Aarav sat staring screen of his laptop, with happiness and pride washing over him. With a father deep into stock market investing, he dipped his toes into stocks early in life. Just this morning, he sold 200 shares of heavyweight – JSW Steel to lock in some profits. Looking at his trading account dashboard, the numbers felt quite rewarding as he gained about 40% with earliest tranche of 15 shares bought about two years back yielding more than 45%. At the time, his father Rajesh, walks into the room carrying two cups of steaming masala chai. Noting his son’s furrowed brow, Rajesh smiled. Knew something interesting is coming.
Aarav laughed, taking cup of tea from his father. ” Pops! I just sold 200 shares of JSW Steel at Rs. 1,298.35. Made about 75K.”
Rajesh kept down the tea cup and pulled a chair. “Congrats, but have your considered taxes in estimating profits. Share sale involves taxes based on period of holding.” Aarav frowned, “why do you spoil the party? But let me understand.”
Taxes depend on the period of holding
“First,” Rajesh began, “we need to know if the gains are in the nature of Short-Term or Long-Term. For listed shares, if you hold them for 12 months or less before selling, it is short-term and becomes long term if you sell after more than 12 months. Tax is lower in case of long term gains.”
“Ohkay! So period of 12 months after purchase is important.” Aarav got interested as a disciplined citizen.
“Yes. In general, it is counted from the date of purchase up to the day immediately preceding the transfer. Since you sold via an online stockbroker, the data is populated and available in portal.” In fact, they calculate capital gains for you, but you need to revisit yourself to pay applicable taxes.”
Rajesh then highlighted that the date of acquisition is an important aspect and explained:
- Demat Account (FIFO Method): If shares are bought in multiple tranches, the tax systems use First-In-First-Out rule. The shares that enter the Demat account first are deemed to be the first ones to be sold.
- Corporate Actions: In case of Bonus Shares, the period of holding starts fresh from the date they are allotted. On the other hand, in case of Convertible Preference Shares or Debentures that later turned into equity, the time the original preference shares or bonds are held are used to find total holding period.
Calculate the true cost of acquisition
Rajesh continued, sipping his tea. “Your profit isn’t just the selling price minus the buying price. You have to look at the Cost of Acquisition.”
“Can I deduct the brokerage fees I paid?” Aarav asked.
“Exactly! Any expenditure incurred wholly and exclusively in connection with the transfer such as brokerages, commission, and stamp duties can be added to the costs and deducted from the sales value to lower the taxable gain. In relevant cases, traveling expenses and legal expenses are also allowed to be deducted.
However, there is a major exception in form of Securities Transaction Tax (STT). You cannot deduct STT when calculating capital gains.”
Tax Rates
“Now, here is where the recent tax reforms come into play,” Rajesh said, tapping the table. “The rules changed midway through last year. Under current income tax rules, listed share gains are taxed at fixed rates depending on holding period.”
Short-Term: Short-term capital gains in case of specified listed securities are taxed at 20% under Section 111A.
Long-Term: The LTCG tax rate is 12.5% without indexation benefits. On the bright side, there is annual tax-exempt limit for long-term gains of Rs. 1.25 Lakhs per financial year.
Exemption Limits and Deductions
“Pops, what if my overall income is less this year? Do I still have to pay the full percentage?”
Bemused father smiled “Ask something that is relevant to you. However, if a person has low total income, the basic exemption limit may reduce taxable income, which can also benefit capital gains in eligible cases. For example, when the basic exemption limit is Rs. 2.5 Lakhs and the regular income is only Rs. 1.85 Lakhs, there is unfilled gap of Rs. 65,000. This can reduce the taxable short-term or long-term capital gains by that Rs. 65,000 before applying the tax rates under STCG.”
Aarav leaned back, his mind clearer. “So, my profits will reduce by the amount of taxes. Is there a solution to not pay these taxes.”
“Not exactly”, the father replied. “The best strategy from tax rate perspective is to play long term and avoid unnecessary selling”. He added “Keep good quality stocks until there is a need or you feel that their prices are going to materially fall.”
Finishing his tea the father added “Your mom wanted to Netflix, so let us continue our discussion some other time to discuss capital gains tax harvesting.” It is very interesting.
Note:
Readers may go through Income Tax website for further details (Click here).