, are subject to a 10% tax deduction if the aggregate dividend paid or distributed to shareholders during the financial year exceeds 5,000.

Regulations by SEBI 

Whether you’re involved in strategic trading or investing to grow your wealth, SEBI ensures fair play for all participants in the financial market. 

Established under the Securities and Exchange Board of India Act, 1992, SEBI is responsible for safeguarding investors' rights and ensuring impartiality and clarity in the stock market. It acts as a vigilant market custodian to maintain fairness and ensure everyone has equal opportunities to succeed. 

Although SEBI is not directly involved in regulating taxation policies, it plays a central role in ensuring tax compliance in the securities market. 

In a nutshell, the functions of SEBI include the following:

  • Disclosure and transparency: SEBI ensures that companies selling their stocks to the public share all their financial information, including anything related to taxes. This transparency helps investors know what they're getting into, including understanding how taxes might affect their investments.
  • Regulating market intermediaries: SEBI monitors the stock market intermediaries like brokers and mutual funds. These intermediaries advise investors on taxes and investments. SEBI ensures that stock market intermediaries comply with relevant regulations, including tax laws.
  • Investor education: SEBI takes initiatives for investor education on various aspects of investing, like stock market transactions and taxation. In this way, SEBI helps investors understand the tax implications of their investments and make smart financial decisions.
  • Market surveillance and enforcement: SEBI watches out for undesirable behaviour, like tax evasion or fraudulent stock market transactions. SEBI ensures fairness and compliance with tax laws by imposing strict regulatory measures and penalising violators.

Conclusion

Understanding the tax rules and regulations in the stock market is crucial for investors to maximise their gains while staying compliant. Being aware of these taxes helps investors plan their investments wisely. Ignoring these taxes and regulations while investing would be foolish, considering how important these variables are in the stock market. 

You can manage your taxes on your investments and trades with Angel One by downloading a detailed Tax Profit & Loss statement directly from your account. Simply log in, navigate to the "Accounts" section, select "Tax P&L" under the Profit & Loss tab, choose your desired time period, and download the report for your convenience.

Moreover, investors can employ tax-savvy techniques in the stock market. By thoughtfully planning investments, using investment options for saving on taxes, and applying losses to counter gains, it's possible to minimise the overall tax burden.

Most importantly, investors must keep in mind the role of regulatory bodies like SEBI in ensuring transparency, fairness, and compliance with tax laws in the securities market. Investors can confidently navigate the stock market and achieve their financial goals by staying informed and abiding by the rules.

References

  1. https://www.azquotes.com/quote/990337
  2. https://www.pwc.in/assets/pdfs/news-alert/regulatory-insights/2023/pwc_regulatory_insights_21_june_2023_sebi_amends_sebi_listing_obligations_and_disclosure_requirements_regulations_2015_highlights.pdf
  3. https://tax2win.in/guide/income-tax-on-dividend 
  4. https://taxguru.in/finance/types-taxes-pay-investing-stock-market.html

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