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Home / Glossary / Capital Gains / Capital Gains on Shares

Introduction

Capital gains on shares represent the profit earned from selling shares at a higher price than the purchase price. Understanding how these gains are taxed is crucial for investors looking to maximize their returns while complying with tax laws. This guide explores the different types of capital gains on shares, the tax implications, and strategies to manage these taxes effectively.

What Are Capital Gains on Shares?

Capital gains on shares refer to the profit made when shares are sold at a higher price than they were bought. The difference between the sale price and the purchase price constitutes the capital gain. These gains can be categorized into short-term and long-term capital gains based on the holding period of the shares.

Types of Capital Gains on Shares

Capital gains on shares refer to the profit realized when shares are sold at a price higher than the purchase price. These gains are categorized into two types:

1. Short-Term Capital Gains (STCG)

Short-term capital gains arise when shares are sold within 12 months of their acquisition. These gains are usually subject to a higher tax rate compared to long-term capital gains.

Characteristics:

  • Short holding period of up to 12 months.
  • More common among traders and investors looking for quick returns.

Example: If you buy shares of a company for ₹100,000 and sell them after 8 months for ₹120,000, the ₹20,000 profit is considered STCG.

2. Long-Term Capital Gains (LTCG)

Long-term capital gains occur when shares are sold after being held for more than 12 months. These gains are often subject to a lower tax rate, but the specific rate and exemptions can vary depending on the prevailing tax laws.

Characteristics:

  • Longer holding period of more than 12 months.
  • Favored by long-term investors seeking to benefit from appreciation over time.

Example: If you buy shares for ₹100,000 and sell them after 2 years for ₹150,000, the ₹50,000 profit is considered LTCG.

You may also want to know Capital Gains Exemption

Tax Implications of Capital Gains on Shares

The tax treatment of capital gains on shares depends on whether the gains are classified as STCG or LTCG:

1. Tax on Short-Term Capital Gains (STCG)

Relevant Section: Section 111A of the Income Tax Act.

Tax Rate: In India, the government taxes short-term capital gains on shares at a flat rate of 15% under Section 111A of the Income Tax Act, provided you sell the shares on a recognized stock exchange and pay the Securities Transaction Tax (STT). If you don’t pay the STT, the gains are taxed according to your income tax slab rate.

You pay a 15% tax on short-term capital gains from the sale of equity shares or equity-oriented mutual funds when you pay the Securities Transaction Tax (STT).

Example: If you have ₹50,000 in STCG from selling shares, your tax liability will be ₹7,500 (15% of ₹50,000).

2. Tax on Long-Term Capital Gains (LTCG)

Relevant Section: Section 112A of the Income Tax Act.

Tax Rate: Long-term capital gains on shares are subject to a tax rate of 10% if the gains exceed ₹1 lakh in a financial year, without the benefit of indexation. This tax applies to shares sold on or after April 1, 2018, where the STT has been paid both at the time of purchase and sale.

LTCG on equity shares and equity-oriented mutual funds is exempt up to ₹1 lakh per financial year. Gains exceeding ₹1 lakh are taxed at 10% without the benefit of indexation.

Example: If you have ₹1.5 lakh in LTCG, you can exempt the first ₹1 lakh, and you will pay 10% tax on the remaining ₹50,000, resulting in a tax liability of ₹5,000.

You may also want to know Long Term Capital Gain on Shares

Calculating Capital Gains on Shares

Short-Term Capital Gains Calculation

To calculate short-term capital gains, use the following formula:

  • Short-Term Capital Gain = Sale Price − (Purchase Price+Expenses related to sale)

Long-Term Capital Gains Calculation

To calculate long-term capital gains, use the following formula:

  • Long-Term Capital Gain = Sale Price−(Purchase Price+Expenses related to sale) − Exemption of ₹1 lakh (if applicable)

Exemptions and Deductions

Certain exemptions and deductions can help reduce the taxable amount of capital gains on shares:

1. Section 54EC Exemption

Investors can avail of exemptions under Section 54EC by investing the capital gains in specified bonds issued by the National Highways Authority of India (NHAI), Rural Electrification Corporation (REC), or other notified bonds within six months of the transfer. The maximum investment limit is ₹50 lakh in a financial year, and the bonds have a lock-in period of five years.

2. Grandfathering Clause

For shares purchased before January 31, 2018, and sold after April 1, 2018, the cost of acquisition for calculating long-term capital gains is higher than the actual purchase price or the fair market value as of January 31, 2018. The grandfathering clause ensures that you are not taxed on gains accrued up to January 31, 2018.

3. Exemption for Long-Term Capital Gains

Threshold: As per Section 112A, LTCG on equity shares is exempt up to ₹1 lakh in a financial year.

Example: If your LTCG for the year is ₹90,000, no tax will be levied.

4. Deductions Under Chapter VI-A

Available Deductions: You can claim deductions under Chapter VI-A (like Section 80C, 80D) while computing your total taxable income. However, these deductions do not directly apply to capital gains but can reduce the overall tax liability.

5. Set-Off and Carry Forward of Losses

Set-Off: You can set off capital losses against capital gains. Set off a Short-Term Capital Loss (STCL) against both Short-Term Capital Gains (STCG) and Long-Term Capital Gains (LTCG), while you can only set off a Long-Term Capital Loss (LTCL) against LTCG.

Carry Forward: If your losses exceed gains, you can carry forward the remaining loss for up to 8 years to set off against future gains.

Strategies for Managing Capital Gains Tax on Shares

Managing capital gains tax efficiently requires strategic planning and awareness of tax laws:

1. Holding Period Optimization

To benefit from the lower tax rate on LTCG, consider holding shares for more than 12 months before selling. This can significantly reduce your tax liability, especially on large gains.

2. Timing the Sale of Shares

Plan your sales to maximize the ₹1 lakh exemption on LTCG each financial year. If your gains exceed ₹1 lakh, consider staggering sales across different years to minimize the taxable amount.

3. Tax-Loss Harvesting

Sell underperforming shares at a loss to offset gains from profitable investments. This reduces your overall capital gains and, consequently, your tax liability.

4. Investing in Tax-Efficient Instruments

Consider investing in equity-oriented mutual funds, which offer favorable tax treatment on gains compared to other instruments. Also, explore options like ELSS (Equity-Linked Savings Scheme), which provides tax benefits under Section 80C.

5. Utilizing Exemptions on Gifts

Gifting shares to family members (e.g., spouse, children) in lower tax brackets can help reduce tax liability, as the tax burden on gains may be lower or exempt altogether.

Conclusion

It is important to understand the types of capital gains on shares, the associated tax implications, and the available exemptions and deductions to have effective tax planning. By employing strategies such as holding period optimization, tax-loss harvesting, and careful timing of share sales, investors can manage and minimize their capital gains tax liability, thereby enhancing their overall returns.

As tax laws and rates may change, staying updated with the latest regulations and seeking professional financial advice to navigate the complexities of capital gains taxation is advisable.

Frequently Asked Questions

What is the difference between short-term and long-term capital gains on shares?

Short-term capital gains on shares are realized when shares are sold within 12 months of purchase and are taxed at a higher rate. Long-term capital gains occur when shares are sold after being held for more than 12 months and are taxed at a lower rate.

How is a short-term capital gain tax on shares calculated?

Short-term capital gain tax is calculated by subtracting the purchase price and related expenses from the sale price. The resulting gain is taxed at a flat rate of 15% if STT is paid, otherwise, it is taxed according to the individual’s income tax slab rate.

What is the tax rate for a long-term capital gain on shares?

Long-term capital gains on shares are taxed at 10% if the gains exceed ₹1 lakh in a financial year, without the benefit of indexation.

What is the grandfathering clause for long-term capital gains?

The grandfathering clause ensures that gains accrued up to January 31, 2018, are not taxed. For shares purchased before this date, the cost of acquisition for calculating long-term capital gains is higher than the actual purchase price or the fair market value as of January 31, 2018.

Can I offset my capital gains with losses from other investments?

Yes, investors can use tax-loss harvesting to offset capital gains with losses from other investments, thereby reducing their overall tax liability.

What is the lock-in period for Section 54EC bonds?

The lock-in period for Section 54EC bonds is five years. These bonds are non-transferable and must be held for the entire lock-in period to claim the capital gains exemption.

How can I reduce my capital gains tax on shares?

Investors can reduce their capital gains tax by using strategies such as tax-loss harvesting, holding shares for more than 12 months to qualify for long-term capital gains tax rates, and utilizing available exemptions and deductions like Section 54EC bonds.

Is there a limit on the amount of capital gains exempted under the grandfathering clause?

There is no specific limit on the amount of capital gains exempted under the grandfathering clause. The exemption applies to the appreciation of shares until January 31, 2018, ensuring that gains accrued before this date are not taxed.

What expenses can be deducted when calculating capital gains on shares?

Expenses related to the sale of shares, such as brokerage fees, securities transaction tax (STT), and other charges, can be deducted when calculating capital gains.

Are dividends from shares subject to capital gains tax?

No, dividends from shares are not subject to capital gains tax. Instead, they are taxed as income from other sources at the applicable income tax slab rates.

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