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What is Tax Loss Harvesting?

Tax loss harvesting is a technique to minimise your taxes on the gains earned by you on sale of your investments. For example – there are few shares in your portfolio which are giving heavy losses and there are also few shares in your portfolio which are giving good returns. In case you want to liquidate the money invested along with minimising your taxes, you can sell the shares which are giving heavy losses as well as the shares which are giving good returns so that the losses will be set-off with the returns subject to satisfying the conditions mentioned below resulting in paying minimum or NIL taxes.

Provisions contained under Income-tax Act, 1961 (“Act”) in respect of set-off of losses under Capital Gains

– Short-Term Capital Loss (STCL) can be set-off either with Short-Term Capital Gains (STCG) and Long-Term Capital Gains (LTCG).

– Long-Term Capital Loss (LTCL) can only be set-off with Long-Term Capital Gains (LTCG).

How to determine whether a Capital Asset is a Short Term or Long Term?

Capital Assets like securities listed on recognised stock exchange (NSE, BSE) in India [where securities transaction tax (STT) is paid on sale and purchase], units of equity-oriented fund [where STT is paid on sale], unit of Unit Trust of India and unit of zero-coupon bond held for a period upto 12 months are considered as Short Term. If the capital asset is held for more than 12 months, it is considered as Long Term.

What is Tax Loss Harvesting and how it works in India

Capital Assets like equity shares of an unlisted company (in India or outside India), equity shares of a listed company which are sold under off-market transaction (without paying STT on sale), preference shares (unlisted) and immovable property held for a period upto 24 months are considered as Short Term. If the capital asset is held for more than 24 months, it is considered as Long Term.

Capital Assets like debt mutual funds [where investment by Mutual Fund in equity shares of domestic company is more than 35% of total proceeds but less than 65% of total proceeds], units of business trust, bonds (unlisted), debentures (unlisted) etc held for a period upto 36 months are considered as Short Term. If the capital asset is held for more than 36 months, it is considered as Long Term.

Capital Assets like specified mutual funds [where investment by Mutual Fund in equity shares of domestic company does not exceed 35% of total proceeds] acquired on or after 1st April 2023 or Market Linked Debentures are always considered as Short Term irrespective of the period it was held (Applicable from FY 2023-24 onwards).

Further, the benefit of indexation is available on all capital assets except listed equity shares (where STT paid on sale and purchase), units of equity-oriented fund, units of business trust, bond, debenture. The benefit of indexation is available on Capital Indexed Bonds issued by Government and Sovereign Gold Bond issued by Reserve Bank of India under the Sovereign Gold Bond Scheme.

Further, in case of a Non-Resident (NR), benefit of indexation is not available in case of income arising from sale of capital assets being unlisted securities or shares of a company not being a company in which the public are substantially interested [refer section 2(18) of the Act for definition of company in which the public are substantially interested].

When Tax loss harvesting needs to be done?

For the India Financial Year (FY) (1st April to 31st March), tax loss harvesting needs to be done before the FY closes i.e., 31st March and generally taxpayers do at the time of computing the Advance Tax for 4th Instalment (on or before 15th March) so that they can clean their portfolio and accordingly minimise the taxes.

Conclusion: Tax loss harvesting represents a sophisticated approach to managing investment portfolios in a tax-efficient manner. By judiciously realizing losses to offset gains, investors can significantly reduce their tax burden, aligning with the provisions under the Income-tax Act, 1961. It’s essential to understand the classification of capital assets, the set-off provisions for short-term and long-term capital gains and losses, and the timing for executing such strategies, ideally before the close of the financial year. While tax loss harvesting offers a valuable tool for minimizing taxes, it necessitates careful planning and consideration of the market conditions and tax implications. Investors are advised to consult with tax professionals to ensure compliance with tax laws and to optimize their investment strategies effectively. This practice not only aids in tax savings but also encourages a proactive approach to portfolio management.

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Disclaimer: This article serves an educational purpose and should not be considered as professional advice. Consultation with a qualified individual is recommended before making any decisions based on the content provided. The author bears no responsibility for any actions taken based on this article.

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