Investment and taxation go hand in hand. Even before you start investing, update yourself on the tax implications that can affect your ultimate return from an investment.
Many people make gainful transactions by buying and selling shares but aren't sure how their income will be taxed.
Like a salary or earning from business, income generated from buying and selling shares is also taxable. Income from share trading/investing is covered under the head' capital gain' and subject to capital gain tax.
To understand capital gain tax, let's begin with the definition of capital gain.
Capital gain refers to an increase in the value of an asset, which you realise when you sell it. There are two types of capital gains on equities: short-term (when the equity holding period is less than one ear and long-term (when the duration is more than one year). This rule is applicable to any equity transaferred (sold) after July 10, 2014, irrespective of date of purchase.
Assets like lands, building, houses, mutual funds, jewellery, and stocks are examples of capital assets. Income generated from selling these assets fall under the category of capital gain.
Depending on the duration of holding an asset, the capital gain is of two types.
Short-term gain: Profit arising from selling equities held for less than twelve months is considered as short term capital gain.
Long-term gain: Equities held for more than one year fall under long-term capital gain.
In case of rights issues and bonus shares the period of holding is calculated from the date of allotment. Depending on the date of allotment to the date of transfer, it will be either short-term gain or long term gain.
However, tenure varies depending on asset type, like debt-oriented mutual funds, bonds and debentures, quoted and unquoted UTI units, equity shares of any listed organizations, equity-oriented mutual funds, zero-coupon bonds are few examples, any capital gain arising from these assets after the period of 12 months comes under the category of long-term gain.
Capital Gain Vs Capital Losses
When you sell a stock, you either incur profit or loss. So, when you sell an asset a higher price than its purchasing price, you earn a profit. Conversely, when the selling price is less than the asset's buying price, it results in a capital loss.
Investors make capital gain/loss on equities sold after 12 months. Capital gain tax on sales of securities was introduced in 2018 budget. It states that capital gain arising from sales of equities above the value of Rs 1 lakh will attract 10 percent capital gain tax, effective from all transactions made after April 2018. Investors will not receive the benefit of indexation as well.
Capital Gain Tax And Equity Shares
Let's understand tax implications on short and long-term capital gains from security transactions.
Short-term capital gain tax (STCG): A 15 percent tax rate will levy on all short-term gains arising from selling securities for profit. So, even if you belong to 10, 20, or 30 percent income tax slab, STCG will apply at the same rate of 15 percent.
But what will happen if you incur a loss? In case the trade result in a loss, investors can use it to offset short-term and long-term gains. There is another provision to carry forward the loss for eight years provided investors file IT within the due date.
Long-term capital gain tax: Per new tax laws in 2018, capital gains above Rs 1 lakh is subject to 10 percent capital gain tax. All transactions carried out after April 2018 come under the new tax rules.
The government has also changed the rules regarding long-term capital losses. From April 2018, investors can carry forward and adjust long-term capital loss against long-term capital gains to get tax advantages.
The above tax rates apply for transactions carried out at a recognized stock exchange, where STT (Security Transaction Tax) is paid. For transaction carried out via delivery instruction booklet, 20 percent LTCG tax will apply. Indexation benefit doesn’t apply to capital gain arising from transaction of equities.
In the case of non-equity oriented mutual funds, property, and gold, investors can take advantage of indexation.
Indexation allows you to adjust capital gains for inflation. Let's understand it with an example.
We all know inflation causes purchasing power to decline. Indexation allows investors to adjust capital gains for changes in inflation rate to reduce the tax burden.
It is a simple method to determine the real value of the income after adjusting inflation. For the value of cost inflation index (CII), you need to visit the website of the Income Tax department.
Suppose you have purchased a debt mutual fund in 2006 for Rs 100,000 and sold it ten years later in 2016 for Rs 250,000.
Long term capital gain (250000 - 100000) Rs 150,000
Without indexation, a 20 percent LTCG will apply to Rs 150,000 which amounts to Rs 30,000.
Now let's see how the equation changes when we apply indexation.
In 2005-06, CII was 117, and in 2014-15 it was 240.
Hence, index purchased value is: Purchase Value (CII of the selling year/ CII of the buying year) or Rs 100,000 (254/122) or Rs 2,08, 196.
Long-term capital gain = Rs 300,000 – 208,196 or Rs 91,803
So, post-indexation LTCG applies at 20 percent equals Rs 91, 803*20% or Rs 18,360 is less than the previous amount.
For an investor, the difference between STCG and LTCG can be huge. If you sell equity, say after 360 days, STCG will apply at the rate of 15 percent. However, if you hold it for five more days, the entire amount will become tax-free as it qualifies as LTCG.
STT And Other Taxes
Since we are at the topic of security investment and taxes, let's also check the other taxes that would apply when you try to buy or sale shares in the stock exchanges.
A 0.1 percent STT (Security Transaction Tax) applies to buying and selling equities in the stock exchange. The above-discussed capital gain tax rates apply only on transactions carried out in stock exchanges and where investors have paid STT.
Income From Equities As Business Income
In 2016, the income tax department finally brought clarity over the confusion arising from treating profit from share trading as income from a business. It allowed taxpayers to decide whether they want to show income from share trading as capital gain or business income irrespective of holding duration. However, once selected, the investor needs to continue on the same categorisation for all future IT filing.
- If you were holding a stock for more than a year and received a dividend, you can list it as an investment in your IT filing.
- If you indulge in delivery-based stock trading and trade only a few times every week, you can mention it as an investment.
- You can mention equity delivery trade as business income but need to maintain consistency across years. Once opted, you can't change your stance.
Hope this chapter on taxation added clarity to your understanding. In the following blogs, we will continue our discussion on other aspects of tax and stock trading.