Article originally published in Guajrati Mid-day newspaper on March 23, 2021. Here is the transcript of the same.
Benjamin Franklin said, there are only 2 things certain in life: Death and Taxes. Life and Death are not in man’s control but with proper planning, we can surely save on some taxes.
Life changed for investors in equity market, when the long-term capital gains (LTCG) on the sale of listed equity shares or equity oriented mutual funds were made taxable from 1 April 2018. In the case of equity investing, long-term means a holding period of more than 12 months from the date of purchase.
Until 2018, LTCG was exempt and investors never even dreamt of paying taxes on LTCG. The introduction of taxes on LTCG was not a welcome decision. However, some relief was provided by making LTCG upto Rs 1 lakh per financial year exempt. LTCG over Rs 1 lakh are taxable at the rate of 10% plus cess 4% without the benefit of indexation.
To explain by way of example, suppose Akbar invests Rs 6 lakhs in listed shares in March 2018. The Value of these shares is Rs 7 lakhs in March 2020 but Akbar does not need the money so he continues to hold the investment. The Value of these shares is Rs 7.5 lakhs in March 2021. Now, Akbar needs the money and so he liquidates the investment. The LTCG on sale of shares is Rs 1.5 lakhs (Sale Value Rs 7.5 lakhs – Cost Rs 6 lakhs). Out of this, Rs 1 lakh is exempt and Akbar pays 10% plus cess of 4% as LTCG tax i.e. Rs 5,200. Here, the actual profit from investments is Rs 1.5 lakhs but after paying tax of Rs 5,200 Akbar left with Rs. 1,44,800 only in his hands.
Is it possible to save LTCG tax even with the above taxation provisions?
Yes with proper planning, we can save tax on LTCG. Suppose that Birbal invests Rs 6 lakhs in equity investments in March 2018 in the same shares as Akbar. The value of these investments becomes Rs 7 lakhs in March 2020. Birbal does not need the money but Birbal is a smart and tax savvy person. So he liquidates the investments in March 2020 and re-invests Rs 7 lakhs in the same shares within next 2 to 3 days. This sale and reinvestment is only a legal transaction and does not affect his investment amount or returns generated. Rs 1 lakh LTCG on sale of investments in March 2020 is exempt for Birbal and the new cost of investments for Birbal under the taxation law is Rs 7 lakhs.
Now say in March 2021, Birbal needs money and he wants to liquidate investments. The value of the investment is Rs 7.50 lakhs. He liquidates the investments. And does not pay any tax as the LTCG for Birbal is only Rs. 50,000 (Sale Value Rs. 7.5 lakhs – new cost Rs. 7 lakhs) which being less than Rs. 1 lakh is exempt.
So, in this transaction when Akbar paid Rs 5,200 tax, Birbal did not pay any tax. By doing these transactions like Birbal on a consistent basis year after year you can save large sums of tax. For the purpose of simplicity, brokerage and other charges have been ignored in this example.
Every financial year, book gains upto Rs. 1 lakh from listed shares and equity oriented mutual funds and save on taxes. This limit of Rs 1 lakh is per financial year per PAN. Hence, these transactions can be done from each family members account to save more tax.
Question : I have bought 1,000 shares of Company A (listed) at Rs 120 each in Feb 2020. Current market price in March 2021 is Rs 300 each. I want to hold these shares for long term. How can I save tax outflow in this case?
Congratulations, your shares have performed extremely well and have generated great returns. Really appreciate that you are looking for long term investment in Equity. Since the investment is held for more than 12 months it will be taxed under LTCG whenever sold. If you sell these shares you will generate profit of Rs 1,80,000 (Sale value Rs 3,00,000 – Cost Rs 1,20,000) and pay tax on Rs 80,000 (Profit Rs 1,80,000 – Exemption of Rs 1,00,000). Tax amount will be Rs. 8,320.
For tax planning, you should sell proportionate investment of 550 shares of Company A and re-purchase it in the next 3 to 4 days. This way, you will stay invested in the shares. Your LTCG from the sale of 550 shares will be Rs 99,000 [Sale Value Rs 1,65,000 – Cost Rs 66,000] which will be exempt and you will not pay any LTCG tax.