Investment is taxed?! Well, not directly, but the returns sure are. There are, of course, caveats that the government has made terming certain instruments as EEE (Exempt- Exempt- Exempt: On deposit, growth and withdrawal), but they are very few.
Now, taxes on investments can happen on two fronts – one will be on the dividend or interest income you receive, and the other on the profit/net gains from the sale or redemption of securities. Also, tax on short term capital gains and long term capital gains will differ vastly.
But what are these taxes? What are the differences between short term and long term gains? Read further to know in detail the taxation process for different asset classes.
Listed stock/equity instruments
Equities can generate returns for you in two forms – capital gains and dividends.
Capital gains that are realised after redemption/selling of equity securities or listed stocks attract two types of taxes, depending on the holding period (the time from when you purchase until the time you sell the shares). They are STCG (Short term capital gains) tax and LTCG (Long term capital gains) tax.
If your holding period of listed stocks/equities is less than 12 months, then according to Section 111A of the Income Tax Act, 1961, your gains are subjected to a flat 15% tax rate. Now, if your holding period is more than 12 months, then in accordance with Section 112A, any gains above the threshold of Rs. 1 lakh will be taxed at 10%, without indexation benefit (adjusted rate for inflation). These taxes would be paid along with applicable cess and surcharges.
Finally, STT (Securities Transaction Tax) of 0.025% is applicable to every transaction involving the sale of equity shares.
Remember, equity mutual funds have the same tax rates for the same period.
Note – STCG would be NIL if your total income, including the short-term gains, is less than Rs. 2.5 lakh.
Now, what about dividend gains?
Dividends from domestic companies remained tax exempted until FY 2019-20, when companies declaring dividends paid taxes before distributing dividends under the DDT (Dividend Distribution Tax) system. However, post this period, under Finance Act, 2020, dividend gains are taxed based on your income slab, with TDS applicable at 10% (which is now 7.5%, because of Covid-19) in excess of Rs. 5000. Read the example below to understand the rules better.
Assume Mr. X is entitled to receive a dividend income of Rs. 5000. Now, the company distributing this dividend will deduct a TDS of Rs. 375 (7.5% of Rs. 5000). Further, this income will be taxed according to Mr. X’s income tax slab.
Confused about equity investments? Read our article’ Equity investments: Benefits, Considerations, and Must Know Tips ‘on the Teji Mandi website.
Debt instruments include debentures, bonds, Government securities, etc., which are listed on a recognised stock exchange. Holding these securities for more than 12 months attracts LTCG tax at 20% (with indexation) or 10% (without indexation), whichever is more beneficial to the investor. If the holding period falls below 12 months, an STCG tax would be triggered as per the tax slab rate applicable to the investor.
The interest earned from such instruments, which is credited to an investor’s bank account, again attracts taxes as per the income slab. However, interest from tax-free bonds is exempted under Section 10(15)(iv)(h) of the Income Tax Act.
Debt mutual funds
These are mutual fund investments in debt securities and related instruments like Commercial Papers, Certificates of Deposits, T-bills, and more. Now, interestingly, the holding period of debt funds is not the same as listed debt securities. If debt funds are sold after a 36-month period, they attract an LTCG tax of 20% (with indexation), and if these funds are redeemed before a 36-month period, the investor will pay STCG tax at his income slab rate.
ETF taxation is determined by the underlying asset they invest in. For equity-related ETFs, holding period, LTCG, and STCG taxes are all the same as listed equity. But, for gold, debt, and other ETFs, a holding period above 36 months attracts a 20% rate with indexation. Any holding below 36 months calls for an STCG tax applicable as per the investor’s tax slab.
Derivatives are a very interesting yet highly risky asset class. These instruments derive their value from underlying assets, such as commodities and metals. While, in reality, this asset is highly speculative, Section 43(5) of the Income Tax Act disregards trading of derivative instruments (on recognised exchanges) as speculative.
Taxation of derivatives is also relatively different from other instruments. Income from derivatives is treated as ‘business income’ or ‘income from other sources.’ Capital gains from this ‘business income’ are taxed as per the tax slab applicable to the investor.
As an investor, you need to not only be aware of your goals and returns but also the taxes that you may attract. Now, this is important as these taxes can eat a considerable portion of your returns. Also, managing these taxes will help you create a tax-efficient portfolio in the long run. Do consult your tax advisor before indulging in any transactions on the stock markets.
Teji Mandi offers ac tive advice and helps you build a portfolio that fits well with your financial goals and risk appetite. Reach out to us to know the best tax saving schemes that will help you minimize your tax liability while maximizing your returns!