Soon after his demonetization drive, Prime Minister Narendra Modi has now hinted at increasing taxes on income from stock markets, saying the contribution of tax from those who make money on the markets has been low and they need to contribute more.
The PM’s remark has left a large number of stock market investors worried as long-term capital gains (LTCG) on listed securities are currently exempt from tax if securities transaction tax (STT) is levied, and only short-term capital gains (STCG) are taxed. Experts say that the tax rates may also be increased, but what the PM perhaps meant was to tax long-term capital gains. However, anything is possible.
“The PM probably means to tax long-term capital gains on sale of equity shares and equity-oriented mutual fund schemes which are exempt today if held for 12 months or more. For holding below 12 months, the profits are taxed at flat 15% presently,” said tax and market expert Balwant Jain, adding that the proposal, if implemented, will adversely affect the equity market.
Now how the PM’s move on gains from the capital market impacts investors remains to be seen. Although Finance Minister Arun Jaitley on Sunday tried to allay the fears of investors, saying that PM’s speech has been misinterpreted in some sections of the media and there is no move to impose long-term capital gains tax on share transactions, but who knows?
You also need to remember that capital gains from stocks are not the only thing which are taxed. There are other capital assets also – like mutual fund, gold and property – which are subject to capital gains tax and going by the current trend, anything can happen with them also in the future.
Whatever be the case, for the benefit of our readers, we are explaining here the types of capital gains, how they work on various capital assets, and how to save on them:
What is capital gain
Capital gain is the profit that one earns by selling his capital assets at a price higher than the money spent to acquire them. The difference is the capital gain (or capital loss if the selling price is lower than the purchase price). You can make a capital gain by selling various types of asset classes such as shares, property, gold, bonds, equity mutual funds and debt mutual funds. Naturally, these gains are taxed by the government. If you are looking for ways to save on capital gains tax, it is imperative for you to understand the types of capital gains, how tax on them works and the concept of indexation.
Types of capital gains
There are two types of capital gains: short-term capital gains (STCG) and long-term capital gains (LTCG). Each asset class has its own rules with respect to both for ascertaining income tax.
The following table shows the tenure considered as short- and long-term for various asset classes and the tax incidence thereof:
|Property||< 3 years||As per respective slab rate|
|Stock and equity mutual fund||< 1 year||15.45%|
|Debt Mutual fund||< 3 years||As per respective slab rate|
|Tax-Free Bond||< 1 years||As per respective slab rate|
|Gold||< 3 years||As per respective slab rate|
|Gold bond||< 3 years||As per respective slab rate|
|Property||> 3 year||20.6% with indexation|
|Stock and equity mutual fund||> 1 year||When STT is levied: NILOr,
When STT is not levied: 20.6% with indexation or 10.3% without indexation
|Debt Mutual fund||> 3 year||20.6% with indexation|
|Tax-Free Bond||> 1 year||10.3% without indexation|
|Gold||> 3 year||20.6% with indexation|
|Sovereign Gold bond*||> 3 year||20.6% with indexation|
* NIL tax if held till maturity
Short-term capital gains (STCG) tax
For an investment instrument like property, debt mutual fund, bond and gold, the tax incidence on STCG corresponds to the respective slab rate, i.e., 10, 20 or 30 per cent. In the case of stock and equity mutual fund, the STCG tax is 15.45% (including education cess).
Long-term capital gains (LTCG) tax
As mentioned in the table, “LTCG tax on all the assets are the same, i.e., 20.6% with indexation, except stock and equity mutual funds, which are tax-free in case STT (securities transaction tax) is levied, and tax-free bonds, which incur 10.3% tax without indexation benefit,” says Adhil Shetty, CEO, BankBazaar.com.
An example for tax calculation with indexation benefit is as mentioned below:
Capital gain = Selling price of the asset – Indexed cost of the asset.
Here, the indexed cost of the asset = Cost of the asset x Inflation index in the year in which the asset is sold/ inflation index in which the asset was bought.
Suppose you bought a property on January 10, 2010, at Rs 20 lakh when the inflation index was 632 and you sold it on January 20, 2015, for Rs 40 lakh when the inflation index was 1024. The calculation of the indexed cost of asset will be:
Indexed cost of asset = Rs 20 lakh x (1024/ 632) = Rs 32.40 lakh.
Therefore, LTCG = Rs 40 lakh – 32.40 lakh = Rs 7.6 lakh.
The tax rate is 20.6% and hence your tax liability on this transaction would be about Rs 1.56 lakh.
How to save tax on capital gains
There are very few ways to avoid STCG tax. You can set off the STCG from stocks or equity-oriented mutual funds against the short-term capital loss of any asset. You are permitted to carry forward the short-term capital loss for 8 years, provided you have filed income tax return.
As far as saving on LTCG tax is concerned, you have several options.
1. You can, for instance, invest for the long run in equity mutual funds and equity. That way you don’t have to worry about taxes at all and all your gains are completely tax-free (provided, the sale of share or equity-oriented mutual fund is liable to STT. Moreover, equities tend to give more stable returns in the long run because the temporary fluctuations even out.
“If you have made short-term losses, you can use these losses against short-term gains in future to reduce your tax liabilities when you do make a profit. Suppose you have incurred short-term losses of Rs 1 lakh in the last year and made a profit of Rs 2 lakh in the current year, you can pay taxes only on the gain of Rs 1 lakh out of Rs 2 lakh. Similarly, long-term capital losses on assets where LTCG is taxed can be offset against LTCG only,” says Shetty.
2. Similarly, a property seller can save LTCG tax by investing the sum in eligible bonds such as National Highways Authority of India (NHAI) or Rural Electrification Corporation (REC) bonds (Section 54EC).
3. Another option is to reinvest the amount in buying another residential property. “There are a few conditions: the LTCG can be set off if the amount is used to purchase a property which is transferred in the one year preceding the sale, or within two years after the sale. If an under-construction residential property is bought for reinvestment, then it should be completed within three years of transfer of property,” says Shetty.
4. If the LTCG income is invested in an eligible start-up with at least 50% stake (majority stakeholder), then also you can save tax. There are, however, a few conditions attached to this provision:
The investor should be the majority stakeholder in the start-up company.
The invested fund should be deployed by the start-up to buy new assets before the due date of filing IT return.
Here the eligible start-up means a company involved in eligible business (related to innovation, service related to technology, etc.) and incorporated after 1st April 2016 with a turnover of below Rs 25 crore from the financial year 2016-17 to 2021.
5. The property seller also has an option to invest the received corpus in a fund of funds (FOF) that invest in a start-up business.
6. If you do not want to immediately take a decision on how you want to save your tax, you have the option of depositing the money in the Capital Gain Account Scheme (CGAS), wherein you can get time to finalise on a way to save tax. The CGAS can be opened at any notified bank by submitting the requisite form along with essential documents that include address proof, PAN card copy, and photograph. You have the option to deposit the amount in cash, DD or through cheque. Some important conditions attached to this provision are:
The corpus deposited under CGAS is not allowed to be kept as a security to raise loan against it.
The interest earned under CGAS account is not tax-free.
If the amount deposited under CGAS is not used within the stipulated period, then the corpus would be liable for capital gains tax in the same year in which the stipulated period lapses.
Things to keep in mind
The LTCG tax exemption, when you invest in a residential property, is available for buying only one residential property. However, you cannot sell such a property within three years of purchase otherwise you’ll be liable to pay the complete tax that was exempted. When you invest a part of the LTCG to buy a new piece of property, the tax exemption will be available for only that portion in which you have invested. The exemption amount cannot exceed the LTCG tax amount.
“If you want to invest in a start-up firm to get the tax exemption, then a fund of funds (FOF) could be a better option than direct investment in a start-up. An FOF would allow you investment diversity by investing in different start-ups after due diligence, thereby lowering your risks,” says Shetty.
Finally, indexation is a great way of reducing your tax liability. Use it wherever you can. If your CA is filing your tax returns, ensure that he uses indexation properly. This delivers huge savings on taxes.
Credits The Financial Express