Hello everyone!! Welcome back to the TAX DESTINATION Blog. The year 2021-22 (April 2021 to March 2022) has been a spectacular year for IPO investors. If you were lucky, you would have made more than 100% gains on listing of shares like Paras Defense, Sigachi Industries, GR Infra, Latent View, etc.
If you are a salaried employee who hasnt done tax planning well in advance (or) who did not consider the above gains before year-end closing, you may have to pay additional tax on these gains along with interest. Tax Destination heard your problems and got a superb technique to reduce your income tax on gains on shares, equity mutual funds.
If you are an unlucky investor like me, you would have received an allotment in IPOs of companies like PayTM, Car Trade Tech and would have lost >50% of your invested amount. This article covers you as well.
By the end of this article, you will know how to use these losses to your advantage and pay less income tax. We end this article with a bonus tip from the author whereby you can get an 80C deduction for investing in various tax-saving options like Tax Saver Mutual Funds, Fixed Deposits, National Savings Certificates, etc without doing so in reality. With the same level of excitement, let’s discuss the above techniques and save our
taxes.
To understand and implement the below concepts, you need to understand how short term & long term gains are taxed and losses can be carried forward under the Income Act. You can learn about the same by clicking our previous article.
Tax Harvesting:
Tax harvesting is a beautiful technique that can be used to build long-term wealth in shares and equity mutual funds with a minimum tax. First, let’s understand how much we can gain by doing SIP in stocks/ equity mutual funds (assuming a 15% return):
Just to make it clear, the above amounts are the gains that we can make over and above the invested amount.
Tax on long-term capital gains is exempted up to Rs.1 Lakh per annum. Gains in excess of Rs. 1 Lakh are taxable at the rate of 10%. 10% may not seem like a big rate of tax but in long term, this will be a huge amount. Say you have made a SIP of Rs.5,000 per month for 10 Years.
As per the above table, the gains you have made will be Rs.7,93,300 approx. Tax on this will be Rs.69,330 (10% on gains exceeding Rs.1 Lakh). To ensure that Income Tax does not eat one’s accumulated corpus, one can plan for the following way:
Assume you have invested Rs.6 Lakhs about a year ago and the value of the same today is Rs. 6.95 Lakhs. Now, if we redeem and reinvest the invested amount again, it will result in long-term capital gains of Rs. 95,000.
Since LTCG up to Rs. 1 Lakh per annum is exempt, you will not be required to pay any tax on that. After a year, assume the value of the same is Rs. 7.75 Lakhs, you do the exercise again and no tax is payable on these gains as well. This is because, once you redeem and
reinvest, your cost of acquisition is calculated as Rs.6.95 Lakhs (Not Rs. 6 Lakhs) and the resultant LTCG for the second year will be Rs.80,000.
Since the gain is well within the annual limit of Rs.1 Lakh, no tax is payable on that gain. For the third year, your cost of acquisition will be Rs. 7.75 Lakhs. If the above exercise was not done in the first year, then LTCG on redemption in Year 2 would have been Rs. 1.75 Lakhs resulting in a tax of Rs. 17,500. The exercise of redeeming and re-investing in securities for saving tax is called Tax
Harvesting.
This exercise can be done for SIPs too. You can redeem units that were held for more than 12 months and reinvest. If you feel doing this exercise every month is cumbersome, you can plan to do the same once every 3 months or even once a year.
Tax Loss Harvesting:
Tax-loss harvesting is another such beautiful concept that can be used to tweak your capital losses for maximum tax benefit. In simple words, you book losses and set them against gains in other instruments.
Let me explain this with an example. Say you have invested Rs.15,000 each in Paras Defense & Cartrade tech at the time of IPO and received allotment (Names are used here only for explaining the concept better, not investment advice).
On seeing 100% listing gains in Paras Defense, assume you have booked profit and you are holding Cartrade Tech with a 60% loss (Rs.9,000). To reduce your income tax on gains you have made in Paras Defense, you can book loss in Cartrade before 1 Year from the date of purchase and buy them again.
By doing this, Rs.9,000 loss you recognized in Cartrade can be used to set off gains in Paras Defense stock and you will be required to pay tax only on balance STCG of Rs. 6,000 at 15%. In the future, Say you exit from Cartrade at Rs.20,000 after 2-3 Years, LTCG will be calculated considering the revised purchase price of Rs.6,000.
LTCG on the above transaction will be exempt since it is well within the annual limit of Rs.1 Lakh. Even if the total LTCG exceeds Rs.1 Lakh in that year, gains will be taxable at the rate of 10% (which is lower than the STCG we saved of 15%).
You can perform tax-loss harvesting even if you don’t have any gains to be set off. Those losses can be carried forward and set off in the next 8 years.
Tax Deduction Investing Cycle:
This is a small yet interesting concept with which one can plan for getting a deduction for investing in Tax Saver Mutual Funds and Fixed Deposits under the Income Tax Act without actually investing in them.
To save Income Tax, say you planned to invest Rs.1.5 Lakhs Tax Saver Mutual Funds every year. By year 4, you will be able to redeem Rs.2.28 Lakhs on the investment you have made in Year 1 (assuming a 15% return).
Now, you can redeem that amount and reinvest it in any tax saver mutual fund and
get an 80C deduction for the same in Year 4 without investing anything fresh. Since the maximum possible limit under 80C is Rs.1.5 Lakhs, you can plan for investing the remaining redemption value (Rs.78,000 in this case) in other products like NPS and plan for getting an additional deduction.
So, you are able to get a deduction and reduce your income tax in Year 4 without even investing a single penny afresh from your pocket. You can run this cycle and get an 80C deduction in Year 5 with sales proceeds of Year 2, in Year 6 with sales proceeds of Year 3, and so on
Isn’t it awesome..? For more such content, subscribe to TAX DESTINATION
CONTENT WRITER
CA. PAVAN KALYAN
