As an Investor, you often need to be aware of the Income Tax provision on capital gains tax liability arising on your Investment Decisions. Awareness of these provisions would certainly help in minimizing the tax incidence on capital gains and hence effectively increasing your return on Investments. I will briefly explain you the concept and things to remember in a simple manner.
When does Tax liability arise ?
1. When you Sale shares, you attract capital gain tax based on period of your holding. A share if sold within 1 Year of buying will be taxed as Short Term Capital Gain. If you sale a share after holding it for more than 1 year, it will be treated as Long Term Capital Gain. For example if you bought 100 shares of Company “X” on 15th March,2008 and sold them on 1st March,2009 the period of your holding is less than 1 year and hence it would qualify for Short Term Capital Gain. If you sell these shares after 15th March,2009, i.e., after holding it for more than 1 year, it will qualify as Long Term Capital Gain.
2. Short Term capital gain is taxable @15% while Long Term Capital Gain on Sale of Shares is Tax free ! Yes, the tax liability on Short Term and Long Term Capital gains makes it important for you to plan your moves carefully. In the above example, suppose you bought 100 shares of company ‘X” @ Rs.100 and Sold the same @Rs.150. If you sell these shares before 15th March , you will be liable to pay short term capital gain tax on the profit earned. In this case your tax liability will be Rs.750 i.e 15% of ( 100*(150-100)). However, you would have sold your shares on or after 15th March,2009, the profit earned (Rs, 5000 in the above example) would be treated as Long term capital gain and would be Tax free.
3. You are liable to pay tax on Net Short term Capital Gains. This means that If you have earned Rs. 5000 on trading in Company “X” and booked a loss of Rs., 3000 on sales of shares of company “Y” (both should qualify as short term capital transaction), then your tax liability would be calculated on Rs. 2000 i.e., 15% of Rs. 2000. In other words, Short term capital gain can be offset by Short Term Capital Loss. However , you cannot offset a Short Term Capital Gain with Long Term Capital Loss. capital gain
4. Bonus Shares should be considered at Nil Cost of acquisition while calculating the gains. the period of holding should be computed from date of issue of Bonus shares.
5. You can claim cost of acquiring shares such as Brokerage charges, Demat charges while calculating capital gains.
Tax Planning Tips
1. Whenever you plan to sell a share, make sure to look at period of your holding. If you are earning profit on a transaction, you may decide to wait for few more days to convert a short term capital gain to a long term capital gain and enjoy tax free earnings.
2. At the end of financial year, say in the month of March, take a stock of all your holdings and see positions where you can book short term capital loss to offset short term capital gain that you have earned during the year. This way you would reduce your capital gain tax liability for the year. You can again take a position the stock on 1st April. This way you have saved paying tax on your capital gains for the year and still holding shares you have sold to book losses and hence offset the gain. This involves incurring transaction cost on buying and selling the shares and hence keep this in your mind while calculating your net gains.
3. If you are incurring huge loss on a position in any share, and if it is nearing a holding period of 1 Year, you would be better off to sell the shares as Long term capital loss cannot be offset with short term capital gain and hence selling it before 1 year holding period would help you to minimize your capital gain tax liability.
Update March 12th : Chinmay has rightly pointed out that Short term Capital Gain Tax has been increased from 10% to 15% with effect from Financial Year 2008-09. Investors should calculate Short term Capital Gain Tax @15% for their earning in year 2008-09. To avoid confusion I have updated the post accordingly.
Nitin had a query on treatment of capital gain on split Shares. When a company splits its shares, the value of the shares also gets allocated accordingly on the record date. Hence in this case the cost of these shares also gets proportionately divided. In this case , the period of holding will continue to be the same as period of holding of original shares.
For example suppose you bought 100 shares of company “X” with face value of Rs.10 @Rs. 100 Per share. Suppose the share is currently trading at Rs. 150. Now if the company announces a stock split by reducing the face value from Rs. 10 to Rs. 5, you will now hold 200 shares of the company and on the record date, the stock exchanges will publish a proportionately reduced price of the share say Rs. 74 in this case. Since your shareholding has increased from 100 to 200, your cost of acquisition per share has also come down from Rs. 100 to Rs. 50. Now you hold 200 shares of the company at Current price of Rs. 74. If you sell these shares your capital gain will be calculated as (200*(74-50). The period of holding will be determined based on the date of purchase of original shares.
Treatment of Shares related to Rights Issue
If a company has issued Shares through issue of Rights, the cost of acquiring these shares would be the actual price paid to acquire the rights. The period of holding would be counted from date of allotment of rights.
In case you transfer these rights instead of acquiring the shares, the cost of acquisition would be treated as “Nil” and the sale price of the transferred rights would be treated as capital gains.