Long Term Capital Gain Tax on Shares

The long-term capital gains tax rate on shares varies depending on factors such as the investor's income level and the type of asset sold.

It is important to have a straightforward overview of this tax, outlining its significance, calculation methods, and implications for investors' financial strategies.

By the end of this article, you will clearly understand how long-term capital gains tax impacts your share sales.

Not all profits from share sales are taxed the same. The Indian government offers a tax break for long-term investments by setting a threshold for long-term capital gains (LTCG) tax on shares. LTCG is different from short-term capital gain on shares.

Here is how it works:

The Threshold:

Up to ₹1 lakh of LTCG earned in a financial year is exempt from tax. This means you do not pay any LTCG tax if your total long-term share sale profits for the year stay below ₹1 lakh.

Tax Rate on LTCG Above the Threshold:

If your LTCG surpasses ₹1 lakh, only the amount exceeding the threshold is taxed. The current tax rate for LTCG on shares above ₹1 lakh is 10%. A surcharge and cess are applied on top of this rate, but the total additional amount typically comes to a few per cent.

For example, let’s say you sold shares for a profit of ₹1.2 lakh in a financial year. In this case, you would only pay LTCG tax on ₹20,000 (₹1.2 lakh - ₹1 lakh exempt threshold).

Budget Updates

Budget updates have significant implications for investors, particularly concerning capital gains tax on shares.

In the 2023 Budget, a notable provision exempts capital gains from intraday trading tax if the proceeds are utilised for acquiring a house property, subject to a capped exemption of ₹10 crores under Section 54F.

Meanwhile, the 2022 Budget introduced measures to restrict the surcharge for Associations of Persons (AOPs) comprising solely companies as members to 15%, applicable when their total income exceeds ₹2 crores.

Additionally, the surcharge on long-term capital gains (LTCG) from listed equity shares and units has been capped at 15%. These updates aim to streamline tax implications and ensure fairness across various investment avenues, thereby influencing investor decisions and strategies.

• Section 112A of the Income Tax Act outlines the conditions under which capital gains tax is applicable. To be subject to this tax provision, the following criteria must be met:

• The sale should involve equity shares, units of an equity-oriented mutual fund, or units of a business trust.

• The securities being sold must qualify as long-term capital assets, indicating a holding period of more than one year.

• Capital gains from the sale must exceed ₹1 lakh.

• Moreover, the purchase and sale of equity shares must be subject to the Securities Transaction Tax (STT).

• Similarly, in the case of equity-oriented mutual fund units or business trusts, the sale transaction must also be liable to STT. These stipulations aim to ensure that taxation applies consistently across different investment instruments and transactions, fostering transparency and compliance within the financial system.

The Grandfathering clause in Section 112A of the Income Tax Act, introduced in 2018, protects investors from being unfairly taxed on long-term capital gains on shares acquired before February 1st, 2018.

Here is how it works:

Before 2018: There was no tax on long-term capital gains from selling shares.

After 2018: A new rule introduced a tax on LTCG exceeding ₹1 lakh.

The Grandfathering clause essentially says:

For shares you owned before February 1, 2018, the cost price used to calculate your LTCG tax can be adjusted to the share's fair market value on January 31st, 2018. This can potentially reduce your LTCG amount and, therefore, your tax liability.

Let us take an example to understand this better:

Imagine you bought shares in 2010 for ₹10 per share. By 2024, the share price has increased to ₹100. If you sell them today, the LTCG would be ₹90 per share, which is ₹100 selling price - ₹10 original cost.

However, with the Grandfathering clause, you can potentially use ₹50, the fair market value on Jan 31, 2018, as your cost price instead. This reduces your LTCG to ₹50 per share, which is ₹100 selling price - ₹50 adjusted cost price.

Calculating long-term capital gains (LTCG) on shares involves several components.

Here is a simple breakdown of the calculation formula to help you understand it better:

LTCG = Sale Price of Shares – (Cost of Acquisition + Cost of Improvement + Transfer Expenses + Other Incidental Charges)

Sale Price of Shares: This refers to the amount received from selling the shares.

Cost of Acquisition: It represents the original cost at which the shares were purchased.

Cost of Improvement: If any improvements were made to the shares, such as renovations or additions, this cost is added here.

Transfer Expenses: These are expenses associated with transferring the shares, including broker fees or any charges incurred during the transaction.

Other Incidental Charges: This includes any additional charges related to acquiring or transferring the shares, like legal fees or other miscellaneous expenses.

Once these components are determined, they are subtracted from the sale price of the shares to calculate the LTCG. Afterward, the applicable long-term capital gains tax is applied based on the prevailing tax laws in the relevant jurisdiction.

This formula helps investors understand how LTCG on shares is computed, ensuring transparency and clarity in tax calculations.

Reducing your capital gains tax liability in India is crucial for investors aiming to maximise their profits. Long-term capital gains (LTCG) tax on shares can significantly affect your earnings, making exploring strategies to minimise this tax burden essential.

Tax Loss Harvesting:

• One method to decrease LTCG tax on shares is through tax loss harvesting. This strategy involves selling off underperforming investments to balance out gains from successful ones. By offsetting gains with losses, you can lower your overall tax liability.

• For instance, if you made a ₹10,000 gain on one stock sale but incurred a ₹5,000 loss on another, your net gain would be ₹5,000, resulting in a lower LTCG tax.

Indexation:

• Indexation is another approach to reduce LTCG tax. It entails adjusting the purchase price of an investment to account for inflation, thereby decreasing taxable gains.

• For example, if you bought a stock for ₹1,00,000 in 2010 and sold it for ₹2,00,000 in 2023, indexation adjusts the purchase price to reflect inflation over this period, reducing the taxable gain and, consequently, the LTCG tax liability.

Other Tax-saving Options:

• Investing in tax-saving instruments like Equity-Linked Savings Schemes (ELSS), premiums for medical plans, the National Pension Scheme (NPS), or a Unit-Linked Insurance Plan (ULIP) can also lower LTCG tax liability.

• These investments offer tax benefits under Section 80C of the Income Tax Act, helping to minimise your overall tax burden. Exploring these options can be instrumental in optimising your investment returns while staying tax-efficient.

Reinvesting your tax return can be a strategic move to make your money work harder for you. If you are pondering how to reinvest your tax return, especially in the context of long-term capital gains tax (LTCG) on shares, consider these steps:

Evaluate Your Investment Portfolio: Start by assessing your current investment portfolio. If you hold shares or stocks that have appreciated over the long term, selling them may trigger an LTCG tax. In such cases, you might explore reinvesting your tax return in other avenues like mutual funds, exchange-traded funds (ETFs), or alternative investment options with potentially lower tax implications.

Invest in Long-Term Growth: Opt for investments geared towards long-term growth. Seek out companies with solid fundamentals, a proven track record, and promising future prospects. Investing in such entities may yield better returns over time, especially if you're willing to hold onto your investments for an extended period.

Consider Tax-Saving Options: Look into tax-saving strategies tailored for LTCG on stocks. Options like indexation, tax-loss harvesting, and investing in tax-efficient instruments such as health insurance plan options, Equity-linked Savings Schemes (ELSS) or National Pension Scheme (NPS) can help reduce your LTCG tax liability. Reinvesting your tax return into these instruments could optimise your tax savings.

Diversify Your Portfolio: Spread out your investment risk and maximise returns by diversifying your portfolio. Consider allocating your tax return across a mix of assets such as stocks, mutual funds, ETFs, and other investment vehicles. Diversification helps cushion against market fluctuations and enhances the overall stability of your portfolio.

Long-term capital gains (LTCG) tax on shares can be exempted under Section 54F, providing individuals with a pathway to savings. To qualify, one must reinvest the net proceeds from the share sale into up to two real estate properties. Previously, before Budget 2019, this exemption was limited to one property.

Reinvestment should occur within one year before the sale or within two years after. Alternatively, one can invest in a construction project, which must be completed within three years of the share sale.

For a complete tax exemption on LTCG, reinvest the entire net proceeds. If this is not feasible, the exemption is calculated based on the portion invested:

Exemption on Capital Gain = (Capital Gains × Cost of New House) / Net Proceeds

However, if the new property is sold within three years, the LTCG exemption is revoked. Although the introduction of income tax on LTCG aimed to be cumbersome, "Grandfathering" provisions were introduced to mitigate the impact.

These provisions ensured that gains accrued before the introduction of the tax were not taxed, thereby easing the transition for investors.

Understanding long-term capital gains tax on shares is crucial for making wise investment choices. Considering the tax consequences when selling shares held for over a year, as well as the exemptions provided by the Income Tax Act, is essential.

Effective planning and employing tax-efficient investment strategies can help reduce tax liabilities and optimise investment returns, even despite LTCG on unlisted shares.

Mastering LTCG tax on shares is fundamental for constructing a diversified and fruitful investment portfolio. By staying informed and proactive, you can navigate investment decisions skilfully, which will bring you closer to achieving your financial objectives.

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