Individual taxpayers do not have to pay income tax on long-term capital gains (LTCG) up to Rs 1 lakh earned on the sale of equity shares or equity-oriented mutual funds. Gains from selling of equity shares and equity oriented MFs is considered long-term if it is sold after holding for 12 months or more. However, this exemption is specific to the relevant financial year, and it cannot be carried forward to the next years. So, if you do not sell your holding and continue accumulating gains for a longer period and withdraw a bigger gain, you will need to pay income tax on gains above Rs 1 lakh applicable to that financial year.
"Gains in excess of Rs 1 Lakh on sale of listed equity shares or equity oriented mutual fund held for more than 12 months are subject to long term capital gains (LTCG) tax @10% (plus applicable surcharge and cess)," says Mitesh Jain, Partner, Economic Laws Practice, a law firm.
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How the capital gains tax would be calculated for equity shares and mutual funds
Capital gains taxation is applied by taking out the difference between the sale price and the cost of acquisition. However, the cost of acquisition of equity shares and mutual funds will be calculated differently if it was bought before January 31, 2018. This is because there is a concept of 'grandfathering clause' at play here. Under this clause, if any equity shares or mutual funds are bought before January 31, 2018, then the acquisition price would be taken as the price on January 31, 2018, even if the said share or mutual funds were purchased much earlier.
For example, if an individual purchased a share for Rs 630 in August 2015 and on January 31, 2018, the price of the share was Rs 1,000. Then the cost of acquisition of this share would be Rs 1000 and not Rs 630. So, if the individual sells the share on January 31, 2020, for Rs 1,500, capital gains would be calculated as follows:
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Cost of acquisition: Rs 1000
Sale price: Rs 1500
Capital gains: Rs (1500-1000) = Rs 500
"LTCG income would not added to the total income of the individual. As per section 112A, LTCG income exceeding Rs 1 lakh is taxed at a flat rate and balance income (after deductions if any) is taxed as per applicable slab rate of the individual." says CA Aastha Gupta, Partner, S.K.Gulati & Associates, a CA firm.
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Here's how to not pay any capital gains tax on equity shares and mutual funds
The mechanism to use is called 'tax harvesting' and it is fully legal and permissible. What an individual needs to do is simply sell their listed equity shares and mutual funds and then buy it back after some days to continue their investment planning.
For example, an individual who has 1,000 shares of a company which he bought at Rs 1,100 per share on March 20, 2019. On March 31, 2023, the share price of this company touched Rs 1,189 and the individual sold them. The long-term capital gains are calculated like this: Rs 1189*1000-1100*1000= Rs 89,000. Since the long-term capital gains amount is less than Rs 1 lakh he does not need to pay any income tax. To continue with his investment financial plan, the individual purchased the same listed equity shares of the company on the next trading day which is on or after April 3, 2023.
"This strategy is legal and technically feasible. It is commonly known as tax harvesting, involves selling shares to realise profits within the current year and take advantage of the Rs 1 lakh exemption. Consequently, the shares can be repurchased after the start of the new financial year, allowing gains up to Rs 1 lakh to become non-taxable for the taxpayer with a revised cost of acquisition and revised date of acquisition. This approach serves to reduce investors' tax obligations over time, all while maintaining the risk profile of their investment portfolio," says Neeraj Agarwala, Partner, Nangia Andersen India, a tax and business consulting group.
However, this option comes with its own share of risks. If an individual is using this method to book profits on their equity investments, then there are certain things to keep in mind.
Things to keep in mind when using tax harvesting to reduce total tax liability
Cost and date of acquisition would change: Tax experts say that since the individual who is using the tax harvesting method is essentially selling their equity investments and buying them back in the new financial year, the cost and date of acquisition would change.
"Tax harvesting should be approached with careful financial planning. It's crucial to consider that the date of acquisition for the reacquired share will be adjusted, and the holding period for the reacquired share will commence from the date of reacquisition," says Agarwala. This means that you will again have to hold it for a minimum of 12 months to enjoy Rs 1 lakh exemption on long-term capital gains and in case you have to sell it early you will need to be prepared to pay higher short-term capital gain taxes.
"So, if an opportunity arises to sell the shares with very good profits within 12 months after reacquisition, any gains from the sale will be considered short-term capital gains, subjecting the taxpayer to a 15% tax on the appreciated value of the shares," says Agarwala.
Tax rebate is not available on LTCG income: Individuals get a tax rebate under section 87A if their total income is below Rs 5 lakh or 7 lakh. "Rebate under Section 87A is not available on the tax liability against LTCG income on listed shares and equity oriented mutual funds under Section 112A," says Anand Bathiya, vice president, Bombay Chartered Accountant Society (BCAS).
Litigations may arise: There is no explicit regulation in India that disallows tax harvesting however experts advise individuals to be cautious about using this method. "It is advisable for individuals to be careful about using tax harvesting method as they could potentially be questioned by the income tax authorities during tax scrutiny if the same stock is sold and bought back just to save on taxes," says chartered accountant Bhavik Gandhi, Head, Operations, Mirae Asset Capital Market.
Opportunity loss might exist: Equity markets are volatile, and the prices of shares fluctuate by the second. There is always a chance that the equities that you sold for capital gain benefit may rise suddenly just after your selling. In this case, you may end up losing the gains and have to repurchase the same equity at a higher price
Impact of brokerage and other costs: Depending upon your stockbroker a brokerage and other statutory charges like stamp duty, security transaction charge, other charges would be charged whenever a listed share is bought or sold. "Tax harvesting method would not work effectively if brokerage and other costs are on the higher side. Hence individuals opting to use tax harvesting method to lower their tax outgo should keep this in mind," says Gandhi.
