The recent correction in stock prices is being recommended as an opportunity to enter at relatively lower prices, with a long-term horizon. This investment perspective is being discussed widely, but this piece is about a tactical opportunity. That is, about setting off taxes and taking the benefit thereof.
Setting off losses
The rule about set-off says that the loss from the transfer of a short-term capital asset can be set off against gain from a transfer of either a long-term or short-term capital asset in that year. The implication in the current context is, if you sell an equity stock or equity-oriented mutual fund scheme (growth option) within one year of purchase at a loss, you can set off that loss against gains from any other capital asset. The other aspect of set-off is that the loss from transfer of a long-term capital asset can be set off against gain from transfer of any other long-term capital asset in that year.
As an example, if you are invested in debt-oriented mutual fund schemes (growth option) and redeem them within three years of holding, you can set off the gains, which are short term, against the short-term capital loss from equity. If you redeem the debt mutual fund after three years of holding, it is long term and the gain can be set off against the long-term capital loss from equity. To recap, in this context, January 31, 2018 is the ‘grandfathering date’ for stock prices. So, if you had purchased prior to January 31, 2018, the initial acquisition price is to be ignored and the price as on January 31, 2018 is to be considered as the reference point for tax purposes.
Investment allocation should be based on your needs and requirements, and not based on tax efficiency. However, once the allocation is decided and executed, there is no harm in looking for tax efficiency. The relevance of the rules discussed above is that the recent correction in the equity market can be used in an opportunistic manner. You can book the loss now, and equities being long-term investments, you can again buy the same stocks or mutual fund units. In the process, the loss you are booking can be used for tax planning by setting it off against capital gains from some other asset such as equity shares (if in profits) or other asset class like debt mutual funds or real estate. Even if you do not have capital gains in this year to set it off, you can carry forward the losses for eight years and adjust profits in subsequent years.
Executing the tax strategy
There is one issue in the strategy discussed above. Equities being long-term investments, you will eventually sell them after, say, five or ten or fifteen years. Since you are selling it now for booking capital loss and buying it at a relatively lower price, you are creating a lower reference point for your ultimate taxation. Well, there is a solution to this as well, provided the quantum of your equity holding is not huge. Upto Rs 1 lakh of long-term capital gains from equities is free from tax, per financial year. Against the price at which you are doing the sale and re-purchase, provided the price appreciates over a period of time, you can book capital gains of upto Rs 1 lakh per financial year, which is free from tax. You can re-purchase the same stock or mutual fund unit to maintain the sanctity of long-term investments. In the bargain, you are creating a higher reference point for taxation, when you ultimately redeem after, say, ten years. There is no limit on the amount you can set off or carry forward, but the quantum of long-term capital gains you can book from equities per year is limited.
The method discussed above would seem opportunistic, distinct from the fundamentals of investment. You should indulge in it if you are savvy, have a finger on events and want to maximize gains in every possible way. Of course. You must talk to your tax consultant before proceeding.