When we talk of taxation of equities, it is an extremely wide and comprehensive topic. Broadly, taxation of equities will cover, inter alia, the following key items:
While there are more items to be covered in the taxation of equities, these are the broad headers that will be covered in this chapter.
When we talk of dividends on equity, here, we are only referring to tax on dividends declared by companies. We will not be covering equity funds in this case, and they will be covered separately. A company pays dividends to reward its shareholders out of net profits. Remember that dividends are a post-tax appropriation, and hence, the company does not get any tax shield on the dividends. Dividends on equity are taxed at two levels:
The dividend distribution tax (DDT) is imposed by the government at the point of dividend declaration. This is a tax that the company declaring dividends has to pay directly to the government. In fact, the company deducts the DDT and only pays the net amount to the shareholders. Currently, the DDT on equity dividends is charged at the rate of 15%. However, there was a change in the calculation of DDT, which has resulted in a sharp rise in the rate of effective DDT from 15% to 20.56%. Let us understand this in greater detail.
In the Union Budget 2014, the finance minister made a small amendment to the Dividend Distribution on equities. From 1997, when the DDT was first introduced, till 2014, the DDT was calculated at 15% on net dividends:
A dividend of Rs100 will attract 15% DDT, i.e., Rs15 (15% of Rs100) will be paid as tax to the government and Rs85 will be paid as actual dividends to the shareholders.
Post 2014, the formula for the calculation of dividends was changed from a net basis to a gross basis. DDT is now charged on the gross amount. This is how the calculation will look like for effective DDT cost.
|Actual Dividend Paid||Rs.100.000|
|Gross Dividend Assumed||100/0.85||Rs.117.65|
|Adjusted DDT||(117.65 – 100.00)||Rs.17.65|
|Adjusted DDT %||17.65/100.000||17.65%|
|Effective DDT % payable||20.56%|
As can be seen from the above table, the effective rate of DDT works out to 20.56% and what shareholders get on hand for every Rs100 declared as dividends is just Rs79.44 (100.00 - 20.56). While the DDT is not directly imposed on the shareholder, it indirectly impacts the shareholder as the total dividends get impacted to that extent. The company declaring dividends is required to remit the DDT amount to the government within 14 days of the payment of actual dividends to shareholders.
The second aspect of dividend taxation is the tax in the hands of shareholders. For example, dividends declared by companies were entirely tax-free in the hands of the shareholders till FY 2015-16. However, in the Union Budget 2016, the government introduced a new tax of 10% in the hands of shareholders if the total dividend income from equities exceededRsRs10 lakhs in a particular financial year. Remember, this only applies to dividends from equities and not for dividends from equity funds. Your total dividend income from direct equities has to exceed Rs10 lakh in a financial year.
An HNI investor, Rajiv Shah, holds 50,000 shares of Ben Bakers Ltd. During fiscal year 2017-18, the company paid a total dividend of Rs15 per share. Rajiv has also received dividends from his other equity holdings to the tune of Rs6 lakhs. What is his dividend tax liability?
Let us first calculate his total dividend income for FY2017-18 as under:
|Shares of Ben Bakers Ltd.||50,000 shares|
|Dividend per share||Rs. 15|
|Total Dividend from Ben Bakers||Rs. 7,50,000|
|Dividend from other shares||Rs.6,00,000|
|Total Dividend Income for FY 2017-18||Rs.13,50,000|
|Tax Free threshold for annual dividends||Rs.10,00,000|
|Tax on dividends at 10%||Rs.35,000|
This limit of Rs10 lakhs per year from all equities will apply to the net dividends received by the shareholder and not the gross dividend declared by the company. This is a point that is of interest to high networth investors and to those promoter groups who hold a large chunk of shares in the company.
Are dividends taxed very heavily in India (Triple taxation)?
There is often a complaint from promoters that dividend tax is like a double tax. In the Indian context, there is a triple tax on dividends. Here is how…
That is why, it is said that dividend taxation in India is one of the steepest. That is also the reason why a lot of companies prefer to reward their shareholders with buybacks rather than through dividends, as buybacks are more tax-efficient. We shall discuss the tax implications of buyback of shares later in this chapter.
While dividends have been discussed in detail, a more common and regular source of income in the equity markets is the capital gain. Capital gains arise when you sell a stock at a price that is higher than the price of purchase. For example, if you buy a stock at RsRs200 and sell the stock at Rs210, the profit of Rs10 becomes capital gains in the hands of the investor. Capital gains tax is charged on the profit that is booked and never charged on notional profit. For example, if you buy a stock worth Rs55,000 and the value of these stocks appreciates to Rs2,50,000 in 5 years’ time, there will be no tax unless you book the profits and the profit actually comes into your account. Broadly, there are 3 categories of capital gains that arise from shares:
Speculative gains are said to arise when the profits are booked on shares during the same day without intent to take delivery. A classic instance is intraday trading in stocks. Remember an important point. Capital gains only arise when you own an asset. In case of intraday trading, shares do not go into your demat account, and hence, there is no ownership. Hence, this is strictly not capital gains and will be treated as other income. However, we are discussing this here only for the sake of completeness.
Mayank bought 2,000 shares of Reliance Industries at Rs845 on March 15th, 2017. He sold 200 shares on the same day at Rs849. Another 500 shares of RIL he sold on January 04th, 2018, at Rs1,055. Mayank sold a total of 1,000 shares of RIL on June 10th, 2018, at Rs1,150. How will his capital gains be classified?
Mayank’s entire break of capital gains on RIL will be as under:
|Particulars||Nature of Capital Gains||Explanation|
|Profit on Intraday||Rs.8,000
200 x (849 - 845)
|This will be treated as speculative gains without the intent to take delivery|
|Short-term capital gains (STCG)||Rs.1,05,000
500 x (1,055 – 845)
|This will be classified as STCG as it is held for less than 12 months from purchase|
|Long-term capital gains (LTCG)||Rs.3,05,0000
1000 x (1,150 – 845)
|This will be classified as LTCG as it held for more than 12 months from the date of purchase|
There will be no tax on the balance 300 shares as they are not booked profits, and capital gains have not been realized.
Understanding the First in First out (FIFO) method
Before we get into the calculation of STCG and LTCG, there is one more point we need to be clear on. The above illustration is perfect if you have bought the shares in one shot. However, that is not what is done normally. Investors tend to buy shares in phases so that they can get the best of rupee cost averaging. It happens quite often that you buy the shares in tranches rather than buying it all in one shot. If all this is done at different costs, the question arises as to which cost should be considered for the purpose of capital gains. This is where FIFO comes in. It is assumed that shares are sold in a chronological order, that is, the shares that are bought first are sold first and once these are sold off, the stocks bought in the next lot are considered. This is called the First in First out method (FIFO) for the purpose of calculation of capital gains. This is how it works in practice.
Pankaj holds 2,000 shares of Tata Steel as on 20th Aug, 2018, purchased as under:
400 shares of Tata Steel bought at Rs700 on 01st Jan, 2017
300 shares of Tata Steel bought at Rs650 on 05th June, 2017
1000 shares of Tata Steel bought at Rs550 on 02nd Feb, 2018
300 shares of Tata Steel bought at Rs510 on 05th May, 2018
If he sells all his 1,500 shares of Tata Steel at Rs722 on 20th Aug, how will his capital gains be calculated?
Pankaj’s calculation of capital gains will be done as per the FIFO method as under:
|Particulars||Shares and price||Explanation|
|Shares sold||1,500 shares sold at Rs.722|
|FIFO Calculation 1||400 shares bought at Rs.700||Will be treated as LTCG|
|FIFO Calculation 2||300 shares bought at Rs.540||Will be treated as LTCG|
|FIFO Calculation 3||800 shares bought at Rs550||Will be treated as STCG|
This is how the FIFO method is applied for calculating capital gains on the sale of equity shares. The shares that are purchased first will presumed to be sold first, and the logic will go in a chronological order.
Taxation of short-term capital gains (STCG)
As we have seen earlier, a profit on the sale of shares is classified as short-term capital gains (STCG) if shares are held for less than 12 months. This is the period from the date of purchase to the date of sale and in case of multiple purchase dates, the STCG will be calculated based on the FIFO method (explained above). Short-term capital gains (STCG) on equities are taxed at 15% of the gain amount. However, there are 2 conditions if you want to avail this concessional STCG rate of 15%:
Note: Period of holding to be considered is 24 months in case of unlisted shares of a company.
How exactly is the short-term capital gains (STCG) tax calculated?
The first step towards understanding capital gains tax is knowing how to calculate the gains from shares. You need to understand what constitutes the sale value and what constitutes the purchase value of a stock. STCG here refers to the sale of shares held for less than 1 year and bought through a recognized stock exchange on which STT has been paid.
There is a 15% tax on STCG that fall under section 111A of Income Tax Act, i.e., equity shares which are listed on the stock exchange. STCG other than that covered under section 111A is charged to tax according to the slab rates determined based on one’s total taxable income. Shares that are not listed on a recognized stock exchange and preference shares are some examples of STCG listed under section 111A. To qualify for a concessional rate of STCG on equities, it is essential that the stock be listed on a recognized stock exchange and also that the investor has paid the STT on the buy leg of the transaction. Let us understand the calculation of STCG tax with an illustration.
Jayant is a salaried employee. In the month of December 2015, he purchased 100 preference shares of Jetking Ltd. at Rs500 per share. These shares were sold in August 2016 at Rs625 per share. Can the capital gain be termed as STCG covered under section 111A?
Section 111A is applicable in case of STCG arising on transfer of equity shares which were transferred on or after 1/10/2004 through a recognized stock exchange and such transaction is liable to STT. In the given case, the shares are preference shares and hence, the provisions of section 111A are not applicable and such a gain will be treated as normal STCG taxed according to slab rates.
Now, let us look at the actual calculation of STCG tax assuming that the shares were bought at different points in time. Here is how it will look like.
Assume that on 10th April, 2017, you bought 100 shares of Reliance at Rs800 per share, and on 1st June, 2017, another 100 shares were bought at Rs820 per share. Later, on 15th December, 2017, you sold 150 shares at Rs920 per share.
In the above the case, the shares are sold within a period of one year, and hence, will classify as short-term capital gains for the purpose of taxation.
Following FIFO guidelines, 100 shares bought on 10th April, 2017, and 50 shares from the 100 bought on 1st June, 2017 should be considered as being sold.
Hence, for shares bought on 10th April, 2017, gains = Rs 120 (920-800) x 100 = Rs12,000/- (Tax at 15% of the STCG will be payable at Rs1,800 = (12,000 x 0.15)).
For shares bought on 1st June, 2017, gains = Rs100 (920-820) x 50 = Rs5,000/- (Tax at 15% of the STCG will be payable at Rs750 = (5,000 x 0.15)).
Thus in the above case, the total STCG as per the FIFO method will be Rs17,000, and a total STCG tax of Rs2,550 will be payable on these shares. Of course, it is assumed that the shares are purchased on a recognized stock exchange and the STT has been paid on these stocks.
One more thing needs to be remembered about short-term capital gains. When it comes calculating of STCG, there was no change made in the Union Budget 2018, which imposed 10% capital gains tax only on LTCG. We shall understand this in detail later in this chapter.
How exactly is the tax on long-term capital gains (LTCG) tax calculated?
When it comes to LTCG on equities, we need to understand this in two phases. Earlier the LTCG falling under the exemption of section 10(38) was not taxable. It was fully exempt income in the hands of the investor. Union budget 2018-19 brought in major changes by amending this section. Now, LTCG from equity shares if exceeding Rs1 lakh in a year (without indexing) will be subject to a flat tax rate of 10%. This rule will be applicable to transfer taken place after 1st April, 2018. Note the use of the word “flat” here. What it means is that irrespective of whether you sell the shares after 1 year or 5 years or even 20 years, the tax on LTCG will be imposed at a flat rate of 10% without any indexation benefits.
Ashok works for Ladybird Ltd., an Indian company. In the month of February 2016, he purchased 1,500 shares of Mex Textiles Ltd. at Rs100 per share. Shares of Mex Textiles Ltd have been listed on the Bombay Stock Exchange. These 1,500 shares were sold in April 2018 at Rs130 per share. He has no other shares in his portfolio. How will the gains be charged to tax?
The shares were held for a period more than 12 months, and hence, will classify as LTCG. Therefore, technically, the LTCG tax at 10% will be imposed since the shares were sold after 31st March, 2018. What is the total LTCG in this case? His LTCG in this case is Rs1500 x (130 - 100) = Rs45,000. Since his total LTCG of Rs45,000 is less than the basic exemption of Rs1 lakh, he will not have to pay any LTCG tax as it is already mentioned that he does not have other shares in his portfolio. Therefore, the LTCG in this case will be exempt as the 10% charge is levied only if gains from selling shares are exceed Rs1 lakh.
The government wants to encourage long-term investment, and hence, has charged tax on the incomes from the sale of short- and long-term capital assets along with reliefs and exemptions. Thus, one has to pay tax on any income from selling shares which are of short-term holding and only on the amount exceeding Rs1 lakh when gains are from long-term stock holdings. Further, the tax on LTCG is at a lower rate of 10% as compared to 15% on STCG. How much difference does the LTCG tax make to your yield in post-tax terms? Let us find out.
How will the tax on LTCG impact you?
The attractiveness of equities as an asset class will reduce, and we need to find out how much it will reduce by. Let us understand how big the difference will be after you consider the impact of tax on LTCG under two different holding period assumptions.
|Particulars of transactions||15-month holding period||Particulars of transactions||50-month holding period|
|ABC Ltd. buy date||Jan 1, 2018||ABC Ltd. buy date||Jan 1, 2018|
|Number of shares||1000||Number of shares||1,000|
|Buying price||Rs.745||Buying price||Rs.745|
|ABC Ltd. sell date||Apr 1, 2019||ABC Ltd. sell date||Mar 1, 2022|
|Holding period||15 months||Holding Period||50 months|
|Selling price||Rs.1,085||Selling price||Rs.2,295|
|Buy cost||Rs.7,45,000||Buy cost||Rs.7,45,000|
|Sell value||Rs.10,85,000||Sell value||Rs.22,95,000|
|LTCG Gains||Rs.3,40,000||LTCG Gains||Rs.15,50,000|
|Profit percentage||45.64%||Profit percentage||208.05%|
|CAGR Returns||35.09%||CAGR Returns||31.00%|
|Now let us consider returns in the post LTCG tax scenario|
|LTCG Gains||Rs.3,40,000||LTCG Gains||Rs.15,50,000|
|Effective tax on LTCG$||11.648%||Effective tax on LTCG$||11.648%|
|Post Tax Profit #||Rs.3,00,397||Post Tax Profit #||13,69,456|
|Post tax sell value||10,45,397||Post tax sell value||21,14,456|
|Post Tax CAGR (%)||31.10%||Post Tax CAGR (%)||28.90%|
# - For the purpose of simplicity, we have assumed that the limit of Rs1 lakh for exempted LTCG is already utilized elsewhere, so the entire LTCG in this case is taxable.
$ - The tax rate on LTCG is 10%, but the effective tax rate works out to 11.648% if you add up the surcharge and the 4% cess effective from this year.
In the above illustration, when you take your holding period from 15 months to 50 months, your reduction in CAGR yield due to the 10% LTCG tax comes down from 4% to 2%. When you consider longer time periods of 10-15 years, the impact is less than 40 basis points. If you are really worried about the impact of the LTCG tax, you can afford to relax! The moral of the story is that as your holding period gets longer, the actual impact of this LTCG tax on your CAGR returns will be quite negligible. So, to answer your big query, it will not make any substantial difference to your long-term investment accumulation.
How to show trading profits (capital gains or as business income)
Actually, there are no hard and fast rules here. Stocks that you hold for more than 1 year can be considered as investments as you would have most likely received some dividends and also held them for a relatively long period. Shorter term equity delivery buy/sells can be considered as investments as long as frequency of such buy/sells is low. If you wish, you can also show your equity delivery trades as business income, but whatever stance you take, you should continue with it in the future years as well. The key requirement of the income tax department is that the methodology that you apply must be consistent in future years.
LTCG has to be a demat trade
Firstly, you need to know that when you buy & sell (long trades) or sell & buy (short trades) stocks within a single trading day, such transactions are called intraday equity/stock trades. Alternatively, if you are buying stocks/equity and waiting till they get delivered to your DEMAT account before selling it, is the transactions are called “equity delivery based” transactions. Any gain/profit earned through equity delivery based trades or mutual funds can be categorized under capital gains. For example, a BTST trade will classify as STCG although there is no demat implication. However, LTCG can only happen if there is demat in and demat out.
What about off-market transactions?
We understand all about the calculation of capital gains. But, what if the transfer of shares happens through an off-market transfer of shares from demat to demat. If the transactions (buy/sells) are executed through an off-market transfer, where shares are transferred from one person to another via a delivery instruction booklet and not via a recognized exchange, the LTCG is 20% in case of non-listed stocks and 10% on listed stocks. (Listed stocks are those which trade on recognized exchanges). Do note that when you carry an off-market transaction, Security Transaction Tax (STT) is not applicable, but you end up paying higher capital gains tax.
You may also note that any receipt of gift from a relative through the DIS slip is not considered as a transaction, and hence, is not capital gain. It is important that the gift not be treated as transfer, and the relative could be (i) the spouse of the individual (ii) a brother or sister of the individual (iii) a brother or sister of the spouse of the individual (iv) a brother or sister of either of the parents of the individual (v) any lineal ascendant or descendant of the individual (vi) any lineal ascendant or descendant of the spouse of the individual (vii) spouse of the person referred to in clauses (ii) to (vi). For the benefit of a legal audit trail, it is always advisable to execute such transactions via a registered Gift Deed.
Is indexation relevant in the case of LTCG on equities?
When calculating capital gains in case of non-equity oriented mutual funds, property, gold, and others where you are taxed on LTCG, you get the indexation benefit to determine your net capital gain. However, the Union Budget 2018, which introduced the 10% tax on LTCG has clearly called it a flat tax (without the benefit of indexation). There is a basic exemption of Rs1 lakh per financial year which has been given for the calculation of tax on LTCG. While indexation gives you protection against a rise in the cost inflation index, this benefit of indexation is not available in case of equities. Hence, indexation is not applicable on LTCG on equities.
The above discussion is entirely predicated on capital gains. However, you don’t always have capital gains. You may also end up with losses. For example, if you buy a stock at Rs150 and sell at Rs128 after 6 months, it is an instance of a short-term capital loss since the holding period is less than 1 year. If you sell the stock after 12 months at a loss, it is a case of long-term capital loss. Till 31st March, 2018, all short-term capital losses could be set off but long-term losses could not be set off since LTCG were liable to zero tax. However, with the introduction of 10% LTCG flat tax on equity gains from 1st April, 2018, the long-term losses will also become available for set off.
When you pay tax on capital gains, it is always paid on net capital gains (capital gains – capital losses). This helps you substantially reduce your tax liability. Here are some key points of loss offsetting that you need to be familiar with:
STT on equity and F&O transactions
Securities Transaction Tax (STT) is a tax payable to the Government of India on trades executed on recognized stock exchanges. The tax is not applicable on off-market transactions, which is when shares are transferred from one DEMAT to another through delivery instruction slips, instead of routing the trades via the exchange. However, off market transactions attract higher capital gains tax as explained previously. The current rate of STT for equity delivery based trades is 0.1% of the trade value.
When calculating taxes on capital gains, STT cannot be added to the cost of acquisition or sale of shares/stocks/equity. On the other hand, brokerage and all other charges (which includes exchange charges, SEBI charges, stamp duty, service tax) that you pay when buying/selling shares on the exchange can be added to the cost of shares, hence, allowing you to indirectly take the benefit of these expenses that you incur.
Advance tax has to be paid on estimated gains of a quarter when you have realized capital gains (STCG or LTCG). Every tax payer with business income or with realized (profit booked) STCG or LTCG is required to pay advance tax on 15th June, 15th Sep, 15th December, and 15th March. Advance tax is paid keeping in mind an approximate income and taxes that you would have to pay on your business and capital gain income by the end of the year. It is always better to overestimate and then claim refund than to underpay. In the case of STCG, you are required to pay 15% of the expected annual tax that you are likely to pay for that financial year by 15th June, 45% by 15th Sep, 75% by 15th Dec, and 100% by 15th March. Please note that not paying tax would entail a penalty of an annualized interest of around 12% for the period by which it was delayed.
You may wonder how to extrapolate your capital gains and losses, but that can be done approximately based on your past performance. When you are investing in the stock markets, it is very tough to extrapolate the capital gain (STCG) or profit that will be earned by selling shares for an entire year just based on STCG earned for a small period of time. So, if you have sold shares and are sitting on profits (STCG), it is best to pay advance tax only on that profit which is booked until now. Even if you eventually end up making a profit for the entire year which is lesser than for what you had paid advance tax, you can claim for a tax refund. Tax refunds are processed quickly with the advent of online filing.
A bonus issue refers to shares issued free of cost to shareholders. This is normally issued out of the free reserves. In case you are holding 1000 shares of Reliance Industries Ltd. and the company announces a 1:1 bonus, you are entitled to receive 1 share for every 1 share held. This means that you will get 1,000 shares against 1,000 shares held and end up with 2,000 shares in total. However, since the issued capital of the company doubles in this case, the EPS will halve (since profits remain the same). This is why, you will find that after a 1:1 bonus, the stock price typically reduces to half on the ex-bonus date. But, how are bonus shares taxed?
For purpose of calculation of LTCG/STCG on bonus shares, their cost will be taken as zero. So if you bought 500 shares of ABC Ltd. at Rs145 on 1st June, 2018, and got a bonus of 1:1 on 1st Jan, 2019, you will have 1,000 shares in all. If the 1,000 shares are all sold on 1st December, 2019, at Rs175, how will LTCG be calculated?
In the above instance, LTCG will be calculated for original shares and bonus shares separately. Consider the table below:
|Original Shares||Amount||Bonus Shares||Amount|
|Holding Period||18 months||Holding Period||7 months|
|Capital Gains||LTCG||Capital Gains||STCG|
|Sale Value for 500 shares||Rs.87,500||Sale Value of 500 shares||Rs.87,500|
|Cost of 500 shares||Rs.72,500||Cost of 500 shares||Nil|
|Tax payable (less than Rs1 lakh)||Nil||15% of STCG||Rs.13,125|
In the above instance, the total capital gains tax payable including the bonus shares will be Rs13,125. That is how the taxation is calculated when capital gains arise in case of bonus shares.
Globally, buybacks are of two types: buybacks for treasury purposes and buybacks for extinguishing capital. In India, buybacks are only permitted for extinguishing capital and not for treasury. Ever since dividends were made taxable at 10% in Budget 2016, there has been a steady shift towards buybacks. This has been especially profitable for promoter shareholders. When a company buys back shares, the profit is capital gains. There is a grey area here. LTCG was tax-free only if STT was paid on the stock. However, promoters would not have paid STT while acquiring the stock. Currently, buybacks are treated as normal capital gains depending on the holding period. Effective, April 2018, even such buybacks will attract an LTCG tax of 10% if the gain is more than Rs1 lakh. The government may tighten the grip by asking promoters to pay 20% tax as is the norm when the STT has not been paid on the stock. This area is still open and a final decision in this regard is still pending.