Tax collection involves two methods, tax loss and tax gain collection. Investors are obliged to pay capital gains tax only when the shares are sold. While taxes are payable on gains, investors also have the opportunity to save taxes if they have losses.
What is tax evasion?
Tax loss harvesting involves selling equity that is at a loss and then reversing the loss for gains in future years. The loss can be carried forward up to eight assessment years from the assessment year in which it was incurred.
Example: An investor named John sold shares of Company X on Friday (purchased in February last year) and made a profit of Rs.5 lakh. Since the holding period is more than 12 months, it is treated as Long Term Investment Gain (LTCG).
Breakdown of his tax liability: Rs 1.25 lakh of profit is exempt, while the remaining Rs 3.75 lakh is taxed at a flat rate of 12.5%. John wants to reduce his tax liability by using tax loss harvesting.
John also owns shares of Company Y, which has significantly undervalued his purchase price. By selling Y shares and having a loss of Rs 3.75 lakh, his total tax liability for the year is reduced to zero, as the loss reduces the gain from X shares.
“This method is called tax loss. Summary of Taxes and Investments Balwan (Jaint-Capital-Balwan) expert said: “It is called tax loss. The normal human tendency is to sell stocks that are profitable and stocks that are at a loss. Tax loss is about selling a stock at a significant loss so that it can offset a profit already made. Unless you sell the shares, you cannot claim a loss under the Income Tax Act.” For example, profits from selling shares for less than 12 months are taxed at a flat 20% and do not enjoy an exemption of Rs 1.25 lakh like LTCG. You can book losses up to gains made during the year to reduce STCG liability, Jain explains.
What if the stock you want to sell to collect tax losses is expected in the future? In John’s example, if he believes that Y shares will go up, he can still book a loss and buy the same stock in a different trading account on the same day. If he has only a demat account, he can buy back the stock on the next day. However, insider sales and purchases on the same day using the same account will not be eligible for tax loss harvesting.
What is a tax return?
Consider an investor named Harry. He has held 100 shares of Company A for more than 12 months. The total profit from selling all the shares today will be Rs 3 lakh.
If Harry sells only 41 shares and keeps the rest, his LTCG comes down to Rs 1.23 lakh, which falls under the exemption limit, resulting in zero tax liability. This strategy is called tax-advantaged.
In the July 2024 Budget, Finance Minister Nirmala Sitharaman revised the STCG and LTCG rates:
- STCG: Increased from 15% to 20% for shares less than 12 months.
- LTCG: Raised to 12.5% on interest exceeding Rs 1.25 lakh for holdings of 12 months or more.
(Disclaimer: The suggestions, recommendations, views and opinions given by the experts are their own. They do not represent the views of The Economic Times.)
