How to Calculate Tax on shares and equity mutual funds?

In this post, we will discuss how to calculate Tax on the sale of shares. The tax implication on equity mutual funds is also the same as equity shares. Thus, if you invest in stocks or equity mutual funds, this post is for you.

Mutual funds come with three major categories. They are equity mutual funds, debt mutual funds, and hybrid mutual funds. Their investment strategy and tax implications are not the same. However, we will restrict our discussion to equity mutual funds only in this session.

Equity mutual fund is a type of mutual fund that invests at least 65% in stocks. Thus, equity mutual fund investors can learn the concept and use it to calculate Tax on the sale of their mutual fund units.

The Tax on the sale of shares and equity mutual funds depends on lots of factors. It makes things more complex to understand. For a newbie, it is like cracking the CA Final exam. However, it becomes easy when one has the willingness to learn.

There are various types of asset classes, and so are their taxation. Thus, understanding the tax implication is a small step towards making the right decisions in your investment life. Let’s explore.

Capital Gain & Loss

You know that you may make a profit when you invest in shares and equity funds or incur loss also. Thus, by the end of your investment journey, two things may happen; either you make a profit and incur a loss.

If you make a profit, we call it Capital Gain, and if you incur a loss, we call it Capital Loss. Further, each of them come with two more options. They are Short Term and Long Term.

For equity shares (the shares we generally hold) and equity mutual funds, a holding period of 12 months or lesser than that is Short Term. On the other hand, a holding period of more than 12 months is Long Term.

Thus, four types of situations can arise. They are as follows.

  • If you hold a share for 12 months or lesser period and make a profit, we call it Short Term Capital Gain.
  • On the other hand, If you own a share for 12 months or lesser period, and make a loss, we call it Short Term Capital Loss.
  • But, If you hold shares for more than 12 months, and make a profit, we call it Long Term Capital Gain.
  • Finally, If you own shares for more than 12 months, and make a loss, we call it Long Term Capital Loss.

Images make things simple. Thus, let’s understand the concept with the help of an image.

Capital Gain or Loss
Capital Gain or Loss

Note: Holding period is the gap between the date of purchase and date of sale of shares or equity mutual funds.

How to calculate Tax on Short Term Capital Gains?

You have to pay tax on your short term capital gain. We call it short term capital gain tax or STCG Tax in short. Further, you need to pay STCG Tax at 15% on your short term capital gains.

However, it would help if you had the following things to calculate your STCG Tax.

  • The Sale Value
  • The Brokerages or Other Expenses you paid during the Transactions
  • The Invested Value

Further, to calculate the taxable amount, you need to apply the following formula.

[STCG = The Sale Value – Brokerages – The Invested Value]

Let’s understand how it works.

Illustration

You had invested Rs 50,000 in the shares of ABC Company on 31st January 2019. However, you booked the profit on 15th November that year, and the sale value was Rs 80,000. How much tax you have to pay?

Analysis

As observed, your holding period was less than 12 months. Thus, it will attract STCG Tax.

Your sale value was Rs 80,000. Further, we assume that you paid Rs 100 as a brokerage. Next, your invested value was Rs 50,000. Thus, to bring the taxable amount, we will use the above formula.

STCG = [Rs 80,000 – Rs 100 – Rs 50,000] = Rs 29,900.

Thus, Rs 29,900 is your Short Term Capital Gain. And, you need to pay a 15% tax on it.

It becomes Rs 4,485. Further, you need to pay cess @ 4%, which is Rs 179. Thus, your total amount becomes Rs 4,664.

Then, what is the net profit?

Your net profit is Rs 25,326 [Rs 29,900 – Rs 4,664].

Disclaimer: The tax rate, cess, surcharges change with time. It is just a representation and for educational purposes only. It would help if you talked to your tax consultant before tax filing.

I expect you got a fair idea on how to calculate Short Term Capital Gain Tax on the sale of shares. It is similar to equity mutual funds. But, you have to take the Net Asset Value or NAV instead of the share price. You will find the information on the account statement you receive after the transaction. Let’s move to Long Term Capital Gain Tax or LTCG Tax now.

How To Calculate Tax On long Term Capital Gains?

You need to pay Long Term Capital Gain Tax or LTCG Tax on your capital gains. In 2018, the Indian Government re-introduced LTCG Tax that was abolished in the year 2005. Thus, the period between 2005-2018 was the golden period for the Indian equity market.

For example, Sensex moved from 6,000 in 2005 to 38,000 in 2018. It translates to more than 15% cagr return. In other words, if you had invested Rs 10,000 in Sensex in 2005, it would have become more than Rs 60,000 in 2018. However, after the introduction of the LTCG Tax, it is under pressure.

Key Takeaways

  • LTCG up to 31.03.2018 is tax exempted.
  • LTCG is taxed @ 10% on your capital gain over an exemption limit of Rs 1 Lakh.
  • However, the Indian Government introduced the grandfathering concept to minimize the LTCG Tax burden.

Illustration

You had invested Rs 1,00,000 in the shares of ABC Company on 15.06.2000. However, you booked a profit on 01.02.2020, and the sale value was Rs 8,00,000. How much tax you have to pay?

Analysis

This information is insufficient to calculate LTCG Tax. You need to find out the value of your investment on 31.01.2018. We call it Fair Market Value. Suppose it is Rs 6 Lakh in this case. Further, we assume that you have paid Rs 500 as a brokerage fee. Let’s calculate the tax.

[LTCG The Sale Value – Brokerages – The Invested Value]

The Government introduced LTCG Tax in 2018. Thus, it allows investors to waive their capital gains up to 31.01.2018. It is the grandfathering concept and relief to investors.

For example, the Taxman will assume your initial investment as Rs 6 Lakh instead of Rs 1 Lakh after the implementation of the grandfathering concept. So, what is the benefit?

Now, LTCG = Rs 8,00,000 (Sale Value) – Rs 500 (Brokerage) – Rs 6,00,000 (The Fair Market Value) = Rs 1,99,500.

Further, you know that you have an exemption limit of Rs 1 Lakh. Thus, your taxable amount falls to Rs 99,500 (Rs 1,99,500 – Rs 1,00,000).

Now, you need to pay 10% on the taxable amount. It is Rs 9,950.

Finally, you need to add cess @ 4%. Thus, your final amount is Rs 10,348 (Rs 398 + Rs 9,950).

Thus, your net profit is Rs 1,89,152 officially. However, your actual net profit is Rs 6,89,152. How? Find out yourself.

Just Imagine, what would you have to pay without this grandfathering clause? See the comparison table below.

Not Grandfathered Vs. Grandfathered

NOT GRANDFATHEREDGRANDFATHERED
Sale ValueRs 8,00,000.00Sale ValueRs 8,00,000.00
BrokerageRs 500.00BrokerageRs 500.00
Invested ValueRs 1,00,000.00Fair Market Value on 31.01.2018Rs 6,00,000.00
LTCGRs 6,99,500.00LTCGRs 1,99,500.00
ExemptionRs 1,00,000.00ExemptionRs 1,00,000.00
Taxable AmountRs 5,99,500.00Taxable AmountRs 99,500.00
LTCG Tax @ 10%Rs 59,950.00LTCG Tax @ 10%Rs 9,950.00
Cess @ 4%Rs 2,398.00Cess @ 4%Rs 398.00
Total Payable AmountRs 62,348.00Total Payable AmountRs 10,348.00
TABLE 1

It is around six times. Finally, I expect you got a fair idea on how to calculate Long Term Capital Gain Tax on the sale of shares and equity mutual funds.

What if you have a capital loss?

The possibility of incurring a loss is not uncommon in equity shares and equity funds. Thus, you should know what to do if you incur a loss.

You can set off your capital loss against your capital gain. But what does it means?

Let’s understand it with an example.

Suppose you had invested Rs 5,00,000 in the shares of ABC Company. However, you had to book loss as there was some fundamental issue with the company. Your total sale value was Rs 3,00,000. Thus, you lost Rs 2,00,000.

Now, in the same financial year, you had booked a profit in the shares of another company named XYZ Company. And your taxable amount is Rs 3,00,000.

Now, you can set off your losses against the gains you have made. It means, you need to pay tax on Rs 1,00,000 (Rs 3,00,000 – Rs 2,00,000) only.

But what if the loss is massive and cannot be set off in a single year?

In that case, you can carry forward the loss up to the next eight assessment years, assuming that you file returns before the due date each year without fail.

Further, here are a few essential points to remember.

  • You can set off Short Term Capital Loss against both STCG and LTCG.
  • However, you can set off Long Term Capital Loss against LTCG only.

I assume you got a basic idea on how to calculate tax if you have made profits or incurred loss in shares or equity funds.

Closing Thoughts on how to calculate tax on shares

Tax and inflation are two crucial things in one’s financial life. These two are the most potent forces in the world of finance. Thus, you need to understand both the concepts to reap maximum benefit from your investment.

But, the tragedy is that most people don’t know either of the two. They are comfortable with fixed assets thinking that they can make a lot of money in the long run. However, the opposite is true.

Because in fixed asset classes, both the powers go against you. Most importantly, fixed asset classes can neither beat inflation nor are tax-friendly.

Holding equities for the long term is the best strategy as you need not have to pay any tax as long as you keep them. You only pay tax when you book a profit. That’s the most exciting feature of equity taxation.

Further, you can book profits partially to avoid tax. For example, you can book profits up to Rs 1 Lakh’s exemption limit in a financial year to avoid tax.

Similarly, short term capital gain comes with 15% tax and without any exemption, whereas long term capital gain is taxed at 10% with an exemption limit of Rs 1 Lakh.

However, you cannot get such tax benefits in a fixed type of asset class. It never means that you should not have exposure to fixed asset classes. But, it should not be the only investment option in your life.

I hope you have got a fair idea of how to calculate tax on shares and equity mutual funds. Finally, I wish you a happy investment journey.

Thanks and regards,

finguru@finlessons.com

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