Before we understand how capital gains on listed shares are taxed it is important to understand how stock trading happens in the Indian stock market.
Indian Stock Market
A popular way to build wealth is by investing in equities, as the stock market has the potential to produce lucrative returns. When investors buy a company’s stock, they not only become a part-owners of the business but also gain from an increase in the share price of the company. They can choose to sell the stock of the company at an appropriate time. Essentially, investors benefit from capital appreciation when the value of their investment increases. Investing in the stock market can be very advantageous to investors if he/she is able to identify the correct stock to invest in.
Having said that, it is important to be aware of the risk involved with the stock market. Investors may benefit from a rising market, but they may also lose money if the market declines. To take advantage of stock market potential, investors need to grasp how the stock market operates and how their gains are taxed. Let us understand the fundamentals of the stock market.
What Exactly Is A Stock Market?
A stock market is a marketplace for buying and selling stocks as well as other securities including bonds, currencies, commodities, and derivatives. Companies can list their stocks for sale on the stock market in order to raise capital. Additionally, it offers investors a platform to trade listed equities in order to earn returns.
What Is A Stock?
Companies issue stocks as a way to raise funds. Stock, often known as a share, refers to ownership of a corporation on a per-unit basis in form of a tradable instrument. An investor is considered to have acquired 10% ownership of a company if it issues 10,000 units of stock and the investor purchases 1000 of those units. Investors have the option to receive dividends on their stock investments as per the discretion of the issuing company. Furthermore, if the price of the share increases, investors’ portfolio goes up. A stock market is a venue where shares of listed companies can be bought and sold.
What Are The Different Stakeholders In A Stock Market
There are many participants in the stock market. In the stock market, each entity has a certain role to play. Here are some examples of the various stock market entities:
- The Regulator: The regulator’s job is to create the laws and rules that govern how the stock market operates. The regulator controls the stock market, makes sure that traders follow the rules, and also controls the market as a whole. India’s stock markets are governed by the Securities and Exchange Board of India (SEBI).
- Listed Companies: Stocks of companies that list on the stock exchange are available for sale and purchase by the general public. To make their shares available for trading, businesses must list themselves on alteast one of the recognized stock markets in India.
- Stock Exchanges: The equities which are listed on the stock exchange. Investors then trade these listed equities, and other listed instruments such as bonds, and derivatives. The National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) are the two main stock markets in India. The benchmark market index for the top 50 NSE-listed businesses is called Nifty, while the benchmark index for the top 30 BSE-listed companies is called Sensex.
- Brokers: Stockbrokers are intermediaries who enable trading in stocks and other instruments. They can be either individuals or businesses. Investors may only purchase and sell shares through licensed stock brokers, following SEBI regulations. Brokers typically charge a fee or brokerage for handling transactions.
- Traders and Investors: Entities and individuals who invest in assets on the stock market from a long-term perspective are known as investors. While those who trade on the market with the intention of making business income from stock market transactions are known as traders.
- Depository Participants and Depository: Investors who wish to trade stocks must have a Demat account. Depositories provide this Demat account for investors. There are two depositories in India: National Securities Depository Limited (NSDL) and Central Depository Services Limited (CDSL). However, depositories do not provide investors with direct access to Demat account services. Investors must open a Demat account through a Depository Participant (DP), who represents the depository on their behalf.
- Clearing Corporation: Stock trades between traders are settled by clearing corporations. When investors swap stocks, one sells the stock while the other purchases it. The trade between the buyer and seller of a certain stock is settled by clearing corporations, they guarantee the settlement of the trade.
Now that we are clear with how the stock market works. Let us understand how your profit/income in the stock market is taxed especially the tax on capital gains.
Taxation Of Shares
You must pay taxes on your gain if you invest or trade on the stock market. Following are the categories of income/profit one can make from the stock market.
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- Long Term Capital Gain (LTCG)
- Short Term Capital Gains (STCG)
- Business income from trading
- Dividend
Let us examine these in detail.
- Long Term Capital Gains On Sale of Shares
If you hold investments in listed shares for a period longer than a year, any profit or gain on account of selling the share is regarded as a long-term capital gain. No tax needs to be paid on long term capital gains upto a limit of INR 1 lakh. Capital gains over Rs. 1 lakh are subject to a 10% tax. Let’s use an example to better grasp this:
Consider that after investing Rs. 5 lakh in a stock of XYZ Ltd., you sold it for Rs. 6.5 lakh. The gain of Rs. 1.5 lakh is regarded as long-term capital gain and will be taxed as such. Listed shares were exempt from LTCG tax up until FY 17–18.
- Short Term Capital Gains On Sale of Shares
If you hold listed shares for less than a year, any profit or gain from those investments is regarded as a short-term capital gain. STCG is subject to a flat tax of 15%. Let’s use an example to better grasp this:
Consider purchasing 100 shares of XYZ Ltd. at Rs. 1000 each, then selling every share at Rs. 1050 after six months. Gain of Rs. 50*100 = Rs. 5000 is categorized as STCG and is subject to a flat tax at the rate of 15%.
- Business Income
Income arising from trading stocks or equities on an intraday basis or non-delivery basis is classified as business income under Section 43(5) of the Income Tax Act. Income from these kind of transactions are added to your income and taxed in accordance with your tax slab applicable to you. As a result, if a person makes Rs. 8 lakh per year from his salary and makes Rs. 50,000 in intraday trading, his total taxable income will be Rs. 8.5 lakh, which will be taxed at the applicable slab rate.
- Taxation Of Dividends
Uptill FY 19–20, in case the entire dividend income from stock were less than Rs. 10 lakh, dividends were tax-free in the hands of investor. Dividend income that use to exceed Rs. 10 lakh was subject to taxation at flat rate of 10%. However, dividends earned by the investors starting from the fiscal year 20-21 are subject to tax as per the individual’s tax slab. In other words, your dividend income will be added to your income, and will then be taxed according to your income tax slab.
- Set-Off
According to income tax laws, any loss under the heading “Capital Gains” may only be offset by income under the same heading. It cannot be offset by any other income head, such as a wage or business income.
Short-term capital losses are permitted to be set off against both LTCG and STCG, while long-term capital losses can only be offset against LTCG. If you are unable to offset your whole loss in the same financial year, there is also a provision for losses to be carried forward. For eight assessment years immediately following the assessment year in which the loss was initially computed, both short-term and long-term capital losses may be carried forward.
How To Save Tax On Equity Investments – ELSS Mutual Funds
The government of India has introduced a special scheme to encourage investment in listed equities. It is called Equity Linked Saving Scheme, under this scheme, investments made in ELSS mutual funds are exempt from income-tax under Section 80C of the Income Tax Act, 1961 upto a limit of INR 1.5 lakh per year.
What Is An ELSS Mutual Fund?
An ELSS fund is a type of equity mutual fund that enables stock investments along with tax exemption under Section 80C of the Income Tax Act. One of the finest ways to profit from the stock market and save tax at the same time is investing in ELSS mutual funds. By investing in ELSS funds, you can receive an annual tax exemption of up to Rs 1,50,000 from your taxable income.
ELSS mutual funds have a three-year lock-in period which is mandatory and cannot be waived in any condition. There is no option to withdraw your money before three years, and this period is non-negotiable. Your income at the conclusion of this period is regarded as a long-term capital gain (LTCG), which is subject to a 10% tax if it exceeds Rs 1 lakh. However, the income invested in the ELSS mutual fund is tax exempt.
ELSS Mutual Funds Explained
Here are some crucial characteristics of ELSS mutual funds that you might find interesting:
- An ELSS fund, as the name implies, invests your money in the stock market. It implies that the asset management firm will put at least 80% of your funds into the stock market. Different investment strategies can be used by each organization to lower risks.
- Most ELSS mutual funds will also pick a selection of equities depending on their market capitalization and potential for future growth.
- Investment through a lump sum investment or through a systematic investment plan (SIP) can be made in the ELSS mutual funds. You will need to make periodic investment in case of SIP. SIP is more convenient option if you do not want to make lumpsum investment.
- There are no guaranteed returns offered by ELSS funds. These funds typically have a high level of risk because to their focus on the stock market and since they invest 80% of their corpus into equities.
- The maximum investments you can make in an ELSS is not capped. To start your investment, you can put in as little as INR 100.
Who May Invest In ELSS Funds?
All investors looking for an investing alternative to produce income and reduce taxes should consider ELSS funds. They are especially advised to people with lesser risk tolerance and appetite, such as those with modest salaries. The ability to invest in ELSS funds is not age-restricted. As a result, newly employed professionals can invest their hard-earned money in these programmes.
Investors who wish to diversify their holdings and are searching for a new alternative to add to their portfolio can consider ELSS funds.
What Factors Ought to Be Taken Into Account Before Investing In ELSS Funds?
Examining an ELSS fund’s long-term performance is crucial before investing. In addition, here are some other things to think about before opening an account.
- Liquidity: Because ELSS mutual funds have a three-year lock-in period, it’s crucial to think about your expenses before investing in one of these funds. You cannot cease investing in a fund in the middle of it.
- Tax Planning: Due to the opportunity to save on taxes, many people invest in ELSS funds. You might want to evaluate your alternative possibilities if tax planning is your only concern. For instance, under Section 80C of the Income Tax Act, your investments in other plans like NPS and PF are also eligible for a tax break.
- Investment Horizon: You might want to reevaluate your selections if you intend to sell your investments after the lock-in term. An ELSS may take 5-7 years to stabilize and provide you with high returns after investing your funds in the stock market. Only those with a longer time perspective should invest in ELSS funds because of how unpredictable and vulnerable to cyclical ups and downs the stock market is.
- To receive tax benefits, many professionals invest in ELSS mutual funds via SIP or lump sum. They complete it at the last minute, forcing them to manage a lump sum at the last minute. In addition to being financially difficult, it is a bad decision. Your returns might not meet your expectations if the market is strong when you make your investment. The SIP approach, which averages the cost of each unit, is a preferable choice.
Conclusion
Before investing in stock market, it is important to understand the various factors that may impact your investment. One of the most important factors is taxation. If you are unaware about the applicable tax rate your investment strategy will definitely falter.
Did you know? You can now invest in ELSS or tax-saving funds on Kuvera:
Step 1: Download the Kuvera app or visit our website.
Step 2: Create your account on Kuvera by completing the mandatory KYC procedure. This will hardly take a few minutes. Once that’s completed, select the ‘Invest’ option on our homepage after which you can select ‘Mutual Funds’ and ‘ELSS’.
Step 3: Kindly go through the list of all zero-commission direct plans of ELSS schemes to start investing.
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