When you own equity shares, there are two kinds of incomes that are generated. Firstly, there are dividends that are earned by you on a regular basis when the company pays out the dividends. Most profitable companies do pay out dividends to shareholders. The second source of income from equities comes from capital gains. Capital gains represent the profits made on sale of shares and represent the excess of the sale price less the purchase price. The chart below captures the essence of capital gains and capital losses.
Chart Source: Cleartax
When we talk of the capital gain or capital loss, the actual amount is adjusted for related expenses like transaction costs, statutory charges, borrowing costs if any etc. There are two types of capital gains that we need to be aware of. When it comes to equities, there are two types of capital gains that investors need to be aware of. If the equity shares are held for a period of less than 1 year, then the gain will be taxed as short term capital gains (STCG). If the equity shares are held for a period of more than 1 year then they represent long term capital gains (LTCG). This distinction is important as it impacts the taxation of capital gains and also the set-off of losses, which we shall see in detail later.
Taxation of short term capital gains (STCG)
STCG represents the profit that arises from holding equities for less than 1 year. The short term capital gains are charged under the Income Tax at the rate of 15% on the amount of capital gains. However, there is a surcharge and cess that is applicable on the STCG tax which also has to be paid on top of the 15% basic tax. The effective STCG tax comes to 17.47% (15% basic STCG tax + 12% surcharge + 4% cess). Let us see how the tax calculations pan out?
|Particulars||Calculation of STCG Tax|
|Shares of RIL bought on 01st January 2017||1000 shares @ Rs.750/share|
|Value of purchase of RIL||Rs.7,50,000|
|Sale of shares of RIL on 01st November 2017||1000 shares @ Rs.875|
|Value of sale of RIL||Rs.8,75,000|
|Short Term Capital Gains (less than 12 months)||Rs.1,25,000|
|Applicable effective tax rate||17.47%|
|Net Capital Gains (net of tax)||Rs.1,03,162|
It can be seen from the above table that the STCG tax reduces the net dividends in the hands of the investor. That is because the shares were sold in less than 1 year. But what happens if the shares were sold after a period of 1 year.
Taxation of long term capital gains (LTCG)
Long term capital gains arise when the shares are held for a period of more than 1 year. Here the taxation becomes slightly more complicated. In case of STCG tax, there is no change in the taxation rules. However, in case of LTCG, it was made taxable effective from April 01st 2018. Any LTCG that arises after April 01st 2018 will be taxable in the hands of the investor at the rate of 10%. Of course, this will be subject to the capital gains being more than Rs.1 lakh overall in any financial year. If the total capital gains in a year are more than Rs.1 lakh then the excess capital gains will be taxed at 10%. Effective tax on LTCG will be 11.648% (which includes 10% basic tax + 12% surcharge + 4% cess). Let us look at 3 different scenarios and how the LTCG tax is calculated.
|Particulars||LTCG but sold before 01st April 2018||LTCG but sold after 01st April 2018||LTCG but sold after 01st April 2018|
|Long Term Capital Gains||Rs.1,95,000||Rs.93,000||Rs.1,65,000|
|Basic Exemption for LTCG||N.A.||Rs.1,00,000||Rs.1,00,000|
|Taxable Capital Gain||N.A.||Nil||Rs.65,000|
|Tax at 11.648%||N.A.||N.A.||Rs.7,571|
|Net Capital Gains for investor on hand||Rs.1,95,000||Rs.93,000||Rs.1,57,429|
As can be seen in the above case, the LTCG tax is only payable in excess of Rs.1 lakh overall provided the LTCG arises after 01st April 2018. There is a catch here. You do not get the benefit of indexation in this case and the 10% is a flat tax. This can be a major loss for you if you are selling the shares after a period of 10-15 years.
Setting off losses and carrying forward the losses
One important aspect of capital gains is that the capital gains and losses on shares can only be set off against capital gains but not against other income. For example, any short term loss can be written off against long term gains and long term capital losses. However, long term losses can only be written off against long term gains and not against short term gains. Such losses can also be carried forward for a period of 8 assessment years and set off accordingly.