EFFECTIVE TAX PLANNING TOOLS FOR LAST MINUTE RESORT FROM CAPITAL GAIN TAXES

The financial year is coming to a close. Are you worried about the capital gain taxes on the income generated from Stock Market/Mutual Funds in the Bull Run? If so, it is important to plan your long-term capital gains in equities as they are no longer tax free. What if you could take advantage of a fall in the value of the asset in the portfolio to reduce the tax liability and to rebalance the portfolio? Are you wondering how it is possible? Try Tax-Loss Harvesting!

New to this term, lets understand it in a simple and better manner.

FIRST THINGS FIRST !!

To understand how you can use tax harvesting to reduce your long-term capital gains, you first need to know how long-term capital gains are taxed.

1. Till 2018, long-term capital gains on equity were tax-free.

2. Long-term capital gains (subject to grandfathering exemption) on equity/equity oriented mutual funds worth Rs 1 lakh in a financial year are tax exempt.

3. Capital gains earned over and above ₹1 lakh on selling equities, including shares and mutual funds are taxed at the rate of 10% now

4. Any short-term capital gains are taxed at a flat rate of 15%.

Capital asset (in case of equity shares and equity oriented mutual funds) is said to be long term capital asset if the asset is held for more than 12 months.

In case of the Balanced/Hybrid Mutual Funds, if the 65% allocation is in stocks, the same will be treated at par with equity oriented mutual funds.

WHAT IS TAX LOSS HARVESTING?

Tax-loss harvesting is the practice of selling a security that has experienced a loss. By realizing, or “harvesting” a loss, investors are able to offset taxes on both gains and income. The shares have to move out of the demat account through a delivery sell transaction and can be subsequently purchased the next day.

The sold security is replaced by a similar one, maintaining an optimal asset allocation and expected returns.

HOW DOES THIS ACTUALLY WORK?

Most of the investors prefer using this strategy at the end of the financial year when they need to file returns.

Tax harvesting can be done in two different manner:

1. Tax Harvesting through Set off of losses

2. Tax Harvesting of Long term capital gains.

TAX HARVESTING THROUGH SET OFF OF LOSSES

Tax-loss harvesting starts with the sale of the stock or an equity fund which is experiencing a consistent price decline. You feel that the security has lost most of its value and chances of a rebound are bleak. Once the loss is realised, you offset it against capital gains that your portfolio has earned over the period.

How to Reduce Capital Gains Tax Liability for the Year

For example,

Assume you have made Rs. 1 Lac in short-term capital gains this year.

You will need to pay 15% of this as taxes or Rs. 15000 (STCG).

Also, assume that you currently hold stocks that are having an unrealized loss of Rs. 60,000. You can sell these stocks to reduce your net STCG to Rs 40,000. You would hence have to pay 15% of Rs. 40,000 or Rs. 6,000 as taxes

Tax payable (without Tax Harvesting) – Rs. 15,000 [15%*1,00,000]

Tax Payable (with Tax Harvesting) – Rs. 6,000 [15%*(1,00,000-60,000)]

Clearly, the method enables a saving of Rs. 9,000 in taxes.

TAX HARVESTING OF LONG TERM CAPITAL GAINS

Under this method, the taxpayer can book long-term gains in equities to the extent of ₹1 lakh and reinvest the same. The value at which the equities are reinvested is the new cost of acquisition. This process can be repeated every year to take advantage of the ₹1 lakh exemption in case of LTCG.

Through this, one can save tax of up to ₹10,000 every year. This exemption is available on the aggregate long-term capital gains from equity-oriented mutual funds and stocks.

For example

Assume you have invested Rs. 5,00,000 in an Equity Mutual fund on 15th Jan 2020, and on Jan 19th, 2021, the value of this investment becomes Rs. 5,90,000. Further, on 31st January, 2022, the value of this investment has further moved up to Rs. 6,50,000.

When we redeem on 31st January, 2022, your gains will be Rs. 1,50,000 (Rs. 6,50,000 – 5,00,000) and you would have needed to pay 10% tax on the amount that exceeded the limit of Rs. 1 lakh. So a tax of Rs. 5,000 (10% of 50,000).

If we follow tax harvesting method: Now, if you redeem the investment on 19th January 2021, your gains will Rs. 90,000 (Rs. 5,90,000 – 5,00,000) and your tax liability will be zero as the gains doesn’t exceed the limit of Rs. 1 Lakh in a financial year.

Next, you invest this entire amount, i.e., Rs. 5,90,000 soon after redeeming. Your investment cost will be reset to Rs. 5,90,000, along with the date of investment.

Now, since your investment value increases to Rs. 6,50,000 after another year. When you redeem, your gains will be Rs. 60,000 – which is still less than the Rs. 1 lakh limit and no tax liability will arise for this financial year.

This is how tax-loss harvesting acts as a critical strategy to save tax for many investors. A good way to use tax-loss harvesting is to remove underperforming funds from the portfolio and not exit from good funds that might have seen a small blip in the short term.

THINGS TO REMEMBER WHILE TAX HARVESTING

1. While computing the long-term capital gains and its harvest opportunity, the first 1L of long-term gains is tax-free.

2. Tax harvesting is applicable on realised profit and losses. Unrealised gains or losses are not taxed.

3. When we sell the stocks/mutual funds, the sell is in FIFO Mode i.e. First In First Out. It should be kept in mind while deciding the period of holding of the stocks/mutual funds.

4. Long-term capital losses can be set-off against only long-term capital gains. You cannot set-off long-term capital losses against short-term capital gains.

5. Short-term capital losses can be set-off against either short-term capital gains or long-term capital gains.

6. Do remember to reinvest the money immediately. If you redeem the units but don’t reinvest, the strategy becomes meaningless.

7. It is also important to consider the cost involved in tax harvesting such as charges in the form of Security transaction tax, stamp duty, brokerage and so on, which are most likely not more than 1% of the amount.

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Disclaimer: The above article has been compiled for educational purpose only. For any financial planning including tax planning and business consultancy, the author can be reached at [email protected]

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Qualification: CA in Job / Business
Company: CHARTERED ACCOUNTANTS
Location: Delhi, Delhi, India
Member Since: 09 Feb 2019 | Total Posts: 15
Experienced Chartered Accountant with a demonstrated history of working in the financial services industry, skilled in Statutory Audits, Income Tax, GST Compliances, Auditing, Financial Accounting and Financial Reporting. View Full Profile

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2 Comments

  1. Kulwant Singh says:

    Sir, If my income from all sources (except LTCG ) is say, Rs. 4,80,000/- and LTCG is 1,15,000/- for AY 2021-22, will benefit of Sec 87A be available to me as LTCG upto Rs. 1 lakh is non taxable.

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