Salute to multibaggers in your portfolio. The Sensex has surged a whopping 100 per cent from the COVID crash in March 2020 to an all-time high on February 16, 2021. It is still trading above Rs 50,000-mark. Many of you must have incurred handsome gains in your equity portfolio. Now is the time to take stock of it and apply some tax planning hacks to reduce your tax outgo on booked profits.
First thing first. Following are four basic tax rules that you must know:
1) Long-term capital gains (LTCG) are when you hold the stock for more than a year. It is taxed at 10 per cent, but LTCG up to Rs 1 lakh is tax free. Short-term capitals gains (STCG) tax at 15 per cent is levied when the holding period is less than a year.
2) One can set off realised losses (except intra-day and F&O losses) against realised gains. Short-term capital loss (STCL) can be adjusted against both short-term gains as well as long-term gains, but long-term capital loss (LTCL) can be adjusted only against long-term gains.
3) If you don't get to absorb all your STCL and LTCL in a financial year, you may carry it forward for up to eight years. Make sure to declare losses in income tax return (ITR) in the same year you incurred it, and file the ITR in time. If you file it after the due date, carry-forward benefit will not apply.
4) You don't get Chapter-VI deductions on capital gains. However, if you have no other income apart from the equities, basic exemption of up to Rs 2.5 lakh is applicable. This is Rs 3 lakh for senior citizens and Rs 5 lakh for super senior citizens.
Let's explore the tax hacks now:
Harvest your losses, that is, sell your loss-making investments to set off losses against gains. Take a deep dive in your portfolio. Give preference to booking short-term losses over long-term ones. Remember, LTCL can only be set off against LTCG, but STCL can be set off against LTCG and STCG both.
Don't want to sell your conviction? Even if you believe in the long-term potential of the stock you are selling, you may again buy it the very next day. That's how you save taxes smartly.
"While most investors try harvesting their capital losses at the end of the financial year, it can also be used as a regular process to maintain the capital gains at a low level. Although tax-loss harvesting does not restore the loss already borne by the investor on the security, it lessens the loss's severity," says Preeti Khurana, chartered accountant with Cleartax.
"Tax-loss harvesting can be used for both LTCG and STCG. Usually, investors use it for STCG because STCG tax is higher than LTCG tax," she adds.
Book LTCG up to Rs 1 lakh each year
The Rs 1 lakh exemption limit on LTCG is valid for each financial year. "If long-term gain is more than Rs 1 lakh, but up to Rs 2 lakh, investors may consider splitting up the gains in two years to keep the gains below Rs 1 lakh in both years. For instance, if you plan to sell stocks at the end of the financial year, you might consider selling one lot with gains less than Rs 1 lakh before March 31 and the remaining lot after March 31 in the new financial year. This way investors can time their withdrawal and can keep the gains below the exemption limit of Rs. 1 lakh," explains Khurana.
Regular churning of portfolio
If your gains are much more than Rs 2 lakh, splitting the gains in two financial years will not benefit you much. This requires churning the portfolio at regular intervals. "It means the investor might sell the stocks whenever the capital gain would reach Rs 1 lakh and then repurchase them. This will increase their cost of acquisition of shares for future sales and thereby reduce the capital gains liable to tax. Although churning the portfolio will involve added transaction cost, it might still be low compared to the tax outflow," says Khurana.
Section 54-F and 54-EC - only applicable for LTCG
If you invest long-term capital gains in purchasing or constructing a house property, LTCG will be exempt from tax on proportionate basis, depending on the value of the house property. However, if you invest the full amount, that is, long-term returns along with the initial investment, no LTCG will be levied. This exemption comes under Section 54F of the Income-tax Act.
Section 54-EC entails investing long-term capital gains (whole of part of it) in NHAI, REC or any other bonds notified by the central government. This has to be done within six months of selling the capital asset. The invested gains will be exempt from tax.