Many retail investors are looking to take advantage of the soaring indices by selling their stocks and mutual funds (MFs). Besides booking profits, they can adjust such profits against any loss making investments, thereby minimising the tax on capital gain.
Investors need to keep a few details in mind. Any Long-Term Capital Gain (LTCG) arising out of sale effected on or after October 1, 2004, on shares and equity oriented MFs are exempt from tax. This provided, the transaction was on a recognised stock exchange in India and the investor has borne the Securities Transaction Tax (STT) on the sale.
CAPITAL GAINS & LOSSES
The Income Tax Act says capital losses can only be set off against capital gains — other incomes like salary or business income cannot be used. Long- Term Capital Loss (LTCL) can only be set off against taxable LTCG. However, Short-Term Capital Loss (STCL) can be set off against both Short Term Capital Gain (STCG) and taxable LTCG.
STT is not required to be paid on the following transactions taken place on or after october 1, 2004:
Ø Asset other than equities and equity-based MF schemes
Ø Sale of equity shares which has not taken place on a recognised stock exchange in India.
Ø Redemptions, share buy-backs by the companies. On such assets, LTCG will be taxed at 10 per cent without indexation or at 20 per cent with indexation, whichever is lower. STCG is considered as normal income of the assessee, added to the income and taxed at the slab rate applicable.
SET-OFF ISSUES
Both LTCG and LTCL are tax-free. So any LTCL incurred from October 1, 2004, arising out of sale of equity shares or equity MFs cannot be set off against any LTCG, even the one arising out of, say, housing property. But it is possible to save tax on LTCGs by using Sec 54EC, 54F, 54 and carrying forward the losses.
Take the case of an individual who has earned taxable LTCG and has invested the gains immediately thereafter in infrastructure bonds, to bring his capital gains tax to nil. The question arises, if during the same financial year, he incurs a LTCL, can he offset the loss against the gains, in spite of having invested in the bonds under section 54EC? Also, can he carry forward the loss? The answers to these questions lie in the fact that sections 54/54EC/54F are exemptions and not deductions. In other words, if an income is eligible for exemption, it is not to be included in the computation of income. On the other hand, deductions (Secs. 80C, 80G, 80D, 80U) are to be claimed after having aggregated the incomes from different sources.
After having claimed the exemption under section 54/54EC/54F, an income ceases to be taxable. As such, the full amount of capital loss can be carried forward. So, if the assessee earns LTCG later in the same financial year, he can invest in bonds within six months, claim exemption under section 54EC and carry forward the loss.
SWITCHING OPTIONS
If an investor is contemplating a switch from dividend to growth or vice versa within a MF, he could attract capital gains tax liability. One should take care to see that the investment has been done over a year. In that case, LTCG would be exempted, else the same would be taxable. However, a switch from dividend to dividend-reinvestment option will not invite any tax liability. Since due to current tax laws, there is no difference between dividend reinvestment and growth, it is suggested that if the switch is being made before a holding period of one year, it should be done in the dividend reinvestment option. This would give a benefit similar to the growth option but without the attendant tax liability.