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Here's a trick to lower your tax on capital gains from equity

Long term capital gains accrued from selling equity shares and equity-oriented mutual funds are exempt from tax for maximum up to Rs 1 lakh in a financial year. The gains in excess of Rs 1 lakh are chargeable at the rate of flat 10 percent.

, ET Bureau|
Last Updated: Jan 06, 2020, 09.34 AM IST
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Savvy investors may also look at tax loss harvesting to offset long term capital gains.
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Have you racked up sizeable capital gains from shares or equity mutual funds this year? It may be worth harvesting some gains if you want to lessen your tax burden.

The last financial year saw the re-introduction of long term capital gains (LTCG) tax on equities. Now, any realised gain from equities over and above Rs 1 lakh in a financial year is taxable at 10%. While small investors would typically not cross this threshold in a year, the gains when allowed to run over many years can balloon. For instance, if you invest Rs 15,000 per month in equity funds, even 12% annualised returns will lead to taxable capital gains within three years (see table). Those who have accumulated a large equity portfolio will also have higher incremental gains.

To prevent gains from building up, experts suggest harvesting. This means booking a portion of your profits and reinvesting the proceeds. So you sell a part of your equity holdings to book long term capital gains, and then buy back the same shares or mutual fund units. Let us suppose you bought 1,000 shares of a company at Rs 80 a share on 1 January 2019 and the stock rose to Rs 130 as of 3 January 2020.

In this scenario, you would have made longterm gains of Rs 50,000 as the holding completed one year. If you sell the shares immediately and buy them back in a few days, your acquisition price and date will be reset to the new purchase price and date of reacquisition. In reality, the share price will fluctuate in the interim. But for the sake of simplicity, let us assume the new purchase price is Rs 130. Now if the stock rose to Rs 200 in another 12 months, your gains on selling the shares will only be Rs 70,000 and still tax free as it is below the Rs 1 lakh threshold. On the other hand, if you allow the gains to run into the second year, your gains would become Rs 1.2 lakh. Of this, Rs 20,000 would be subject to tax at 10%.

Says Sudhir Kaushik, Co-founder and CFO, Taxspanner, “Consider booking profits up to the Rs 1 lakh threshold as it improves tax efficiency over the long term.”

Capital gains can build up over the years
To avoid shelling out huge tax later, consider harvesting some gains regularly.
harvesting-of-gains
Figures highlighted indicate taxability of realised gains

Harvest losses too when you still can
Several stocks are in the red. Book losses to offset any capital gains.
harvest-losses
NOTE: For booking capital loss, sale price should be below purchase price. If pruchase price is below 31 Jan 2018 price, booking capital loss against 31 Jan 2018 is not permitted.
Data compiled by ETIG Database. Source: Capitaline

This exercise can be replicated even when you are investing via SIPs in mutual funds. If you started the SIP about a year ago, start redeeming units after they complete a year and reinvest the proceeds in the same or different fund. This will reset the buying price and ensure your capital gains do not overshoot the Rs 1 lakh tax free threshold. However, if you redeem the units but don’t reinvest, the exercise becomes futile.

Taking gains out without investing an equivalent amount again can upset your asset allocation and impede long-term wealth creation. “Tax harvesting can be more productive when used in conjunction with asset allocation. Use this approach when rebalancing your portfolio,” says Ankur Maheshwari, CEO, Wealth Management, Equirus Capital. Investors must also be mindful of exit loads when selling units for tax harvesting.

Savvy investors may also look at tax loss harvesting to offset long term capital gains. This involves selling holdings currently in losses to offset gains in any other instrument and bring down the tax liability. This may also allow you to effectively nullify tax liability by bringing down your capital gains for the year below the Rs 1 lakh threshold.

Suppose you have sold some shares or fund units during this financial year, incurring gains of Rs 1.4 lakh. Here, Rs 40,000 is liable to be taxed. Now suppose you had bought 1,000 shares of a company at Rs 80 a piece in January last year, which are now trading at Rs 30. If you sell the shares today your long term loss of Rs 50,000 can bring down your aggregate capital gain for the year to Rs 90,000 (Rs 1.4 lakh – Rs 50,000).

Effectively, you will not be liable to pay any tax on capital gains for the year. Alternatively, if you are not able to set off your entire capital loss in the same year, you can carry forward these losses for up to 8 assessment years. Says Maheshwari, “Use tax harvesting to prune bad investments. Don’t exit a good quality fund purely because it is temporarily in losses.”

Investors who wish to offset other long term gains with long term losses may find several opportunities within their portfolios. Those who bought shares or units before 31 January 2018 will have enough to work with. This is the date considered by tax authorities for ‘grandfathering’ of capital gains. Under this rule, the government had pegged the price of a stock or mutual fund unit on 31 January 2018, or the actual purchase price, whichever is higher, as the cost in computing the gain.

For instance, if a stock purchased at Rs 400 in 2017 was sold at Rs 800 in January 2019, but the share closed at Rs 600 on 31 January 2018, the gain for tax computation is Rs 200, not Rs 400. However, if the sale price is Rs 500, you cannot book loss against the 31 Jan 2018 price of Rs 600 as the actual purchase price is lower than the 31 Jan 2018 price. Here, you can book a loss only if sale price is below purchase price of Rs 400. Since the markets have largely tanked since this date, investors may find several harvestable losses in their portfolio. For instance, of the 2,328 listed stocks on the exchanges, as many as 2,003 stocks are in the red, considering 31 January 2018 as date of purchase. Out of the 500 BSE 500 stocks, 340 are showing negative returns.
Click here for all the information and analysis you need for tax-saving this financial year

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