Markets & Taxation Series – In Layman’s Terms

Series – 1. Introduction, Residential Status & Long Term Capital Gain

Investment in stock market has increased manifold in recent times. India’s total active demat accounts stood at 56.9 million as of 30 April, up from 40.8 million at the end of 31 March 2020 and 35.9 million in 31 March 2019. A strong rally in the equity markets in the past year and new investment opportunities in the form of initial public offerings (IPOs) lured retail investors. The market share of individual investors increased sharply by 12 percentage points to 45% in FY21 from 33% in FY16, offsetting the decline in the share of FIIs and public and private corporates during the same period. Retail investors are now Big Bulls of Indian equity markets.

Statistics related to number of tax payers – The number of taxpayers in India is reportedly 1.46 crore, as confirmed by the Central Board of Direct Taxes. This is a small number when you take the total population of 130 crore into perspective. CBDT further clarified that one crore taxpayer reported income between the range of Rs 5-10 lakh, while only 46 lakh reported over Rs 10 lakh.

“If you look at the above active retail participation numbers, the yearly active customers are just ~1% of India’s population. This if you would compare to developed markets, is ~ 20%.People who can invest or trade in the markets need to have money to trade or invest. There were only 5.78 crore people who filed income tax returns last year. Out of that, 75% earned less than ₹5L/year. While there still exists a substantial parallel economy where income isn’t declared, it is difficult for such money to flow into capital markets. With this data in mind, if you looked at the target market size, it would seem like it has to be a subset of 5.78 crores. At 1.3 crores active investors, that is an almost ~20% penetration of the realistically addressable market and not ~1%.”- Nithin Kamath,CEO,Zerodha

By such an increase in Retail Individuals in Indian Markets, we felt the need for TAX LITERACY.

An investment in knowledge pays the best interest.” — Benjamin Franklin

Taxation plays a major role in your Investment journey. In order to increase return on investment, one cannot ignore the tax aspect in every Investment decision. So we tried to simplify tax for you by explaining the provisions in layman’s terms. We have only confined to taxation of stock market transactions by Resident Individual.

Income tax in India is levied vide Income tax Act, 1961. Levy of income tax is based on the type of income you earn. Heads of income under Income tax are broadly classified as –

  • Income from Salary
  • Income from House Property
  • Profits and gains from business or profession
  • Capital Gains
  • Income from other Sources

In this post we will be discussing taxation of Stock market gains from both Investor and trader’s perspective. We have started this initiative as we observed that people ignore tax aspects while taking their financial decisions. Out of them –Some regret at the year-end while filing return by paying more taxes and some are non-compliant. If you are either of them, this series is for you.

You can go through this series and learn taxation aspects while taking financial decisions (Significance of such consideration is explained by an example – If you sell a share holding it for 364 days then such gain is taxable at 15% and if you sell the same after 365 days you are not required to pay tax up to gain of 1 lakh). One may argue that they have their financial or tax consultant for this, but you have to be aware of the basics of taxation as you are going to submit your statement of transactions to your consultant at the year end but by then all the transactions are done and they cannot be modified.

For Non Complier’s – It’s high time you have to disclose your earnings and pay tax dues genuinely. In this digital era, everything is being tracked on real-time basis and it is highly impossible to escape from paying taxes and day by day the regulations are being more stringent. You can consider many recent improvements such as SFT Filing, Mandatory return for Individual paying electric bill above 1lakh etc. Government has access to all your stock market holdings and transactions, so rather than receiving notices from Department, it is better to you file your returns voluntarily.

In this series, rather than using jargons, we will keep it simple and understandable by describing in such a way that a layman can understand.

In order to determine the amount of tax liability on your stock markets transactions, you have to go through some basic concepts of Income tax.

We will explain these in four parts –

  • Determine your residential status
  • Determine your Tax Liability
  • Check whether you are liable to Audit under Income Tax Act (Audit means confirmation of tax amount you have to pay, by a Chartered Accountant)
  • File your ITR form

1. Residential Status –

Residential status of an individual determines the amount of tax that an individual is liable to pay. If an individual is a Resident of India as per Income-tax rules, then he is liable to pay income tax on Global Income. So, if you are a resident of India, you will be liable to pay income tax on your income derived from Indian holdings and foreign holdings (Ex – Dividend from Google Inc). If you are a Non-Resident of India, you will only be liable to pay tax on Indian Holdings. 

We will confine this article assuming that the tax payer to be resident. If tax payer is a Non-resident, he is eligible to certain exemptions. We will discuss Non-Resident taxation in our future articles.

To make it simple assume that if your stay in India is for more than 183 days in the previous year (April to March) that you considered to be a resident.

Tax Slabs –

Individual Age – less than Or equal to 60 years            

IncomeTax Rate
0 to 2.5 Lakh*0
2.5 to 5 Lakh5%
5 to 10 Lakh20%
Above 10 Lakh30%

Individual age above 60 years

Income Tax Rate
0 to 3 Lakh0
3 to 5 lakh5%
5 to 10 lakh 20%
Above 10 lakh30%

Individual age above 80 years –

Income Tax Rate
0 to 5 Lakh0
5 to 10 lakh 20%
Above 10 lakh30%

Above tax rates are normal rates of tax chargeable to Individual. However capital gains are chargeable at a concessional rate in order to encourage Investing in Financial Markets.

2. Determine your tax liability –

Individual earns three types of Income from Stock market –

Capital Appreciation (Capital Gain)

  • Short Term Capital Gain (Holding Period – Less than 12 Months)
  • Long Term Capital Gain (Holding Period – More than 12 Months)

Business Income

  • Speculative Income (Intraday Equity)
  • Non-Speculative Income (Futures, Options, Shares)

Dividend (Income)

Every classification above has different treatment for their taxation. We will discuss each head separately.

As discussed above capital gains are taxed at low rates when compared to Business Income (Normal Slab rates). So, every Individual wants to classify his income as Capital Gain to earn the benefit of being taxed at low rates. However, it’s not that simple. This is always a matter of contention between the department and tax payer regarding the classification of earnings from stock market. In order to clarify on the above issue, government has given two-point criteria.

  • If the tax payer claims his trading activity as business income (tax @ normal rates), then irrespective of the period of holding, department has to accept that.
  • If the tax payer holds a stock for more than 12 months and classified such trade as capital gains, then department has to accept that.

However, this is still an open issue which is a matter of disagreement between tax payer and the department. The various judicial pronouncements have given conflicting judgements. the

It is further clarified that FIFO method is to be considered while determining the Cost of Acquisition. (Assume that you bought 1 Yes Bank share at 155 on 05 Feb 2016 and one at 323 on 14 Sep 2018. Your average cost is 239.You sold one share at 268 on 12th April 2019. What is your capital gain? It is not 29 (Rs268-Rs239), it is Rs 113 (268-155).)

Taxation of Capital Gains

Long Term Capital Gains –

Capital Gain = Sale Value – Purchase Value (Expense such as brokerage, GST etc., on purchase and sale are also allowed as deduction).

However, STT is not allowed as deduction.

Capital gain above 1 lakh is chargeable at a rate of 10%. So, if you have a capital gain of 2 lakh in a year then 1 lakh is not chargeable to tax and 1 lakh is chargeable at the rate of 10%. This exemption is only available for listed shares. As this article is confined to taxation on listed shares and derivatives, we have not discussed the other rates of tax for unlisted shares, debentures etc

Capital gains are exempt (not chargeable) from tax irrespective of amount of gain till FY 2017-18. However, in Budget 2018 the limit of 1 lakh was imposed (Post this amendment market has fallen 3000 points between the period Feb-March2018). It would be unfair to bring such a sudden change, hence Government decided to provide relief to tax payers who are holding stocks as on 31.01.2018 to consider market price [Highest Price (Imagine an upper circuit on that day and you would be benefited) on such date as their cost of acquisition. If your cost is more than the market price as on 31.01.2018 then you can continue to consider your actual cost as your cost of acquisition (For example ITC is trading around 275 on 31.01.2018, if you have purchased ITC during June 2017 your Cost of acquisition would be 310+. In such cases you can consider your original cost as Cost of acquisition].

Govt has issued FAQ’s regarding the amendment(change). Extract of the same (modified for clear understating) is given below –

Q 4. What is the method for calculation of long-term capital gains?

Ans 4. The long-term capital gains will be computed by deducting the cost of acquisition from the full value of consideration on transfer of the long-term capital asset.

 Q 5. How do we determine the cost of acquisition for assets acquired on or before 31st January, 2018?

Ans 5. The cost of acquisition for the long-term capital asset acquired on or before 31st of January, 2018 will be the actual cost. However, if the actual cost is less than the market value of such asset as on 31st of January, 2018, the market value will be deemed to be the cost of acquisition. Further, if the full value of consideration on transfer is less than the fair market value, then such full value of consideration or the actual cost, whichever is higher, will be deemed to be the cost of acquisition.

 Q 6. How will the market value be determined?

Ans 6. In case of a listed equity share,

Market value means the highest price of such share or unit quoted on a recognized stock exchange on 31st of January, 2018.

 However, if there is no trading on 31st January, 2018, the fair market value will be the highest price quoted on a date immediately preceding 31st of January, 2018, on which it has been traded.

 Q 7. Please provide illustrations for computing long-term capital gains in different scenarios, in the light of answers to questions 5 and 6.

Ans 7. The computation of long-term capital gains in different scenarios is illustrated as under – Scenario 1 – An equity share is acquired on 1st of January, 2017 at Rs. 100, its fair market value is Rs. 200 on 31st of January, 2018 and it is sold on 1st of April, 2018 at Rs. 250. As the actual cost of acquisition is less than the fair market value as on 31st of January, 2018, the fair market value of Rs. 200 will be taken as the cost of acquisition and the long-term capital gain will be Rs. 50 (Rs. 250 – Rs. 200).

Scenario 2 – An equity share is acquired on 1st of January, 2017 at Rs. 100, its fair market value is Rs. 200 on 31st of January, 2018 and it is sold on 1st of April, 2018 at Rs. 150. In this case, the actual cost of acquisition is less than the fair market value as on 31st of January, 2018. However, the sale value is also less than the fair market value as on 31st of January, 2018. Accordingly, the sale value of Rs. 150 will be taken as the cost of acquisition and the long-term capital gain will be NIL (Rs. 150 – Rs. 150).

Scenario 3 – An equity share is acquired on 1st of January, 2017 at Rs. 100, its fair market value is Rs. 50 on 31st of January, 2018 and it is sold on 1st of April, 2018 at Rs. 150. In this case, the fair market value as on 31st of January, 2018 is less than the actual cost of acquisition, and therefore, the actual cost of Rs. 100 will be taken as actual cost of acquisition and the long-term capital gain will be Rs. 50 (Rs. 150 – Rs. 100).

Scenario 4 – An equity share is acquired on 1st of January, 2017 at Rs. 100, its fair market value is Rs. 200 on 31st of January, 2018 and it is sold on 1st of April, 2018 at Rs. 50. In this case, the actual cost of acquisition is less than the fair market value as on 31st January, 2018. The sale value is less than the fair market value as on 31st of January, 2018 and also the actual cost of acquisition. Therefore, the actual cost of Rs. 100 will be taken as the cost of acquisition in this case. Hence, the long-term capital loss will be Rs. 50 (Rs. 50 – Rs. 100) in this case.

 Q 10. What will be the tax treatment of accrued gains up to 31st January 2018?

Ans 10. As the fair market value on 31st January, 2018 will be taken as cost of acquisition (except in some typical situations explained in Ans 7.), the gains accrued up to 31st January, 2018 will continue to be exempt.

 Q 12. What will be the tax treatment of transfer made on or after 1st April 2018? Ans 12. The long-term capital gains exceeding Rs. 1 Lakh arising from transfer of these asset made on after 1st April, 2018 will be taxed at 10 per cent. However, there will be no tax on gains accrued up to 31st January, 2018 as explained in Ans 10.

Q13. What is the date from which the holding period will be counted?

Ans 13. The holding period will be counted from the date of acquisition. (Holding period is relevant to determine whether gain is chargeable as long term (10%) or short term (15%) –will be discussed subsequently)

Q21. What will be the cost of acquisition in the case of bonus shares acquired before 1 st February 2018?

Ans 21. Market value of the bonus shares as on 31st January, 2018 will be taken as cost of acquisition (except in some typical situations explained in Ans 7), and hence, the gains  upto 31st January, 2018 will continue to be exempt.

Cost of acquisition of bonus shares is NIL. As you have not paid any consideration for such shares there is no cost of acquisition.

 Q 22. What will be the cost of acquisition in the case of right share acquired before 1st February 2018?

Ans 22. Market value of right share as on 31st January, 2018 will be taken as cost of acquisition (except in some typical situations explained in Ans 7), and hence, the gains accrued upto 31st January, 2018 will continue to be exempt.

Q 24. What will be the treatment of long-term capital loss arising from transfer made on or after 1st April, 2018?

 Ans 24. Long-term capital loss arising from transfer made on or after 1st April, 2018 will be allowed to be set-off and carried forward in accordance with existing provisions of the Act. Therefore, it can be set-off against any other long-term capital gains and unabsorbed loss can be carried forward to subsequent eight years for set-off against long-term capital gains.

When you are paying taxes on your gains, then what about the cases in which you incur losses. Will the government refund your tax which you have paid in the previous year! Unfortunately, No. However, you have an option to carry forward such loss to future years so that if you have profit in future years, you can pay less tax by adjusting your losses pertaining to the previous years. – we will discuss rules regarding these subsequently.

So, the key takeaways are –

  • Long term capital gain is exempt up to 1 lakh.
  • Above 1 lakh, it is chargeable at the rate of 10 percent
  • Amendment with effect from 31.01.2018 is to be considered (Refer Q.No. 4)
  • Cost of acquisition of bonus shares is NIL
  • Holding period for a stock to be considered as Long term is 12 months
  • In case of Stock split holding period is from date of purchase of original shares
  • Basic Exemption Limit of Rupees 2,50,000/3,00,000/5,00,000 can be used against capital gain (For example If you have a capital gain of 5,00,000, after considering 1 lakh exemption and 2.5 Lakh basic exemption limit, you are only liable to pay tax on 1.5 lakh at the rate of 10% plus 4% (on such tax of 10%) as Health and education cess (form of tax collected along with normal tax for providing health facilities)). The effective tax rate will come as 10.4%.Basic exemption limit cannot be utilised by Non Resident.
  • No benefit of Rebate (Rebate is available to Individual having income less than 5 lakh. This is a relief provided to Individual with low income to reduce their burden of tax. The relief provided is lower of amount of tax payable or 12500). However, such relief is not available in case of Long-term capital gain. The only exception for Rebate is Long term capital gain.
  • No deductions such as LIC Premium, Medical Insurance, Payment of Principal amount of housing loan etc. will be allowed against LTCG.
  • Loss from house property subject to a limit of 2 lakh can be claimed as deduction. Loss from house property is possible if interest paid by you is more than the rent received or in case of self-occupied, total interest paid by you is considered as loss as there will be no rent received. This loss can be adjusted against LTCG, subject to a limit of 2 lakh.

To be continued…..

This post is published in association with Stox N Tax (Personal Investment & Taxation Blog).

https://stoxntax.wordpress.com/

Got questions? Just ask-taxconcept4@gmail.com,anilteneti6@gmail.com.

also read

Interest on delay payment to MSME’s – Implications

ANIL KUMAR

Anil Kumar Tenneti

Editor, Tax Concept & TC VIP. Chartered Accountant II Stock Market Enthusiast. I write articles related to market, taxation, Company law and MSME.
Social profiles