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- Category: Beginners Guide
Tax makes up a significant portion of our savings and incomes. Day-in and day-out, most of us investors look for a way to save our taxes, to reduce our taxable income in one way or the other. Well, most of us are lucky to either have a considerate and a skillful financial manager to guide us through the maze of tax deductions, or possess required knowledge bank to figure out the clever legal ways to do away with our payable taxes.
However, many young, budding investors who have stepped fresh into this vast complex field of finance, fall short of the necessary resources to guide themselves through the streets of investments, savings, and most importantly, tax.
For this very reason, Finnovationz aims at bridging the gap between the fortunate and the unfortunate, in order to promote the vital market efficiency in an emerging market like India and to build a stellar reputation of finance and investment as a profession.
We present you with a one-stop-shop article on how an investor, through investments in equity, can minimize taxes on income in so many various easy ways, as detailed below!
Long-term Capital Gains
Q.1: What are Capital Gains?
Capital Gains can be defined as the gains that an investor makes when he or she sells their shares at a price higher than the price at which they had bought them in the past.
Example: In 2015, Mrs. Jain buys XYZ shares at Rs. 100 per share. But in 2017, because of certain reasons, she decides to sell the same number of shares at their current price in the market, which is now Rs. 250 per share. The profit that Mrs. Jain made after selling her shares at a higher price in 2017 is exactly what we call a Capital Gain. Hence, in this example, Mrs. Jain made a capital gain of (250-100=) Rs. 150.
Q.2: What implications do Capital Gains from Equity Investments have on tax?
The Capital Gains on all the equity investments held for up to or more than 12 months are absolutely tax-free.
Note: Capital gains on equity investments held for up to or more than 12 months are known as Long-term Capital Gain. Similarly, all the capital gains on investments held for less than 12 months are known as Short-term Capital Gains. Short-term Capital Gains are taxed at 15% + 3% Cess.
Example: Jain bought shares worth Rs. 1000 in January 2016, and held them till January 2017 before selling her investments for Rs. 5000. The Capital Gain of Rs. 4000 that she made her investments would be absolutely tax-free since it’s a long-term capital gain tax as Mrs. Jain held her investments for more than 12 months.
Q.1: What are Dividends?
Dividends can be defined as the amount of money a company pays back to its shareholders, by sharing a proportion of its current period‟s profits with its shareholders. In simpler words, if a company earns profits in the current period, and if it decides to share some of those profits with its shareholders, it will do so by paying them dividends.
Q.2: How do dividends help in saving tax?
Dividends are Tax-free! Yes, you read it right. Whatever income you receive in the form of dividends will never be subject to any sort of tax. While filing income tax return, there is no need for you to present dividends as your income.
Example: Mrs. Jain, in 2016, earned an annual income of Rs. 20 lakh, out of which, her income from dividends was 1 lakh rupees. This implies that her taxable income (the amount of income which would be taxed) is Rs. 19 lakh and not Rs. 20 lakh. Had Mrs. Jain invested her money somewhere else and then earned a return of 1 lakh, whole 20 lakh of her income would have been taxable. But with the help of equity investments, she saved her taxes on Rs. 1 lakh she earned as Dividends!
Adjustable Capital Gain
Q.1: What is meant by adjustable Capital Gain?
Adjustable capital loss can be defined as a situation where an investor uses his or her capital loss they incurred to set-off their capital gains.
Q.2″ How do adjustable Capital Gain help an investor save tax?
Now, this is a really interesting concept. The reader is advised to pay special attention to the details here.
Any short-term capital gain an investor makes on his or her equity investments is allowed to be set-off by whatever capital loss they incur on any type of investment, equity or non-equity. This means, that only that amount of short-term capital gains of their equity investment will be taxed which remains after adjusting all the capital losses in the investor‟s portfolio from it. This way, the investor gets an opportunity to save taxes on a number of capital gains that can be set-off by a number of capital losses.
Example: In January 2016, Mrs. Jain invested Rs. 1000 each in Equity and Bond. However, Mrs. Jain decides to sell both of her investments in the middle of the year 2016, when the value of her equity investments was 1500 rupees while the value of her bond investments was only Rs. 700. Therefore, Mrs. Jain made a short-term capital gain of (1500-1000 =) Rs. 500 on her equity investments, and incurred a capital loss of (1000-700 =) Rs. 300. But, because Mrs. Jain’s capital gains were made from her equity investments, they can be adjusted or set-off by the amount of capital loss she incurred in her portfolio (on her bond investments). Therefore, only the adjusted capital gain of (500-300 =) Rs. 200 will be taken into account to compute taxes and not 500 rupees (which is the original amount of her capital gain).
Deferrable Capital Loss
Q.1:What is Deferrable Capital Loss defined?
Deferring of Capital Loss arising from the equity investments is more commonly known as Carry Forward of Capital Loss. Basically, the underlying concept of such a carry forward is to allow the investors to use the losses arising from their equity investments to set-off their future short-term capital gains from equity investments.
Note: Investors must note that their equity capital losses can be carried forward only up to 8 years and not more than that. Hence, such capital losses can be used to set-off any short-term equity capital gain an investor makes within those 8 years.
Q.2: How does deferrable Capital Loss help in saving tax?
Deferrable capital losses help an investor save tax in the same as we understood under the section of “Adjustable Capital Gain”, except that here, both the capital loss and the short-term capital gain need to come from the investor‟s equity investments. Additionally, such savings by „set-offs‟ can be made at any point of time but within the period of 8 years, beginning from the year of capital loss under consideration.
Example: In 2008, Mrs. Jain incurs a loss of Rs. 300 in her equity investments. She chooses to carry her capital loss forward. Later in the year 2014, Mrs. Jain makes a short-term capital gain of Rs. 1000, again from her equity investments. Here, Mrs. Jain can save her tax by reducing the amount of her capital gain she made in 2014 by bringing forward the amount of capital loss she incurred back in 2008. This implies, that instead on the whole Rs. 1000 of capital gain, a tax will be computed only on (1000-300 =) Rs. 700. Moreover, she is allowed to do so because her capital loss hasn’t expired yet, i.e. Mrs. Jain is still well within the period of 8 years of her capital loss (in the 7th year to be precise).
ELSS (Equity-linked Saving Scheme)
Q.1: What is Equity-linked Saving Scheme?
Equity-linked Savings Scheme popularly known as ELSS are open-ended, diversified equity schemes offered as Mutual Funds. They offer tax benefits under the new Section 80C of the Income Tax Act 1961.
Q.2: How does investing in ELSS Mutual Funds help an investor in saving tax?
Investment in Equity-linked Saving Scheme gives an investor the tax benefit on incomes other than capital gains. The tax on the income from employment salary, business or real-estate can be minimized by investing in ELSS. The Equity-linked Saving Scheme is the part of section 80C. The section 80C gives tax deduction up to the investment or expense of Rs 1.5 lakh. Hence, an investor can invest in ELSS and save tax up to Rs. 46,000.
Note: ELSS Funds have a lock-in period of 3 years, i.e. investor wouldn’t be allowed to liquidate his or her investments in the fund before the 3–year period.
RGESS (Rajiv Gandhi Equity Savings Scheme)
Q. What is Rajiv Gandhi Equity Savings Scheme?
The Rajiv Gandhi Equity Savings Scheme is a tax saving scheme announced in the 2012-2013 Union Budget of India, aimed at the first time individual investors. This scheme presents investors with tax benefits provisioned as a new section, 80CCG in the Income Tax Act, 1961.
As per this scheme, the first time investors who have an annual income of less than Rs. 12 lakh would be granted tax deductions of 50%, up to the investments of Rs. 50,000. Hence, the maximum possible tax savings for an investor is Rs: 5150.
However, there are certain terms to this scheme that the investor must be aware of.
- In the first year, investors can‟t sell shares. After this period, shares can be sold but proceeds are to be reinvested.
- The Scheme has a lock-in period of three years. The new retail investor shall be permitted to trade the eligible securities after the completion of the fixed lock-in period.
- Long-term capital gains are tax-free.
- Investing through the mutual fund is not necessary for this scheme.
Moreover, an investor must meet the following eligibility criteria, two criterions out of which have already been mentioned above:
- The investor must be a first-time investor.
- The investor should not have had a Demat account prior to 23 November 2012, or should only have a Demat account that has never been used to trade.
- The scheme can be availed by Indian residents with an annual income not exceeding Rs: 12 lakhs (raised from Rs. 10 lakhs to Rs. 12 lakhs in the year 2013-14)
Note: Readers/Investors must understand the point that all the tax benefits its that have been mentioned for
the Equity Investments apply to the “Equity” Mutual Funds as well, in exactly the same manner.