Tax filing season is the busiest period of financial year for earning people as one has to complete tax filing formalities. Situation gets tough if you are earning from diversified sources and your investments spans debt, equity, mutual funds, real estate and commodities which ultimately increase the complexity of tax filing process.Taxes for different asset classes are handled differently by Indian tax laws.

Awareness of the tax laws pertaining to individual asset classes can help you save quite a lot of money every financial year. In this article we will try to explore how equity investment is treated for taxation purpose. Taxation rules related to equities are quite interesting and clarity regarding the same will enhance your returns in long run.

 

Taxation is based on time frame of holding your equity investment

There are broadly two types of capital gains taxes on equity investment:

  1. Short term capital gains tax- If the holding period of the stock is less than one year it’s treated as short term investment by tax man and any capital gain on this investment attracts a tax of 15% of the gain.
  2. Long term capital gains tax- If the holding period of the stock is more than one year it’s treated as long term investment and the long term gain on such investment do not attract any tax.

Let's take example of Mr. Shyam which will explain the capital gains taxes in details.

Let us say Mr. Shyam has bought stock X and Y both on April 10, 2011 for a price of 10000 each. As on Nov 20, 2011, his investment portfolio is as follows:

 

Stock

Purchase Price - April 10 2011

Market Price - Nov 20 2011

X

10000

15000

Y

10000

8000

 

In Nov we can see that he is having a capital gain of 5000 on stock X and a capital loss of 2000 on stock Y.

Now Mr. Shyam can do four things with his investment and accordingly his tax will vary:

  1. He holds his stock and doesn’t sell it till April 11 2012 and sells after that – Zero tax as his holding period is more than one year (Long Term Capital Gain Tax)
  2. He sells stock X (Profit = 5000) and hold stock Y which is in loss - On the profit of 5000 in stock X he pays short term capital gains tax of 15% i.e. 750.
  3. He sells stock X, books profit of 5000 and sells stock Y, books loss of 2000 – His net profit is 3000. He pays tax of 15% on profit i.e. 450.
  4. He holds stock X for more than one year and book loss in stock Y – No long term capital gains tax in stock X and short term capital loss of 2000 in stock Y. This loss of 2000 can be carried forward for 8 years and whenever he has short term profit this short term loss will be deducted from that profit and then short term capital gain tax of 15% will be applied.

 

Conclusion

These rates apply to shares traded through the stock exchange (on which STT is paid). Long Term Capital Gains on unlisted shares is taxed @ 20%. Similarly Short Term Capital Gains on unlisted shares is subject to tax rates according to ones tax slab.

Now as you know how the tax man treats tax on your equity investment, it’s pretty obvious that by just holding the stock for one year you enhance your return by 15%. One of the most ignored parts is the carry forward rule which provides you an opportunity to reduce the tax burden in case of capital loss for another 8 years. Equity investment from the core of its heart is a long term investment and this taxing benefit proves to be an icing on the cake. So from next time whenever you plan to sell your stock just take into consideration the tax benefit.

 

 

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