One has heard the famous saying “Make sure you pay your taxes otherwise you can get into a lot of trouble”. This is a statement made by the former US President Richard Nixon. One has made a profit in the equity market by selling his shares in a short span of time. Now it is time to relax, boast about the profits and enjoy the benefit of this hard labor. Unfortunately there is a tax on these gains called a capital gains tax. Speak of the slip between the cup and the lip. Remember once the law starts asking questions there’s no stopping them.
One invests in equity such as shares or an equity mutual fund. If the selling price is greater than the purchase price one obtains a profit or a gain. One can also purchase a debt mutual fund and sell it for a profit. This is known as a capital gain. Capital gains stress on the word “Transfer” which basically means sale, gift, redemption or an exchange. When does one have a short term or a long term capital gain in equity or in a debt mutual fund?
If one invests in an equity mutual fund which basically invests over 65% in equity and sells it for a profit or a gain in a period under a year he obtains a short term capital gain and is charged a short term capital gains tax. If one has paid the securities transaction tax his profit or gains are taxed at the rate of 15.45% including cess. One has invested in the equity mutual fund and sold units for a profit under a year. One has the selling price greater than the purchase price which results in a gain. One is charged tax at the rate of 15.45% on the difference between the selling price and the purchase price as a short term capital gains tax.
If one has a total taxable income in the financial year which is greater than INR 1 Crore an additional surcharge of 10% is charged on the base rate of 15% which includes the education cess. Hence the capital gains tax rate including surcharge would amount to 16.95%.
If one does not have to pay the security transaction tax then the short term capital gains are added to ones taxable income and charged as per the income tax bracket one falls under .If one is an NRI tax is deducted at source at 15% on his short term capital gains in the equity mutual fund.
If one obtains a long term capital gain by selling the equity mutual fund for a profit after a year and security transaction tax has been paid then this gain is exempt from tax .Surely it serves as an incentive to hold the equity mutual fund for over a year as long term capital gains are not taxed.
One invests in a debt mutual fund which has less than 65% exposure to equities. If one sells this fund within a year at a profit he has to pay short term capital gains tax on his profits. One has these profits added to his taxable income and he is taxed as per the income tax bracket he falls under. If one falls in the highest tax bracket he is taxed at the rate corresponding to this slab which is 30%.One has a short term capital gains tax of 30% charged on his gains. If one is an NRI he has Tax deducted at source of 30% on his capital gains.
If one invests in a debt mutual fund in a period over one year and gains a profit it is called a long term capital gain. The Government is as ready as ever to tax this gain .However one can argue that inflation eats into this gain and its value is reduced .Inflation eats into purchasing power of money. One has a valid argument that there is no gain left after inflation and taxation. The Government has handed a benefit called indexation in order to reduce the impact of inflation.
What is indexation?
Let us consider Mr Vijay purchased 500 units of a debt mutual fund which had a net asset value of INR 10 on March 11th 2007.He sold the 500 units on March 20th 2010 at a net asset value of INR 25 for a profit. Mr Vijay opted for the indexation benefits on his long term capital gains. Let us calculate taxation of his gains with and without indexation.
With indexation taxed at 20.6%
Table showing the cost of inflation index
Without indexation taxed at 10.3%
What is the conclusion one draws from this example ?
There is a famous saying “Don’t be afraid to take a big step when one is necessary. You can’t cross a chasm in two steps.
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