The majority of queries I receive, both through email and in person, have to do with capital gains in relation to stock market and mutual fund transactions.
Here are some technical considerations on the tax treatment
The majority of queries I receive, both through email and in person, have to do with capital gains in relation to stock market and mutual fund transactions.
Till last year, the queries were limited to capital gains — as in profits—and losses were unheard of. However, now, with the stock market turmoil, capital loss too has come into the equation.
The tax treatment of a capital loss has suddenly become equally important. After all, though you might lose money initially, booking a loss could well help you make up by saving tax on some other taxable income.
Last week, Raghu, a client who has now become a good friend ,emailed me some questions on this topic. Since his query encompassed a number of issues relating to capital gains and losses and the tax treatment thereof, I thought of sharing the same with readers.
Admittedly, the topic is a bit technical, but I assure you, if you read through it, it would be of immense benefit for your tax planning.
With the introduction of the securities transaction tax (STT) from October 1, 2004, the tax treatment of long term capital gains (LTCG) on shares and equity mutual funds (MFs) has changed. Since that date, LTCG has been exempted from tax, provided the transactions are entered into through a recognised stock exchange, and the STT has been paid. However, before that date, LTCG was payable @10% or 20% with cost indexation, whichever is lower. Also, on other assets, apart from shares and equity MFs, LTCG is payable either at 10% or 20%, as the case may be. Am I right on this?
Your understanding on the first point is perfect. LTCG arising out of any sale of equity shares effected on or after October 1, 2004 is tax-exempt provided such a transaction has taken place on a recognised stock exchange in India and the investor has borne the STT. The LTCG earned from sale of units of equity-oriented MF schemes is also exempt from tax.
Therefore, to summarise:
LTCG is exempt and consequently not available for set-off of long-term or short-term capital loss (LTCL or STCL) or the carried forward losses of yesteryears;
As a corollary, LTCL is also ‘exempt’ and cannot be set off against LTCG;
STCG earned shall be charged to tax @10% flat;
LTCL was never allowed to be set off against STCG either before or after October 1, 2004; and
STCL can be set off against any STCG, or taxable LTCG (say on non-equity units or property, etc).
The point regarding set-off requires further discussion. The Income Tax Act draws a boundary around capital gain incomes and losses. In other words, capital losses can only be set off against capital gains — other incomes such as salary or business income cannot be used for set-off. Now, LTCL can only be set off against taxable LTCG.
However, STCL can be set off against both STCG as well as taxable LTCG. This rule existed much before the exemption to LTCG was brought in. The reason is that setting off long-term losses against short-term gains created a sort of tax arbitrage since STCG is taxable at a higher rate (30% in most cases) than LTCG. Therefore, it has been provided by the law that LTCL shall only be set-off against taxable LTCG while STCL may be set-off against both taxable LTCG as well as STCG.
STT is not required to be paid on the following types of transactions, even if these take place on or after October 1, 2004:
Sale or purchase of any asset other than equities and units of equity-based schemes of MF;
Sale or purchase of equity shares which have not taken place on a recognised stock exchange in India; and
Redemptions or buybacks of its shares, preferential or otherwise, by the companies.
On such assets, capital gains and losses shall continue to be taxed as per the old provisions. This means:
LTCG on debt-based schemes will be charged to tax @10% without indexation or @20% with indexation, whichever is lower; and
STCG is considered as normal income of the assessee, added to the income and taxed at the slab rate applicable to him. Consequently, the rate depends upon his other income.
The question that arises now is that, if during the current year when one incurs some LTCL and LTCG on various sale transactions of equity shares, can the LTCL be set off against LTCG? If not, then what can be done about such LTCL?
If the LTCG is tax-free, the LTCL is also tax-free. In other words, any LTCL incurred from October 1, 2004, arising out of sale of equity shares or units of equity-oriented MFs, cannot be set off against any LTCG, even the one arising out of say, housing property. This is the inherent provision of Sec. 10(38) itself.
The following example explains the above provisions:
LTCL from shares Rs 20,000
LTCG from equity MFs Rs 60,000
STCL from shares Rs 40,000
LTCL from non-equity MFs Rs 25,000
STCG from sale of shares Rs 50,000
LTCG from sale of gold Rs 15,000
Now, LTCL from shares cannot be set off since the LTCG from this source (in this case Rs 60,000) is exempted. The LTCL from non-equity MFs of Rs 30,000 can only be adjusted against the LTCG from sale of gold. Therefore, only Rs 15,000 can be adjusted and the balance Rs 10,000 will be non-adjustable. Lastly, the Rs 40,000 STCL from sale of shares can be adjusted against the Rs 50,000 STCG and only the balance Rs 10,000 STCG would be taxable.
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