To illustrate the significance of how taxes impact your stock market earnings, picture this - when you built a sand castle as a child, did you ever try to fill the moat surrounding the castle with water? Ever tried to poke a hole in the roof of your sandcastle, and try to fill it with water, taaki aapka castle fancy rahe - with a jacuzzi and all? Kya hua tha? Paani theek se baet gaya tha? Of course not, the sand soaked up all the water aur pool, jacuzzi, moat sab bilkul khali pada ….hain nah? Thoda bahut, the sand in the hole where you put the water, was damper than the other sand, but definitely, most of the water disappeared.
Ignoring the impact of taxes on your stock market trading and investment returns ka yahi asar pad sakta hai. You can end up with damp sand instead of a jacuzzi, or in other words what you end up with after the deduction of taxes, could be hardly anything.
Investments choose karte samey hi taxes consider karna zaroori hai. This is what goes through a smart investor’s mind when he comes across an exciting investment: ‘iss investment pe agar mujhe xyz earnings mila, then my tax amount will be x. Taxes subtract karne ke baad, i will have yz in hand. Kya yeh earnings ko kisi dusre investment ke losses se offset kar sakta hu? Yes or no…. Ab yeh sab dekhne ke baad, kya yeh investment karna worth hai ki nahi?’ This is the kind of lens or filter used by experienced investors. Of course they might not know exactly how much they will earn and as a result, all their calculations estimates ke basis he bana jayega, lekin at least he is not going in blind. He has a somewhat clear idea - at least in terms of percentages - of how much he will be left with on a given investment, after he has paid his taxes.
You must also strive to be a savvy investor who considers the impact of taxation on his returns before making any investments. But to do that, you need to be aware of the taxes out there. So let’s begin
Short term capital gains
Agar aapka investment is a short term investment - or an investment that is made for less than one year - then your gains from such an investment are considered as short term capital gains, abbreviated as STCG.
Let us say that Rajesh invests Rs 100,000 in the stock market and by the time he sells his stock, his investment is valued at Rs 150,000. Lucky guy, it isn’t usually so fantastic for everyone. He needs to, however, part with a portion of his amazing earnings because he needs to pay tax on STCG. The amount of this tax is fixed at 15 percent. He loses Rs 7,500 as tax and therefore his actual gains stand at Rs 42,500. Not bad, haan? Well that is for Rajesh to decide. Lekin at least now he is aware of how much he is actually earning.
Long term capital gains
In the same way dost, if yours is a long term investment - or an investment that is made for more than one year - then your gains from such an investment are considered as long term capital gains, abbreviated as LTCG.
If Rajesh had invested his capital for say thirteen months or fourteen months - anything longer than a year, he might have instead paid no tax. Ji haan, you did not mishear, I really did say that he would have been exempt from tax if he had just held the investment for a slightly longer period.
However, if his earnings on even a thirteen or fourteen or twenty-four-month-long investment had crossed 1 lakh within one financial year, he would have to pay 10 percent tax on his earnings. Let’s say Rajesh somehow landed up with 10 lakhs in hand, which he used to buy shares…. and within one financial year, he earned Rs 1 lakh by way of the stock price being higher when he sold his shares. That Rs 1 lakh would indeed be taxable.
An important note, let’s say Rajesh’s shares purchased for 10 lakh within this financial year are worth Rs 11 lakh now. But he does not sell his shares. He does not need to pay tax right now. Tax tabhi barna hota hain when the gains are realised.
Tax on dividends
Previously there was in place a Dividend Distribution Tax, abbreviated as DDT. Under that tax, the company whose shares you hold - or alternatively the fund house whose mutual fund units you hold - needed to pay tax before distributing the dividend to shareholders or fund holders.
As of budget 2020, DDT has been scrapped aur abhi investors ko dividend pe tax dena hota hain.
Many investors have therefore started choosing growth option mutual funds or have preferred to go with the shares of companies that reinvest the capital for growth rather than distribute it as dividend.
Speculative business income
I just said some big words didn’t I? Fikar math karna dost - I need to explain this as part of taxation linked to stock market investments, lekin zyaada tal, yeh aam admi ke liye applicable nahi rehta hai. But listen carefully if the volume of share trading transactions in a year crosses Rs 2 crore.
With volumes like that you are definitely on the Income Tax department’s rader - but there is no need to be afraid. You just need to tread carefully and do things right.
Step 1 - invite an auditor to go through your portfolio.
Step 2 - seek advice on whether you need to file your holdings as speculative business income.
Step 3 - the answer to the above will most likely be yes, so you need to file your potential earnings as speculative business income and pay tax according to the tax slab applicable to you. Aapka tax slab aapke overall income ke basis calculate kiya jata hai.
Non speculative business income
If you deal in futures and options contracts or in other words trade with contracts on commodities, then your income is still business income and it is categorised as non speculative business income.
Just like speculative business income, it is added to your overall income and then you are taxed according to your tax slab. Toh maine kyun aapka time waste kiya aur differentiate karne ke liye bita diya? Because, yeh differentiation samjhane ke baad hi, can I show you a neat trick on how you can reduce your tax.
Using F&O losses to offset earnings from other sources Losses arising from F&O or in other words losses arising from non speculative business income can be used to offset profits from speculative and non speculative business income. Simple words mein if you make any losses on your F&O trading, you can use it to offset profits from F&O trading and to offset income from other sources - don’t get too excited though… income from other sources excludes your monthly salary. As a result, you will be less tax because your losses will be deducted from your earnings and you will be taxed on only the remaining amount. However, losses from speculative business income - or share trading - cannot be used to offset any profits. Yaha pe aapko koi tax discount ya tax benefit nahi milta hai dost.
Dost aside from calculating your taxes, do also evaluate your risk appetite when making investments in the stock market. Aapke daily life aur basic lifestyle maintain karne ke liye paise hamesha side mein rakh do, aur baaki paise se he invest karna. And don’t forget to diversify your investment to reduce your risk - ek investment category mein kam tax hain, iska mathlab yeh nahi ki you throw all caution out of the window. Invest safely and responsibly always.