Tax Harvesting: A smart way to save Tax on Stocks and Mutual funds Income
If you use to invest in Stocks and Mutual funds you probably know that you have to pay Taxes whenever you generate returns out of it. These returns are called CAPITAL GAINS, it can be of short term or long term. There are certain predefined rules by Income Tax Department for Taxes on Income as Capital Gains. You must be aware of terms like STCG on Equity/Debt, LTCG on Equity/Debt etc. If you don’t know, you can understand the complete Taxation on Capital Gains here- “Complete guide of Taxation on Income from Stock market and Mutual Funds”. Now if you understand this Taxation on Capital Gains, further you will see how these Taxes can be reduced and made Zero in some cases. It is completely legal and it is only possible with proper Tax-planning. It is called TAX HARVESTING. So let’s understand it-
What is Tax Harvesting- It is a technique to reduce you Tax liability in a particular financial year by putting BUY and SELL orders in your existing portfolio without disturbing your returns. It can be done on both LTCG and STCG of your Capital Gains using the rule of exempted Income on Capital Gains and rule of Capital Loss can be off set for next 8 assessment years with Capital Gains.
IT department has set a rule that Capital Loss can be off set against a particular Capital Gains as follows-
| OFF SET | Long Term Capital Gains (LTCG) | Short Term Capital Gains (STCG) |
| Long Term Capital Loss (LTCL) | Yes | No |
| Short Term Capital Loss (STCL) | Yes | Yes |
STCL can be off set with STCG and LTCG but LTCL is only be set off with LTCG.
Tax Harvesting on LTCG:
For Tax harvesting on LTCG, the important thing is to note is that the Taxes levied on CAPITAL GAINS when PROFITS are REALISED; so if you have any profit like 10 lakh or so in your portfolio but it is Unrealised it will not considered for Taxation. It is only considered for taxation when that profit is Realised by selling that stocks.
Before Budget 2018 the Tax on LTCG on Equity was completely exempted but now it is only exempted upto Capital Gains of Rs. 1 Lakh and whatever above 1 lakh carries the tax of 10%. So if you have stocks whose gains reached to 1 lakh, you should SELL it and again BUY it. In this way you don’t have to pay any Tax on this LTCG. Understand it with 2 scenarios-
Scenario 1: Suppose you have shares of XYZ Company of worth 1 lakh. You have purchased it in Jan 2020; after 1 year in Jan 2021 it becomes 2 lakh and it is still in your portfolio. Its Unrealised Capital Gains is of 1 lakh so your Tax will be Zero. Now after one more year in Jan 2022 it becomes 3 lakh so Capital Gains will be of 2 lakh and then you have sold it and now REALISED profit will be of 2 Lakhs and these 2 lakhs will be added in your Income as Capital Gains. The 1 lakh is exempted and on next 1 lakh you have to pay Tax on LTCG of 10%. Your net Tax payable will be of Rs. 10000.
Scenario 2: Same as first scenario, you have shares of XYZ Company worth 1 lakh. You have purchased it in Jan 2020 and after 1 year in Jan 2021 it becomes 2 lakh. But this time you Relaised the Profit by selling it and Purchased it again for 2 lakhs. Now after one more year in Jan 2022 it becomes 3 lakh so Capital Gains will be of 1 lakh and then you have sold it, Buy it again and REALISED profit of 1 Lakh. Hence your Tax this year is also ZERO. Your net Tax payable will be ZERO in this scenario.
So basically you have to Realise the profit when you think it is reaching to 1 lakh and buy that stocks or Mutual funds again in every financial year. The point to note is that it is only valid for LTCG on Equity as there is no Exemption for LTCG on Debt.
The second way of Tax Harvesting for LTCG is that you should book losses time to time when you see any Stocks or Mutual funds is in loss and repurchase them. For example- If you have Mutual funds units of more than one year holding period and due to temporary market crash it has gone to loss, you should book the loss and repurchase it again. Now you can use this Loss to set-off your Capital Gains in any of your upcoming assessment 8 years with LTCG. Usually good Stocks and Mutual funds rarely go to Loss in long term, so this technique is used during Market crash due some unpredictable events like Covid pandemic, wars etc. This is applicable for both LTCG on Debt and Equity but it is rarely used.
Tax Harvesting on STCG:
STCG can be off-set with both STCL and LTCL unlike LTCG which is only off-set with LTCL. So first thing you should reduce STCG Tax (instead of LTCG Tax) because it 15% with no exemption. If you have booked a good profit in short term and you have some Stokcs/MF units in loss and you decided to hold it. You should book that Loss and repurchase it and use this booked loss to off-set your STCG. Further if you have any LTCL in past years you should first off-set STCG with that LTCL.
Example: You have 2 stocks, Stock ‘A’ of worth 1 lakh and another Stock ‘B’ of 1 lakh. Let’s suppose you booked a profit of Rs. 50000 from Stock A in short term and Stock B is showing Loss of Rs. 30000 and you have decided to hold Stock B for longer duration. You should now Sell Stock B and book loss then again repurchase it, you can off-set this loss against profit of Stock A. Your net profit will be 50000-30000 = Rs. 20000 and net tax payable will be 15% of 20000 = Rs. 3000 instead of 15% of 50000 = 7500. You will save 7500-30000 = Rs. 3500.
You have seen, with some small operations you can harvest your Taxes but you should be little careful while doing this. Some very important points to keep in mind while doing Tax Harvesting:
- You should have enough liquidity while selling and repurchasing the stocks because Stocks delivered on T+2 days. If you wait for 3 days its price may fluctuate and your returns may get impacted.
- Don’t wait for March month for Tax harvesting. Do it in small intervals for whole years like monthly or quarterly. By doing this you will get benefit Short term loss off-set and liquidity issue will also reduce.
- For Mutual funds don’t Buy/Sell if it is in Exit load else it will rather increase your burden. Only do Tax harvesting with Mutual funds when it is out of exit load.
- Tax Harvesting does not impact your compounding. It just takes away your feel good factor of seeing large return numbers like 300%, 1000% etc because you are time to time booking profit and loss. It reduces return % but increase the base amount.
- If you are OK by paying tax and keep that feel good factor with you; you can avoid Tax harvesting completely.
With Tax harvesting you can a good amount every year, you must take benefit of it.
