Long Term Capital Gain on Shares

Introduction

Long-term capital gain (LTCG) on shares refers to the profit earned from selling shares after holding them for more than 12 months. This concept is crucial for investors looking to understand the tax implications of their investments in equity markets. This comprehensive guide explores the intricacies of long-term capital gain on shares, including tax rates, exemptions, and strategies to manage these gains effectively.

What is Long-Term Capital Gain on Shares?

Long-term capital gains on shares occur when shares held for over a year are sold at a profit. The difference between the selling price and the adjusted purchase price represents the capital gain. Tax implications for LTCG on shares differ depending on whether the shares are listed or unlisted.

Tax Implications of Long-Term Capital Gain on Shares

1. Long Term Capital Gain Tax on Listed Shares:

As per the current tax laws in India, long-term capital gains on listed equity shares exceeding ₹1 lakh in a financial year are taxed at 10% without the benefit of indexation, unlike short term capital gains.

This tax rate was introduced in the Union Budget 2018, effective from April 1, 2018. Prior to this, LTCG on listed shares were exempt from tax under Section 10(38) of the Income Tax Act.

2. Long Term Capital Gain Tax on Unlisted Shares:

Long-term capital gains on unlisted shares are taxed at 20% with the benefit of indexation. Indexation allows investors to adjust the purchase price of the asset for inflation, thereby reducing the taxable gain.

Calculation of Long Term Capital Gain on Shares

The calculation of long-term capital gain involves several steps:

1. Determine the Sale Price: The price at which the shares are sold.
2. Calculate the Purchase Price: The original cost of acquiring the shares.
3. Adjust for Expenses: Deduct any expenses related to the sale, such as brokerage fees and transaction charges.
4. Apply Indexation (for Unlisted Shares): Use the Cost Inflation Index (CII) to adjust the purchase price for inflation.

Example Calculation

Consider an investor who bought 1000 listed shares at ₹100 each in January 2017 and sold them at ₹200 each in February 2019.

1. Sale Price: ₹200,000 (1000 shares * ₹200 each)
2. Purchase Price: ₹100,000 (1000 shares * ₹100 each)
3. Capital Gain: ₹100,000 (₹200,000 – ₹100,000)
4. Taxable LTCG (exceeding ₹1 lakh): ₹0 (as gain does not exceed ₹1 lakh)
5. Tax Payable: ₹0 (10% of ₹0)

For unlisted shares, the same principle applies but with indexation benefits.

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Exemptions and Deductions

Grandfathering Clause

The government introduced the grandfathering clause to protect gains accrued up to January 31, 2018, from being taxed under the new regime. For shares purchased before this date and sold after April 1, 2018, you consider the cost of acquisition as the higher of:

• The actual purchase price, or
• The fair market value as of January 31, 2018.

Section 54F Exemption

Investors can claim an exemption under Section 54F by reinvesting the sale proceeds of long-term capital assets (other than residential property) into a residential house property within the specified time frame. The conditions to claim this exemption include:

• Purchase a new residential property within one year before or two years after the sale, or construct a residential property within three years.
• The exemption is proportionate if the entire sale proceeds are not invested.

Strategies for Managing Long Term Capital Gains Tax

Managing Long-Term Capital Gains (LTCG) tax effectively can significantly enhance your net returns on investments. Here are some detailed strategies to help minimize and manage your LTCG tax:

1. Maximize the ₹1 Lakh Exemption Limit

Strategy Overview:

Annual Exemption: Under Section 112A of the Income Tax Act, LTCG up to ₹1 lakh per financial year on equity shares and equity-oriented mutual funds is exempt from tax.

Action Plan:

• Stagger Your Sales: If you have large gains, consider spreading the sale of assets over multiple financial years to take full advantage of the ₹1 lakh exemption each year.
• Example: If you have ₹2 lakhs in LTCG, selling half this year and half the next year could make the entire amount exempt, saving you from paying 10% tax on ₹1 lakh.

2. Invest in Tax-Efficient Funds

Strategy Overview:

• Equity-Linked Savings Scheme (ELSS): ELSS funds not only provide tax benefits under Section 80C but also qualify for LTCG tax treatment after a 3-year lock-in period.

Action Plan:

• Dual Benefit: By investing in ELSS, you can claim a deduction of up to ₹1.5 lakhs under Section 80C and benefit from a lower tax rate on any LTCG post the 3-year lock-in.
• Example: Investing ₹1 lakh in an ELSS fund provides a tax deduction of ₹1 lakh under Section 80C. After 3 years, any gains are treated as LTCG and taxed favorably.

3. Strategic Asset Allocation

Strategy Overview:

• Diversify Your Investments: By holding a mix of equity, debt, and other assets, you can manage your LTCG effectively.

Action Plan:

• Rebalance Carefully: Periodically review and rebalance your portfolio to lock in gains while staying within the ₹1 lakh exemption limit.
• Example: If your equity portfolio has grown significantly, consider moving some of the gains into debt instruments or other tax-efficient investments to avoid exceeding the exemption threshold.

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4. Tax-Loss Harvesting

Strategy Overview:

• Offsetting Gains with Losses: Tax-loss harvesting involves selling underperforming assets to realize a loss, which can offset LTCG from other investments.

Action Plan:

• Review Portfolio Regularly: Identify assets that have declined in value and consider selling them to offset any LTCG.
• Example: If you have ₹1 lakh in LTCG and also have a ₹50,000 loss on another investment, selling the losing investment can reduce your taxable gains to ₹50,000, lowering your tax liability.

5. Gift Shares to Family Members

Strategy Overview:

• Shifting Tax Liability: Gifting shares to family members in lower tax brackets can help reduce the overall tax burden.

Action Plan:

• Transfer to Lower-Tax Bracket Individuals: Consider gifting shares to a spouse, children, or parents who are in a lower tax bracket or have unused exemption limits.
• Example: If your spouse has no other income, gifting them shares that realize a ₹1 lakh gain would result in zero tax liability due to the ₹1 lakh exemption.

6. Utilize the Capital Gains Account Scheme (CGAS)

Strategy Overview:

• Deferring Tax by Investing in CGAS: If you plan to reinvest LTCG in property but need more time, you can use the Capital Gains Account Scheme (CGAS) to defer tax until you invest.

Action Plan:

• Deposit Gains in CGAS: Open a CGAS account and deposit your LTCG to claim an exemption under Section 54, 54F, or 54EC until you are ready to reinvest in a new property or asset.
• Example: If you sell a house and plan to buy another within the next two years, depositing the gains in a CGAS account allows you to defer the tax and claim an exemption when you make the purchase.

7. Invest in Specified Bonds (Section 54EC)

Strategy Overview:

• Lock-In Gains in Tax-Exempt Bonds: Section 54EC allows you to invest LTCG in specified bonds (e.g., NHAI, REC) to claim tax exemption.

Action Plan:

• Invest Within 6 Months: Invest the capital gains in specified bonds within 6 months of the sale of the original asset.
• Example: If you have ₹10 lakhs in LTCG, investing the entire amount in 54EC bonds within the specified period will exempt the gains from tax. However, remember that these bonds have a 5-year lock-in period.

8. Plan for Retirement Accounts

Strategy Overview:

• Tax-Deferred Accounts: Retirement accounts such as NPS (National Pension Scheme) offer tax benefits and help you defer or minimize LTCG tax.

Action Plan:

• Long-Term Planning: Invest in NPS to reduce your current taxable income and defer tax until withdrawal, where gains might be taxed at a lower rate.
• Example: Contributing to NPS not only provides a tax deduction under Section 80C but also allows your investments to grow tax-deferred, reducing immediate LTCG tax.

Conclusion

Understanding long-term capital gains on shares and their tax implications is crucial for investors aiming to maximize their returns while complying with tax laws. It is important to distinguish between listed and unlisted shares, utilizing exemptions, and employing strategic tax planning methods, to manage the long-term capital gains tax liability.

Staying updated with the latest tax regulations and seeking professional financial advice can further help navigate the complexities of capital gains taxation.