Till now I have been covering topics related to how to make money wisely and efficiently. But, recently, one of our readers had an unusual but very relevant request… to discuss the basics of Income Tax and whether profits earned from the share market are taxable or not. To be honest, this is not my area of expertise, but, at the same time, I am convinced that this topic is as important as making money. If you want to enjoy the share market ride, you will have to catch the Bull by its horns, and if you want to hold on to the profits you made… you literally have to hold on to its tail, probably the last hair on its tail. This was figuratively speaking and was probably a poor joke……….but it does convey the sense. Let’s take a closer look at this subject.
Like we pay society/colony maintenance fees and club membership fees, our government too requires money to pay civil servants, police, army and also for making roads, hospitals and providing for poor. In short, whatever government is spending… it collects from its citizens in form of some taxes either direct or indirect. What concerns us at this stage is direct taxes and our personal liabilities in form of Income Tax. As the name suggests… it is the tax that is collected based on the income of any individual. The more the income, the higher is the tax. Over the period of time, through many reforms, the government is continuously trying to lower the burden on lesser / medium income groups by widening the tax-paying population base and cutting down on tax evasion by plugging loopholes in the system. For this purpose, it allows income up to 2.5 lakhs as tax-free and a further rebate of 12,500/- under section 87A. While on the other hand, by linking all financial instruments such as banks, mutual funds, and equity market to the income tax department… it is endeavoring for zero tax evasion. From this year onward, Income Tax Department has started uploading pre-filled IT forms, which takes data from all possible sources of income, including share market data from brokers to curb tax evasions. Therefore, in all probability, when you open Income Tax Department Portal, all the profit generated through the equity market will already be pre-filled. However, if it is not reflected… don’t feel too happy, later or sooner the IT Department will catch up with you to not only extract all the pending taxes but some fine too. Therefore, my advice to all my friends here will be to pay taxes, if due.
That brings us to a new topic, which we have not discussed so far… how much taxes do we owe to the government on profits earned from the equity market??? For this, let’s understand taxation rules, one by one.
Equity / Shares Trading — If you too have been investing or trading in shares like me, your trades will qualify in one of the following categories:-
1. The gap between buying and selling is more than one year — In this case, the profit generated will fall under Long Term Capital Gain (LTCG) and will be taxed at a flat 10%. This too is tax-free up to one lakh, and profits above one lakhs will be taxed at 10%.
2. The gap between buying and selling is less than one year — Now, the profit generated is considered as Short Term Capital Gain (STCG) and is taxed at 15%.
3. Intraday — Bought and Sold in the Same Day — Government does not see this as investing but sees it as Speculative Income and, therefore, adds this to your overall taxable income and charges it as per income tax slabs.
4. Dividends — Exactly the same as above. From 01 April 2020 onwards, it is taxable as normal income, and if you download TRACES (Form 26AS), it will be reflected in it too under Part A.
5. Mutual Funds — I am personally not a great fan of Mutual funds as I feel that with equity investing, you retain more flexibility, as well as you can generate greater profits. However, for purpose of taxation…….if you have earned profits from buying and selling mutual funds or have received dividends, it will be treated similarly as per rules discussed above for equity trading except for Tax Saver Mutual Funds or ELSS (Equity Linked Saving Scheme). ELSS Funds have a lock-in period of 3 years and are covered under Section 80C up to a limit of 1.5 lakhs. In simple words, if you invest up to 1.5 lakhs in these, your taxable income comes down by the amount invested. However, investment over and above 1.5 Lakhs will be treated as Long Term Capital Gains and profit generated would be taxable at 10%.
Fixed Deposits (FD) — The interest earned on an FD is added to the total taxable income and is taxed as per applicable slabs. For example, if you have invested one lakh in an FD at 5% and generated interest income of 5,000/-. It will be taxable at your existing tax slab (say 10%). Reducing your profits further. In this case, your net profit will come down to 4.5% if you are in the 10% slab and 3.5% if you are in the 30% tax slab. Is it really worth it?????
Debt Funds / Debentures / Bonds — I presume very few people must be investing in these instruments as their returns are much lesser than equity market/equity mutual funds. However, these too have their usefulness especially, for people who cannot afford risk either due to their financial commitments or they are well past their earning stage, such as senior citizens. Somehow, Government is not very kind towards such investments, and these attract severe taxation. Firstly, the Long Term Capital Gain period for them is stretched to 3 years from 1 year as applicable to equity investing, and Secondly, the tax slabs are also steep. In this category, Short Term Capital Gain (< than 3 years) is added to the total income of an individual and is taxed as per existing slabs, and tax for Long Term Capital Gain (> than 3 years) is fixed at 20%.
OK… feeling depressed that your hard-earned money is being taken away from you??? But, you should not… as this money is what keeps you safe and the society organized. However, it will be foolishness, if we do not even consider the impact of this on our long-term wealth creation. Therefore, while there are many instruments for wealth creation, choose your’s with care. Compare interest earned at 5% in FD (final profit after tax at 3.5%) to a conservative estimate of profit from investing in Blue Chips at 8 to 10%. If this too is less than a lakh, it becomes tax-free. Great, isn’t it.
Pro Tip:- Even if you want to hold your shares for long, sell the shares for at least one day after completing one year so that your profit up to one lakh becomes tax-free. Since you would not be able to carry forward this rebate to next year, it is best to cash in this tax-saving offer of 10,000/- every year.
Honestly, this was a new topic for me too, and it took some effort to understand and simplify the contents. I sincerely hope you enjoyed reading it and are a little wiser than before. Please do like and share the contents with your loved ones, and do not forget to hit the FOLLOW button on the top left.
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Be a Responsible Bull (Pay Your Taxes Wisely) was originally published in The Capital on Medium, where people are continuing the conversation by highlighting and responding to this story.
