Taxability of Stock Market Transaction
“The avoidance of taxes is the only intellectual pursuit that still carries any reward.”
John Maynard Keynes
It is important for you to know the correct tax implications of various transactions pertaining to stock market investment. Some people presume there are no taxes on stock market transactions. Some like to leave the complexities of taxation to the chartered accountant. Some just like to close their eyes to it (‘Not my cup of tea’). No doubt taxation in India is complex, yet taxation of securities is not complex, and the provisions are unambiguous. Since the tax is a cost to be factored in while calculating return on investments, it is important that you understand your taxes well. The government loves to present tax in a language incomprehensible to most of its subjects except a small tribe of tax experts. Let me hack it for you and present it in plain English.
The Income Tax Act likes to distinguish between an investor, a speculator, and a trader for tax treatment. If you are buying and selling shares intra-day (i.e. you square off your transactions without taking delivery), you are considered a speculator. If you buy and sell frequently, with each stock coming in and going out of your demat account, you may consider yourself a trader.
If you are an investor, income arising from the sale of your shares is considered as capital gains. Income from trading is considered business income. We will discuss the two categories and their subcategories.
First, investment income. Since you are reading this book, I presume, you are a long-term investor and are more interested in this section. Let us understand the taxability applicable to you as an investor. Tax depends upon the holding period (i.e. for how long you have held the share before selling it off). The government encourages long-term investment; you pay less tax when you hold a share for the long term. The law divides income from capital gains into (a) short-term capital gains and (b) long-term capital gains. Let us understand the two concepts.
The law has a simple definition of short term. An investment held for less than one year is considered a short-term investment, and investment held for more than a year is considered a long-term investment. This is fantastic from the point of view of investors. Since most of you will hold many of your investments way beyond one year, so your investments will fall in the category of long-term investment, qualifying for soft tax treatment.
Short-Term Capital Gains (STCG)
When the shares are sold within 12 months of their purchase, the profit on the sale of such shares is called the short-term capital gains and is taxed at a flat rate of 15%.
Here’s an example. I buy 100 shares of Maruti Suzuki on June 2018 for ₹6,000 a share and sell them off in November 2018 for ₹6,800. The short-term capital gains will be:
Sale price ₹6,80,000
Purchase price ₹6,00,000
Short-term capital gains ₹80,000
Tax at 15% ₹12,000
Please keep a couple of things in mind:
1. Short-term capital gains are taxed at a flat rate of 15%. This is likely to be lower than the rate at which your other income is taxable. Of course, this is higher than the tax on long-term capital gains. Still, tax at 15% may be considered quite a low rate of taxes. My wish is that the readers of this book change their investment strategy and stay invested for the long term so they pay even fewer taxes than this.
2. This concession on short-term capital gains is available only to a special class of assets, which includes equity shares. The concession is not available regarding other class of assets (for example, land, and machines) where tax treatment is different.
3. The law requires that this concessional treatment is available only if the securities transactions tax (STT) has been paid on the sale of such shares. STT is the tax that your broker collects from you when you sell your shares through him. It implies that your shares are being sold through a stock exchange in India (your contract note from the broker will show details of STT paid) and are not off-market transactions or sale against buy-back offer by the company, in which cases this concessional treatment will not be available to you.
Let us now consider the long-term capital gains.
Long-Term Capital Gains (LTCG)
Long-term capital gains arise when you hold your investments for over one year. The rate of tax on capital gains is 10%, but the effective tax rate is likely to be much lower, for the reasons explained below.
• If the capital gains during the year are less than ₹1,00,000, there will be no tax. LTCG up to ₹1,00,000 is exempt from tax.
• If your LTCG is ₹1,50,000, the tax will be payable on ₹50,000 alone after deducting the exemption of ₹1,00,000.
• On capital gains beyond ₹1,00,000, the law allows you concessions to reduce your liability further. Suppose you had bought 100 shares of Azko Nobel in 2015 for ₹1,000 a share and you sell them on November 2018 at ₹1,500 per share, the tax treatment will be as follows;
purchase price ₹1,00,000
sale price ₹1,50,000
There is a capital gain of ₹50,000 in the transaction, but as said before, let us explore the additional concessions available.
The law says for shares purchased before 31 January 2018 which are long-term capital assets (that is, held for over 12 months), you have an option of substituting the price as of 31 January 2018 instead of the purchase price. Let us say the price on 31 January 2018 is ₹1,200.
Now the figures change as below:
purchase price (deemed) ₹1,20,000
sale price ₹1,50,000
Voila! The capital gain has been reduced to ₹30,000 now instead of ₹50,000.
The rate of tax being 10%, your tax will be ₹3,000. If you have sold no other shares during the year, there will be no tax; the exemption of ₹1,00,000 will take care of that.
Please keep these in mind:
1. As explained earlier, the concessional treatment will be available only if the STT has been paid on the transaction.
2. This special treatment is available to equity shares and some special assets alone.
Let us now consider taxability where income is not considered a capital gain but as a business income.
A. Income from intraday trading. Income from intraday trading is considered as a speculative business income. If you buy in the morning and sell in the afternoon or if you sell in the morning and buy it back in the evening, the income is considered a speculative business income.
B. Income from futures and options (F & O). F & O may be speculative instruments from the point of view of readers of this book; however, tax laws do not consider them speculative because some people use F & O for hedging. So they may be legitimate, non-speculative transactions (though, I suspect, the lawmakers want to promote F & O, thus this special treatment).
Income from the speculative and the non-speculative businesses is clubbed together and added to your income and charged to tax at the normal rate. The rate of tax depends upon your income slab and can vary from 0% to 30%. The only difference between the income from a speculative business and the income from a non-speculative business is that losses arising out of the speculative business (to recall, intraday trading) cannot be set off against the income arising out of the non-speculative business (that is, F & O). In short, they discourage intraday trading but not F & O.
Tax on Dividends
Dividends received from an Indian company are tax-free. The company is required to pay a dividend distribution tax before it pays you a dividend. As far as an investor is concerned, whatever he gets from his investments as the dividend is exempt from tax.
However, in the case of a resident individual/HUF/firm, the dividend shall be chargeable to tax at 10% if the aggregate amount of the dividend received from a domestic company during the year exceeds ₹10,00,000. Thus, if you receive ₹12 lakhs as dividends, after deducting the exemption of ₹10 lakhs, the remaining 2 lakhs will be put to tax at 10%, and the total tax will be ₹20,000.
Note that dividends received from foreign companies are taxable.
Tax Is an Important Variable to Consider
Having understood the taxability of investment income, let us delve deeper into it. This book is about long-term investment and discourages speculation and short-term investments. Our investment periods are 5, 10, 20, or 30 years—or even a lifetime. So not many of your transactions will fall under taxation for trading and for short-term capital gains. Only a few would come in the category of short-term capital gains; for example, you buy a stock only to discover later that your fundamental assumptions were wrong, so you need to sell them. In my investing life of more than 30 years, I have not earned a single rupee from either speculative or non-speculative trading. I hope you also emulate my example.
Dividends are a welcome source of income, and the best part is, it comes tax-free. However, the dividend payout ratio of good companies is low. Whatever you get is tax-free, but you get little.
Let us talk about the tax we all are concerned with: the tax on long-term capital gains. The tax rate is 10%. This 10% tax is payable when you sell your shares. If you are following the investment philosophy explained in this book, you will sell your shares after holding them for many, many years. The liability arises at the exit point. It means as your capital continues to appreciate, you pay no tax. You can watch your investment turn into a ten-bagger or a multi-bagger. Without paying a cipher penny as the tax. Only when you sell it will the liability be attracted. If you understand the time value of money, the liability paid ten years from now has very little monetary value now. Your effective rate of taxation thus comes to a ridiculously low figure.
A short-term investor pays a high tax. First, the rate of tax to a short-term investor can range from 15% to 30%, depending upon whether he is a speculator or a short-term investor. Second, the tax is required to be paid in advance or during the year in which he earns it. Thus, his outflow is higher, and it’s earlier. This reduces the funds available to him for compounding, reducing the overall return.
STT is also a major dent on the corpus of a short-term investor. The short-termer trades frequently, and he pays higher STT since the STT is to be paid on every contract note. The long-term investor buys far too infrequently and sells even less infrequently. Thus, he saves a lot from STT. STT is to be paid upfront on every transaction, and thus it reduces the investible funds, resulting in lower compounding. One often-ignored component is the brokerage paid on transactions. The brokerage curve runs parallel to the STT curve, and the more frequently you trade, the more money you make for your broker. When you trade frequently, you deserve a letter of appreciation from two sets of people you toil for: the government and your broker.
(Dr. Tejinder Singh Rawal is the author of the best-selling book ‘Loads of Money: Guide to Intelligent Stock Market Investing: Common Sense Strategies for Wealth Creation.’)
John Maynard Keynes
It is important for you to know the correct tax implications of various transactions pertaining to stock market investment. Some people presume there are no taxes on stock market transactions. Some like to leave the complexities of taxation to the chartered accountant. Some just like to close their eyes to it (‘Not my cup of tea’). No doubt taxation in India is complex, yet taxation of securities is not complex, and the provisions are unambiguous. Since the tax is a cost to be factored in while calculating return on investments, it is important that you understand your taxes well. The government loves to present tax in a language incomprehensible to most of its subjects except a small tribe of tax experts. Let me hack it for you and present it in plain English.
The Income Tax Act likes to distinguish between an investor, a speculator, and a trader for tax treatment. If you are buying and selling shares intra-day (i.e. you square off your transactions without taking delivery), you are considered a speculator. If you buy and sell frequently, with each stock coming in and going out of your demat account, you may consider yourself a trader.
If you are an investor, income arising from the sale of your shares is considered as capital gains. Income from trading is considered business income. We will discuss the two categories and their subcategories.
First, investment income. Since you are reading this book, I presume, you are a long-term investor and are more interested in this section. Let us understand the taxability applicable to you as an investor. Tax depends upon the holding period (i.e. for how long you have held the share before selling it off). The government encourages long-term investment; you pay less tax when you hold a share for the long term. The law divides income from capital gains into (a) short-term capital gains and (b) long-term capital gains. Let us understand the two concepts.
The law has a simple definition of short term. An investment held for less than one year is considered a short-term investment, and investment held for more than a year is considered a long-term investment. This is fantastic from the point of view of investors. Since most of you will hold many of your investments way beyond one year, so your investments will fall in the category of long-term investment, qualifying for soft tax treatment.
Short-Term Capital Gains (STCG)
When the shares are sold within 12 months of their purchase, the profit on the sale of such shares is called the short-term capital gains and is taxed at a flat rate of 15%.
Here’s an example. I buy 100 shares of Maruti Suzuki on June 2018 for ₹6,000 a share and sell them off in November 2018 for ₹6,800. The short-term capital gains will be:
Sale price ₹6,80,000
Purchase price ₹6,00,000
Short-term capital gains ₹80,000
Tax at 15% ₹12,000
Please keep a couple of things in mind:
1. Short-term capital gains are taxed at a flat rate of 15%. This is likely to be lower than the rate at which your other income is taxable. Of course, this is higher than the tax on long-term capital gains. Still, tax at 15% may be considered quite a low rate of taxes. My wish is that the readers of this book change their investment strategy and stay invested for the long term so they pay even fewer taxes than this.
2. This concession on short-term capital gains is available only to a special class of assets, which includes equity shares. The concession is not available regarding other class of assets (for example, land, and machines) where tax treatment is different.
3. The law requires that this concessional treatment is available only if the securities transactions tax (STT) has been paid on the sale of such shares. STT is the tax that your broker collects from you when you sell your shares through him. It implies that your shares are being sold through a stock exchange in India (your contract note from the broker will show details of STT paid) and are not off-market transactions or sale against buy-back offer by the company, in which cases this concessional treatment will not be available to you.
Let us now consider the long-term capital gains.
Long-Term Capital Gains (LTCG)
Long-term capital gains arise when you hold your investments for over one year. The rate of tax on capital gains is 10%, but the effective tax rate is likely to be much lower, for the reasons explained below.
• If the capital gains during the year are less than ₹1,00,000, there will be no tax. LTCG up to ₹1,00,000 is exempt from tax.
• If your LTCG is ₹1,50,000, the tax will be payable on ₹50,000 alone after deducting the exemption of ₹1,00,000.
• On capital gains beyond ₹1,00,000, the law allows you concessions to reduce your liability further. Suppose you had bought 100 shares of Azko Nobel in 2015 for ₹1,000 a share and you sell them on November 2018 at ₹1,500 per share, the tax treatment will be as follows;
purchase price ₹1,00,000
sale price ₹1,50,000
There is a capital gain of ₹50,000 in the transaction, but as said before, let us explore the additional concessions available.
The law says for shares purchased before 31 January 2018 which are long-term capital assets (that is, held for over 12 months), you have an option of substituting the price as of 31 January 2018 instead of the purchase price. Let us say the price on 31 January 2018 is ₹1,200.
Now the figures change as below:
purchase price (deemed) ₹1,20,000
sale price ₹1,50,000
Voila! The capital gain has been reduced to ₹30,000 now instead of ₹50,000.
The rate of tax being 10%, your tax will be ₹3,000. If you have sold no other shares during the year, there will be no tax; the exemption of ₹1,00,000 will take care of that.
Please keep these in mind:
1. As explained earlier, the concessional treatment will be available only if the STT has been paid on the transaction.
2. This special treatment is available to equity shares and some special assets alone.
Let us now consider taxability where income is not considered a capital gain but as a business income.
A. Income from intraday trading. Income from intraday trading is considered as a speculative business income. If you buy in the morning and sell in the afternoon or if you sell in the morning and buy it back in the evening, the income is considered a speculative business income.
B. Income from futures and options (F & O). F & O may be speculative instruments from the point of view of readers of this book; however, tax laws do not consider them speculative because some people use F & O for hedging. So they may be legitimate, non-speculative transactions (though, I suspect, the lawmakers want to promote F & O, thus this special treatment).
Income from the speculative and the non-speculative businesses is clubbed together and added to your income and charged to tax at the normal rate. The rate of tax depends upon your income slab and can vary from 0% to 30%. The only difference between the income from a speculative business and the income from a non-speculative business is that losses arising out of the speculative business (to recall, intraday trading) cannot be set off against the income arising out of the non-speculative business (that is, F & O). In short, they discourage intraday trading but not F & O.
Tax on Dividends
Dividends received from an Indian company are tax-free. The company is required to pay a dividend distribution tax before it pays you a dividend. As far as an investor is concerned, whatever he gets from his investments as the dividend is exempt from tax.
However, in the case of a resident individual/HUF/firm, the dividend shall be chargeable to tax at 10% if the aggregate amount of the dividend received from a domestic company during the year exceeds ₹10,00,000. Thus, if you receive ₹12 lakhs as dividends, after deducting the exemption of ₹10 lakhs, the remaining 2 lakhs will be put to tax at 10%, and the total tax will be ₹20,000.
Note that dividends received from foreign companies are taxable.
Tax Is an Important Variable to Consider
Having understood the taxability of investment income, let us delve deeper into it. This book is about long-term investment and discourages speculation and short-term investments. Our investment periods are 5, 10, 20, or 30 years—or even a lifetime. So not many of your transactions will fall under taxation for trading and for short-term capital gains. Only a few would come in the category of short-term capital gains; for example, you buy a stock only to discover later that your fundamental assumptions were wrong, so you need to sell them. In my investing life of more than 30 years, I have not earned a single rupee from either speculative or non-speculative trading. I hope you also emulate my example.
Dividends are a welcome source of income, and the best part is, it comes tax-free. However, the dividend payout ratio of good companies is low. Whatever you get is tax-free, but you get little.
Let us talk about the tax we all are concerned with: the tax on long-term capital gains. The tax rate is 10%. This 10% tax is payable when you sell your shares. If you are following the investment philosophy explained in this book, you will sell your shares after holding them for many, many years. The liability arises at the exit point. It means as your capital continues to appreciate, you pay no tax. You can watch your investment turn into a ten-bagger or a multi-bagger. Without paying a cipher penny as the tax. Only when you sell it will the liability be attracted. If you understand the time value of money, the liability paid ten years from now has very little monetary value now. Your effective rate of taxation thus comes to a ridiculously low figure.
A short-term investor pays a high tax. First, the rate of tax to a short-term investor can range from 15% to 30%, depending upon whether he is a speculator or a short-term investor. Second, the tax is required to be paid in advance or during the year in which he earns it. Thus, his outflow is higher, and it’s earlier. This reduces the funds available to him for compounding, reducing the overall return.
STT is also a major dent on the corpus of a short-term investor. The short-termer trades frequently, and he pays higher STT since the STT is to be paid on every contract note. The long-term investor buys far too infrequently and sells even less infrequently. Thus, he saves a lot from STT. STT is to be paid upfront on every transaction, and thus it reduces the investible funds, resulting in lower compounding. One often-ignored component is the brokerage paid on transactions. The brokerage curve runs parallel to the STT curve, and the more frequently you trade, the more money you make for your broker. When you trade frequently, you deserve a letter of appreciation from two sets of people you toil for: the government and your broker.
(Dr. Tejinder Singh Rawal is the author of the best-selling book ‘Loads of Money: Guide to Intelligent Stock Market Investing: Common Sense Strategies for Wealth Creation.’)
No comments have been added yet.
