Taxation for Investors

4.1 – Quick recap

In continuation of the previous chapter: Classifying your market activity

You can consider yourself an investor when –

• Buying and selling stocks after taking delivery to your DEMAT account

If the frequency of transactions (buy/sells) is high, it is best to consider them as trades and not investments. If considered as trades, any income is non-speculative business income, whereas if these are investments, then it falls under capital gains.

Keeping this in perspective, you may have few questions –

• What is long term?
• What is considered high frequency of transactions (buy/sells)?

We discussed this in the previous chapter, but just to refresh your memory – there is no set rule from the IT department to quantify ‘frequency’ or determine ‘long term’.

As long as your intent is right, and you are consistent across financial years in the way you identify long term or high frequency, there is nothing to worry about.

Do note, if you are indulging in equity delivery based trades as frequently as a few times every week, it would be best to consider all of them as ‘trades’ and classifying income from them as business income instead of capital gains.

Reiterating again that if investing/trading on the markets is the only source of income, and even if you are trading with moderate frequency, it is best to classify income from all your equity trades as a business income instead of capital gains.

On the other hand, if you are salaried or have some other business as your primary source of business, it becomes easier to show your equity trades as capital gains even if the frequency of trades is slightly higher.

Updated 2nd March 2016

Finally, the income tax department has brought in clarity by allowing an individual to decide on his own to either show his stock investments as capital gains or as a business income (trading) irrespective of the period of holding the listed shares and securities. Whatever is the stance once taken, the taxpayer will have to continue with the same in the subsequent years. Check this circular.

So essentially,

1. Stocks that you hold for more than 1 year can be considered as investments as you would have most likely received some dividends and also held for a longish time
2. Shorter-term equity delivery buy/sells can be considered as investments as long as the frequency of such buy/sell is low.
3. If you wish, you can also show your equity delivery trades as a business income, but whatever stance you take, you should continue with it in the future years as well.

The focus of this chapter is on investing; hence we will keep the discussion limited to just points 1 and 2. We will talk about taxation when trading/business income in the next chapter.

4.2 – Long term capital gain (LTCG)

Firstly you need to know that, when you buy & sell (long trades) or sell & buy (short trades) stocks within a single trading day then such transactions are called intraday equity/stock trades. Alternatively, if you are buying stocks/equity and wait till it gets delivered to your DEMAT account before selling it, then it is called ‘equity delivery based’ transactions.

Any gain or profit earned through equity delivery based trades or mutual funds can be categorized under capital gains, which can be subdivided into:

• Long term capital gain (LTCG): equity delivery based investments where the holding period is more than 1 year
• Short term capital gain (STCG): equity delivery based investments where the holding period is lesser than 1 year

Taxes on long term capital gains for equity and mutual funds are discussed below –

For stocks/equity – 0% for first Rs 1lk and @10% exceeding Rs 1lk

The above taxation rate is only if the transactions (buy/sells) are executed on recognized stock exchanges where STT (Security transaction tax) is paid. As discussed above, LTCG is a holding period of more than 1 year.

If the transactions (buy/sells) are executed through off-market transfer where shares are transferred from one person to another via delivery instruction booklet and not via a recognized exchange by paying STT, then LTCG is 20% in case of both listed and non-listed stocks (Listed are those which trade on recognized exchanges). Do note that when you carry an off-market transaction Security Transaction Tax (STT) is not paid, but you end up paying higher capital gains tax.

Note that a gift from a relative through DIS slip is not considered as a transaction and hence not capital gain. It is important that gift not be treated as transfer, and relative could be (i) spouse of the individual (ii) brother or sister of the individual (iii) brother or sister of the spouse of the individual(iv) brother or sister of either of the parents of the individual (v) any lineal ascendant or descendant of the individual(vi) any lineal ascendant or descendant of the spouse of the individual (vii) spouse of the person referred to in clauses (ii) to (vi)

For equity mutual funds (MF) – 0% for first Rs 1lk and @10% exceeding Rs 1lk 

Similar to equity delivery based trades, any gain in investment in equity-oriented mutual funds for more than 1 year is considered as LTCG and exempt from taxes up to Rs 1lk per year. A mutual fund is considered as equity-oriented if at least 65% of the investible funds are deployed into equity or shares of domestic companies.

For non-equity oriented/Debt MF – flat 20% on the gain with indexation benefit

Union budget 2014 brought in a major change to non-equity mutual funds. As opposed to 1 year in equity-based funds, you have to stay invested for 3 years in non-equity/debt funds for the investment to be considered as long term capital gain. If you sell the funds within 3 years to realize profits, then that gain is considered as STCG.

4.3 – Indexation

When calculating capital gains in case of non-equity oriented mutual funds, property, gold, and others where you are taxed on LTCG, you get the indexation benefit to determine your net capital gain.

I guess we would all agree that inflation eats into most of what is earned as profits by investing in capital assets such as the ones mentioned above.

For someone wondering what that inflation is, here is a simple example to help you understand the same –

All else equal, if a box of sweets priced at Rs.100 last year, chances are the same could cost Rs.110 this year. The price differential is attributable to Inflation, which in this example is 10%. Inflation is the % by which the purchasing value of your money diminishes.

Assuming the average inflation rate in India of around 6.5%, if you had invested into a debt fund, wouldn’t a big portion of your long term capital gain at the end of 3 years get eaten away by inflation?

For example assume you had invested Rs.100, 000/- into a debt fund, and you got back Rs 130,000/- at the end of 3 years. You have a long term capital gain of Rs.30,000/-. But in the same period assume the purchasing value of money is dropped by 18k because of inflation. Should you still pay long term capital gain on the entire 30k? Clearly this does not make sense right?

Indexation is a simple method to determine the true value of the sale of an asset after considering the effect of inflation. This can be done with the help of the Cost inflation index (CII) which can be found on the income tax website.

Let me explain this with an example of a purchase/sale of a debt mutual fund.

Purchase value:  Rs.100,000/-

Year of purchase: 2005

Sale value: Rs 300,000

Year of sale: 2015

Long term capital gain: Rs 200,000/-

Without indexation, I would have to pay tax of 20% on the capital gains of Rs 200,000/-, which works out to Rs 40,000/-.

But we can reduce the LTCG by considering indexation.

To calculate indexed purchase value, we need to use the cost inflation index (CII). Find below the cost inflation index from the income tax website until 2019/20. Refer to this for CII data before 2001/02.

Going back to the above example,

CII in the year of purchase (2005): 117

CII in the year of sale (2015): 240

Indexed purchase value = Purchase value * (CII for the year of sale/ CII for the year of purchase)

So –

Indexed purchase value = Rs 100000 * (240/117)

= Rs 205128.21

Long term capital gain = Sale value – Indexed purchase value

Therefore, in our example

LTCG = Rs 300,000 – Rs 205128.21

= Rs 94871.79/-

So the tax now would be 20% of Rs 94,871.79 = Rs 18,974.36, much lesser than Rs 40,000/- you would have had to pay without the indexation benefit.

Like I had said earlier, the indexed purchase value can be calculated using the above method for all long term capital gains which are taxable like debt funds, real estate, gold, among others. You could use the IT department’s Cost inflation index utility to check on the indexed purchase value of your capital assets instead of having to calculate manually.

The interesting thing to note in regards to 20?ter indexation for non-equity oriented or debt funds: Most of these funds return between 8 to 10% and typically inflation in India has been around that for the last many years. So with the indexation benefit, you typically won’t have to pay any tax on LTCG of non-equity oriented funds.

4.4 – Short term capital gain (STCG)

Tax on short term capital gains for equity and mutual funds are discussed below –

For stocks/equity: 15% of the gain

It is 15% of the gain if the transactions (buy/sells) are executed on recognized stock exchanges where STT (Security transaction tax) is paid. STCG is applicable for holding period over 1 day and not more than 12 months.

If the transactions (buy/sells) are executed via off-market transfer (where shares are transferred from one person to another via delivery instruction booklet and not on the exchange) where STT is not paid, STCG will be taxable as per your applicable tax slab rate. For example, if you are earning over Rs.10,00,000/- per year in salary, you will fall in the 30% slab, and hence STCG will also be taxed at 30%. Also, STCG is applicable only when the income exceeds the minimum tax slab of Rs 2.5lks/year. So if there is no other income for the year and assuming there was Rs 1lk STCG, it would not entail the flat 15% tax.

For equity mutual funds (MF): 15% of the gain

Similar to STCG for equity delivery based trades, any gain in investment in equity-oriented mutual funds held for lesser than 1 year is considered as STCG and taxed at 15% of the gain. Do note a fund is considered Equity based if 65% of the funds are invested in domestic companies.

For non-equity oriented/Debt MF: As per your individual tax slab

Union budget 2014 brought in a major change to non-equity mutual funds. You have to now stay invested for 3 years for the investment to be considered as long term capital gain. All gains made on investments in such funds held for less than 3 years are now considered as STCG. STCG, in this case, has to be added to your other business income and tax paid according to your income tax slab.

For example, if you are earning around Rs 800,000/- per year in your normal business/salary and you had STCG of Rs 100,000/- from debt funds, you will fall in the 20% slab as your total income is Rs 9,00,000/-. So effectively in this example, you will pay 20% of STCG as taxes.

4.5 – Days of holding

For an investor, the taxation difference between LTCG and STCG is quite huge. If you sold stocks 360 days from when you had bought, you would have to pay 15% of all gains as taxes on STCG. The same stock if held for 5 days more (1 year or 365 days), the entire gain would be exempt from taxation as it would be LTCG now.

It becomes imperative that you as an investor keep a tab on the number of days since you purchased your stock holdings. If you have purchased the same stock multiple times during the holding period, then the period will be determined using FIFO (First in First out) method.

Let me explain –

Assume on 10th April 2014, you bought 100 shares of Reliance at Rs.800 per share, and on June 1st, 2014 another 100 shares were bought at Rs.820 per share.

A year later, on May 1st, 2015, you sold 150 shares at 920.

Following FIFO guidelines, 100 shares bought on 10th April 2014 and 50 shares from the 100 bought on June 1st, 2014 should be considered as being sold.

Hence, for shares bought on 10th April 2014 gains = Rs 120 (920-800) x 100 = Rs 12,000/- (LTCG and hence 0 tax).

For shares bought on June 1st, Gain = Rs 100 (920-820) x 50 = Rs 5,000/- (STCG and hence 15% tax).

Small little sales pitch here ???? – if you are trading at maximmillionaires the holdings page in our back office platform called Console will keep a tab for you on a number of days since your holdings were purchased, and even a breakdown if bought in multiple trades.

The highlights show –

1. Day counter
2. A green arrow signifying holdings more than 365 days, selling which won’t attract any taxes.
3. If you have bought the same holdings in multiple trades, the split up showing the same.

Besides maximmillionaires Q, equity tax P&L is probably the only report offered by an Indian brokerage which gives you a complete breakdown of speculative income, STCG, and LTCG.

4.6 – Quick note on STT, Advance Tax, and more

STT (Securities Transaction Tax) is a tax payable to the government of India on trades executed on recognized stock exchanges. The tax is not applicable to off-market transactions which are when shares are transferred from one DEMAT to another through delivery instruction slips instead of routing the trades via exchange. But off-market transactions attract higher capital gains tax as explained previously. The current rate of STT for equity delivery based trades is 0.1% of the trade value.

When calculating taxes on capital gains, STT can’t be added to the cost of acquisition or sale of shares/stocks/equity. Whereas brokerage and all other charges (which include exchange charges, SEBI charges, stamp duty, service tax) that you pay when buying/selling shares on the exchange can be added to the cost of share, hence indirectly taking benefit of these expenses that you incur.

Advance tax when you have realized capital gains (STCG)

Every taxpayer with business income or with realized (profit booked) short term capital gains is required to pay advance tax on 15th June, 15th Sept, 15th December, and 15th March. Advance tax is paid keeping in mind an approximate income and taxes that you would have to pay on your business and capital gain income by the end of the year. You as an individual are required to pay 15% of the expected annual tax that you are likely to pay for that financial year by 15th June, 45% by 15th Sept, 75% by 15th Dec, and 100% by 15th March. Not paying would entail a penalty of annualized interest of around 12% for the period by which it was delayed.

When you are investing in the stock markets, it is very tough to extrapolate the capital gain (STCG) or profit that will be earned by selling shares for an entire year just based on STCG earned for a small period of time. So if you have sold shares and are sitting on profits (STCG), it is best to pay advance tax only on that profit which is booked until now. Even if you eventually end up making a profit for the entire year which is lesser than for what you had paid advance tax, you can claim for a tax refund. Tax refunds are processed in quick time by the IT department now.

You can make your advance tax payments online by clicking on Challan No./ITNS 280 on https://incometaxindiaefiling.gov.in/.

Which ITR form to use

You can declare capital gains either on ITR 2 or ITR3

ITR3 (ITR 4 until 2017): When you have business income and capital gains

ITR 2: When you have a salary and capital gains or just capital gains

4.7 – Short and long term capital losses

We pay 15% tax on short term capital gains and 0% on long term capital gains, what if these were not gains but net losses for the year.

Short term capital losses if filed within time can be carried forward for 8 consecutive years and set off against any gains made in those years. For example, if the net short term capital loss for this year is Rs.100,000/-, this can be carried forward to next year, and if net short term capital gain next year is Rs.50,000/- then 15% of this gain need not be paid as taxes because this gain can be set off against the loss which was carried forward. We will still be left with Rs Rs.50,000 (Rs.100,000 – Rs.50,000) loss which is carried forward for another 7 years.

Long term capital losses can now (post introduction of LTCG tax@10%) also be set off against long term gains.

Long term capital loss can be setoff only against long term capital gain. Short term capital loss can be setoff against both long term gains and short term gains.

Key takeaways:

1. LTCG : Equity, Equity MF – 0% for first Rs 1lk, 10% on exceeding Rs 1lk, Debt MF: 20?ter indexation benefit
2. STCG: Equity: 15%, Equity MF: 15%, Debt MF: as per individual tax slab
3. You can use the cost inflation index to determine and get the benefit from the indexed purchase value
4. Index purchase price = Indexed purchase value = Purchase value * (CII for the year of sale/ CII for the year of purchase)
5. If you have bought and sold the same shares multiple times then use FIFO methodology to calculate the holding period and Capital gains
6. STT is payable to the Govt and cannot be claimed as expense when investing

Interesting reads:

Livemint: If you pay STT STCG is 15% otherwise as per tax slab

Income tax India website – Cost inflation index utility

Taxguru – Taxation of income & capital gains for mutual funds

HDFC- Debt mutual funds scenario post finance bill (no2), 2014

Disclaimer – Do consult a chartered accountant (CA) before filing your returns. The content above is in the context of taxation for retail individual investors/traders only.