Complete guide of Taxation on Income from Stock market and Mutual Funds
Few years back, the investing was not everyone’s cup of tea. At that time investors who were interested in investing in shares and mutual funds have to go either to experts or to brokers and they use to charge hefty fees. But now things have been changed, there is plethora of sources for investing and Discount brokers come into the picture who charges Zero brokerage. Investing has become easy and completely technologically driven but that is not the case with TAXATION on income from stock market and mutual funds. Before investing or trading you must have to understand Taxation then only get to your real returns. To understand taxation clearly, here is s the complete guide for Taxation. After understanding Taxation you will be always confident about your net Income from Stock market. So let’s start-
As per Income tax department, there are 5 heads of Income:
- Business Income
- Capital Gains
- House property
- Other Income
Stock Market and Mutual funds investing Income falls in third category CAPITAL GAINS. Further Capital Gains is of 2 types: First is STCG (Short term Capital Gains) and Second is LTCG (Long term Capital Gains).
Now, IT department has defined rules for Short term and Long term for Equity and Debt investments whether it is Stocks or Mutual Funds. Let understand one by one the STCG and LTCG taxation on different instruments.
STCG on Equity: This is Tax on Capital Gains of Equity oriented Stocks or Mutual funds. It is considered as short term if the holding period of that Stock or Mutual fund LESS THAN 1 year. For example- if you purchased an Equity Mutual fund units on 1st Jan 2021 and sold it on 31st Dec 2021, it will be considered as short term because holding period is one day less than a year. Short term can be one day, one month or 364 days; if is less than a year it is Short term. The STCG you have to pay is 15% plus applicable 4% Cess.
STCG in Debt: This is Tax on Capital Gains of Debt Mutual funds, Bonds or debentures. Here the holding period is LESS THAN 3 years. The STCG you have to pay as per your Income tax slab. If you fall under 30% Income tax category, the STCG on Debt funds will be 30%.
LTCG on Equity: If the holding period of your equity Stocks or Mutual funds is MORE THAN 1 year it is considered as Long term. It was introduced in Budget 2018 before that there was NO LTCG on Equity. The LTCG is ZERO till your gains are less than 1 lakh in that financial year and 10% on any income above 1 lakh. For example- if you have purchased stocks of Rs. 10 Lakh on 1st Jan 2019 and you sold it at Rs. 13 lakhs on 1st Feb 2020. The holding period of this equity stocks is 13 months (more than one year) hence you have to pay LTCG in FY 2019-20. The Capital Gains is of Rs. 3 lakhs and 1 Lakh is exempted, so you have to pay Tax of 10% on next 2 lakhs i.e. Rs. 20000.
LTCG on Debt: This is Tax on Capital Gains of Debt Mutual funds, Bonds or debentures which have holding period MORE THAN 3 years. For LTCG on Debt you have to pay 20% of Capital Gains. In LTCG on debt you get the Indexation Benefit (explained in next section) that reduces your tax burden to an extent.
Benefits by Government on Taxation for Long Term investments:
Indexation Benefit: It is a concept where Inflation is adjusted before calculating Tax on Capital Gains. You don’t have to pay Tax on your whole Capital Gains; you have to pay Tax on Capital Gains which are above Indexed Purchased Value which is defined through Cost of Inflation Index (CII) values of Sale and Purchase of those respective years. Indexed value is calculated as:
Indexed Purchase Value = (Actual Purchase Value) X (CII of Sale year/CII of purchase year)
Below are the CII values provided by IT department:
For example: Suppose you have purchased an asset of worth Rs. 1 lakh in year 1st Jan 2015 and you sold it after 5 years on 1st Jan 2020 at Rs. 2.5 lakh, hence the Gain is of Rs. 1.5 lakh and its Indexed Purchase Value from above formula will be 1 lakh X (289/240) = 1.2041 Lakh. If this asset has indexation benefit then you don’t have to pay tax on whole Capital Gains of Rs. 1.5 lakh but Tax will be on 2.5 -1.2041 = Rs. 1.2959 Lakh. In case of debt fund, LTCG is 20% so net tax payable will be 20% of 129.59 = Rs. 25.91. The Indexation benefit is only valid on LTCG on Debt funds.
God fathering concept: It is concept introduced with LTCG on Equity and it is only valid for LTCG on Equity. It is introduced to reduce the tax burden when you are holding equity stocks from very long time and then decided to sell it. According to this concept, the Taxation is considered on equity Capital Gains after the date 31st January 2018. For example if you are holding stocks of one company since 2000 and at that time its purchase value was Rs. 100 but today its value is Rs. 2500 and its value on 31st January 2018 was 2000. If you sell these stocks today- your real gains will be of 2500-100= Rs. 2400 but you have to pay tax on 2500-2000= Rs. 500 that is of 10% so the net tax payable will be 10% of 500= Rs. 50.
STCG and LTCG on Equity and Debt instruments Snapshot:
Taxation on Intraday and Futures & options (F & O) trading: The Intraday and F & O trading income is altogether have different Income head, it falls under Business Income. Intraday trading comes under Speculative Business Income and F & O income comes under Non-Speculative Business Income. You have to pay Tax as per you Income Tax slab if you make any income from trading.
Capital Loss set off: When you do investing or trading, it not necessary you will always make profit, there are times when you make loss too. This is called CAPITAL LOSS and IT department has defined rules that anybody who make Loss can set off these loss from Capital Gains following certain conditions. Below is the snapshot showing when and under which category you can set off your Capital loss. You must use this set off method if you have any Capital loss through investing or trading.
Taxation on Dividends: Previously dividends were taxable through Dividend Distribution Tax at the hands of companies. But now it has been changed, you have to now include Dividend in your Income and pay tax as per you Tax slab.
ITR for Capital gains and Business Income from Trading: Usually ITR-1 is filed by most of the people but if you have income from Capital Gains you should choose ITR-2. If you have more sources of Income you should go for choose ITR-4 as it covers almost all heads of Income.
Final words: Taxation on income from Investing and Trading is very important factor that you should never ignore else it will impact your expected returns. You should first understand taxation properly then only take decision to invest or trade in that particular financial instrument.