Here is how you can maximise your tax-savings from equity investments (shares and/or equity mutual funds). Using this trick you can save tax on the capital gains occured from selling of equity shares and/or mutual funds.
One of the ways to maximise your tax-savings before the end of a financial year is by using your equity investments. You can do this by selling and then buying back your equity investments. This can be done, as long as the gains are within Rs 1 lakh, per financial year. Even though this will not give you any tax benefits this financial year, it will help you later.
Let us see how it works.
Taxation of equity investments
Long-term capital gains (or LTCG) from equity is taxable at 10% (plus surcharge and cess as applicable) after a holding period of one year. This includes equity stocks as such and equity-oriented mutual funds. However, this LTCG tax of 10% is applicable for gains beyond Rs 1 lakh per financial year. In other words, LTCG of up to Rs 1 lakh is exempt from tax. That being the case, how can you benefit from it, or how can you use it for tax planning?
For equity taxation, there is the concept of “grandfathering clause” as on January 31, 2018. The reason is, LTCG tax on equity was introduced in the Union Budget on February 1, 2018 and the earlier story (prior to Feb 1, 2018) was forgotten. That is, for equity shares acquired prior to January 31, 2018, the acquisition price is to be ignored and the price as on that date (January 31, 2018) is to be considered for tax purposes. Since prices of assets such as equity increase over a period of time, the government has given this benefit of not having to pay LTCG tax prior to the grandfathering date.
From there onwards, either the equity price as on January 31, 2018 or if it was acquired subsequently, the acquisition price will be the base point on which capital gain will be computed and tax will be levied. Typically, closer is the date of acquisition of a growing asset, lower will be the gain on selling it and hence, there will be lower tax outgo.
As an illustration, let us say you acquired a stock on September 13, 2015 for Rs 63. As on January 31, 2018, the price was Rs 100. When you eventually sell, the tax will be on sale price minus Rs 100, and not sale price minus Rs 63. Let us say you sell this stock after 5 years at a price of Rs 150 (assumed). Hence, you will pay tax on Rs 150 minus Rs 100 = Rs 50, and not on Rs 150 minus Rs 63 = Rs 87.
Tax planning on equity investments
Now comes the part we started off with: tax planning on your equity investments, i.e., equity stocks and equity-oriented mutual funds. Let’s say the price of the stock as of today (March 2022) is Rs 119. You can sell the stock or redeem the MF units and buy it back. As long as the capital gains from selling it is within Rs 1 lakh, it will be exempt from LTCG tax. To be noted, the holding period should be more than one year, otherwise it will be counted as short-term capital gains (STCG), where the taxation rules are different.
When you are selling the stock or redeeming the MF units, it is going out from your holdings and when you are purchasing, it becomes a fresh holding with a fresh acquisition price. In this illustration, Rs 119 is the new acquisition price. When you eventually sell the stock after, say 5 years at a (assumed) price of Rs 150, the LTCG tax will not be on Rs 150 minus Rs 100 = Rs 50, but on Rs 150 minus Rs 119 = Rs 31.
This method of creating a higher base point for future taxation is clean and within the rules. The extent to which you would do this depends on the size of your portfolio. As an illustration, if the initial purchase price of your entire portfolio is Rs 10 lakh, acquired over various dates, and the current market valuation is say Rs 10.9 lakh, you can sell-and-buy-back your entire portfolio. In this case, your capital gains is within Rs 1 lakh. If the cost price of your equity portfolio is Rs 1 crore and the market valuation is say Rs 1.2 crore, to execute the strategy discussed here, you should sell only as much so that your capital gains booked is less than Rs 1 lakh in that year.
While this exercise may not cost much if you invest in load free equity mutual funds especially with the holding period of more than a year, however, when it comes to equities, investors will have to bear transaction cost in selling and buying shares which is most likely to be insignificant compared to tax savings.