As the FY 2020-21 is closing, here is a set of some simple points on how equities are taxed and how you can save income tax by following simple logical steps.
Firstly, let us understand the types of capital gains that are taxed in equities. These are,
A. Short term capital gains
B. Long term capital gains (1/n)
If an investor is holding shares listed on a recognized stock exchange (NSE, BSE) for more than 12 months, the gain/loss arising from the sale shall be ‘Long’ term. Else, it shall be ‘Short’ term. (2/n)
Let us now understand the rates of taxes on these gains. (3/n)
Short term gains on the above shall be taxed at 15% u/s 111A if STT (Securities Transaction Tax) is paid. Please note that usually every investor pays STT which is charged at 0.1%, both at the time of buying as well as selling the shares. (4/n)
Long term gains on the above shall be taxed at 10% u/s 112A only on capital gains exceeding Rs. 1 lakh. So, if your long term gains come at Rs. 3 lakh, then you need to pay Rs. 20,000 (10% of Rs. 2 lakh). (5/n)
Now, few more important things to note here before we dig deeper. Resident Individual/ HUF do not need to pay tax if their income is less than Rs. 2.5 lakh. So, if the gains on equities are less than this limit, one need not pay tax (assuming there is no other income). (6/n)
‘Short’ term loss can be adjusted against both short term gains (taxed at 15%) as well as long term gains (taxed at 10%). However, ‘Long’ term loss can be adjusted only against long term gains (taxed at 10%). (7/n)
Let me tell you the little logic behind this provision. In case you are holding the shares for long term, you must make more money. Why? Because you gave more time. (8/n)
But, if you make loss on your long term holdings, the government won’t allow you to set that off against the short term gains. Simple! (9/n)
So, the very first tax saving tip here is to book short term loss on shares. To simplify, sell the short term shares in loss before 31st March. By doing this, you are actually using that loss to set off against your short term gains and hence save tax at 15%. (10/n)
Follow this. Look at your portfolio, there can be few stocks which you bought during the financial year. If it is making loss, sell them and book the loss on paper at least. Doing this will help you set off it against both short term and long term gains. (11/n)
Remember this, if you are convinced that the stock is a great buy even though in loss, you can buy again after a couple of days. But selling once and booking loss is actually helping you save taxes. (12/n)
Also, if you are late in selling, say if you sell the stock in loss after one year, it will become long term loss. So, better to sell them during the FY. A bull market like this is the best time to sell your mistakes.(13/n)
And as discussed earlier, you cannot set off long term loss against short term gains (taxed at 15%). You will have to set off it against only long term gains (taxed at 10% and that too after the exemption of Rs. 1 lakh). (14/n)
Another obvious tax saving tip from our above discussion is that you must book long term gains on paper every year. Say you have shares that are making you a long term gain of Rs. 1 lakh, you need not pay tax on this as long term gains are exempt to the tune of Rs. 1 lakh. (15/n)
So, it is always prudent to book long term gains every year at least to the tune of Rs. 1 lakh. Remember, this limit of Rs. 1 lakh exemption on long term capital gains is every financial year. (16/n)
Its a great idea to hold a stock for long term. But you can book profits on paper upto Rs. 1 lakh every year and again buy the stock for another long term period. That’s smart tax saving! (17/n)
And for all these tips you need to do another simple task: File your income tax return in time. The due date for individual and HUF (non audit case) is 31st July and for others it is 31st Oct. (18/n)
Belated return filing would mean non eligibility for carrying forward the short term and long term losses. This is govt’s way of rewarding a prompt tax filer. (19/n)
Short and Long term capital loss can be carried forward for 8 assessment years. Again, Long term loss can be carried forward to be used against only long term gains. Whereas, Short term loss can be carried forward to be used against both short and long term gains. (20/n)
Avoid intraday and trading in derivate market. The losses from these are tagged as ‘Speculation loss’. And this cannot be set offed against the regular short term or long term loss on sale of shares. So, the law makers too demotivate this. (21/n)
So to summarize the thread,
1. Book short term loss before 31st March.
2. Book long term gains to save tax on gains upto Rs. 1 lakh.
3. File the income return on time.
4. Avoid intraday and derivative trading unless you are an expert. (22/n)
NOTE: Please consult your tax advisor before acting on any of the above.