When you sell something at a price higher than its purchase price, you earn profit. The profit earned by selling any capital asset is known as capital gains. Capital assets are of many types such as real estate or housing property, jewelry, stocks, etc. Capital gains are also further classified into two categories- Short Term Capital Gains (STCG) and Long Term Capital Gains (LTCG). Both the gains are taxed differently as per laid provisions in the Indian Tax Act. In this article, we will focus on discussing the tax on LTCG on shares.
Every share investor should know about tax on LTCG in shares
Tax on LTCG on Shares
Long Term Capital Gains or LTCG on shares is realized when the shares are sold after being held for a minimum of 12 months. For example, if you have purchased equity shares on 1st January 2020 and sold the same on 1st January 2021, i.e; after 12 months, the gain made from the sale will be considered as LTCG. On the other hand, if the shares are sold before within 12 months of their purchase, the gains made from the same will be called STCG. Both LTCG and STCG are taxed differently. In the case of the LTCG tax rate on shares, there are two cases-
Case 1: If the LTCG is up to Rs 1 lakh
The tax on LTCG on shares of up to Rs 1 lakh is nil or the gains are exempted from taxation. This means that if you have gained less than or equal to Rs 1 lakh by selling shares after holding them for 12 months, you will not have to pay any taxes.
Case 2: If the gain is above Rs 1 lakh
The tax on LTCG on shares of above Rs 1 lakh is 10%. This means that if you have gained more than Rs 1 lakh by selling shares after holding them for 12 months, you will have to pay 10% tax on gains made. You also have to pay the applicable surcharge and cess along with the tax. Moreover, you cannot enjoy the benefits of indexation on tax on LTCG on shares.
The provisions for tax on LTCG on shares were introduced in the Financial Budget of 2018. There also came a ‘grandfather rule’ for the purchase of shares made before 31st January 2018. We will understand this with an example later.
Calculation of Tax on LTCG on Shares
To calculate the tax on LTCG on shares, we will have to calculate the LTCG first. The simple formula used to calculate LTCG on shares is:
LTCG = Sale consideration – Cost of acquisition
Sale Consideration: In the case of shares, sale consideration is the amount received from selling the shares excluding the brokerage fee and STT (Securities Transaction Tax).
Cost of Acquisition: The amount paid to acquire ownership of the shares excluding the brokerage fee and STT (Securities Transaction Tax). However, if the actual cost of the capital asset is less than its fair market value as of 31st Jan 2018, the latter, i.e; the fair market value will be considered as the cost of acquisition.
Let us understand the tax on LTCG on shares with an example:
Suppose Aakash purchased certain shares for Rs 1,25,000 on 1st January 2019. He then sold the same for Rs 2,50,000 on 1st February 2020, i.e. holding the shares for more than 12 months. Now, Aakash has made an LTCG of above Rs 1,25,000 (more than 1 lakh). As per the tax laws, he will be charged 10% on the gains made.
LTCG in this case: Sales value – Purchase Price – Brokerage – STT
LTCG= 2,50,000 – 1,25,000 – 0.5% – 0.025%
LTCG= Rs 1,24,343
Now 10% tax on Rs 1,24,343 is Rs 12,434. This means Aakash will have to pay Rs 12,434 as LTCG on tax on shares along with surcharge and applicable cess.
Now, let us come back to the ‘grandfather rule’. According to this rule, if certain shares are purchased before 31st January 2018 and sold after 31st January 2018, the gains will be taxed in two different ways. The gains made up to 31st January 2018 will be taxed according to the previous tax rate, while the gains made after the 31st January 2018 until the sale will be taxed according to the new tax rate. The first part will be exempted from taxation, while the next part will be taxed at 10%, considering the total gain is above Rs 1 lakh.
Importance of LTCG Tax on Shares
- Tax on LTCG on shares allows investors to save money. By knowing the fact that LTCG up to Rs 1 lakh is exempted from taxation, they will sell the shares after 12 months to enjoy the given tax benefits.
- The tax on LTCG on shares is considerably lower than LTCG on other capital gains and STCG in general. By this, the government aims to motivate investors to make long term investments. This will allow the investors to enjoy higher returns in the long run as well as keep enough capital in the market for the companies.
Knowing about taxation on LTCG on shares is extremely important to save taxes on the gains made from selling shares. This gives investors the knowledge to choose the right moment to make a sale and invest accordingly.