Capital Market and Tax Planning

By: CA (Dr.) Alok ShahPartner

Contractor, Nayak & KishnadwalaChartered Accountants

Investor Awareness Programme- Vadodara Stock Exchange Ltd. 23.06.2012

Contents1. Meaning of Capital Gains and Tax

thereon2. Long Term and Short Term Capital

Gain3. Taxation on Capital Gain on Shares

and Securities4. Taxation of certain Transactions

related to Capital Market5. Taxation of Mutual Fund

Transactions6. Taxation of Debentures7. Tax Planning

What is Capital Gain?

Capital gain is a Profit that results from transfer of investments of  Capital Asset/s, such as Shares, Bonds, Land, Building, etc., which exceeds the purchase price.

What is Capital Gain Tax?

Capital gains tax (CGT) is a tax on capital gains i.e. tax on the profit that arise on the sale/transfer of a Capital Assets.

Capital Gain on Shares and Securities

Long term

Short term

Investments in shares or mutual funds (whether quoted or not)if held for a short period (12 months or less) is taxed as short term capital gains.A long term capital gain arises when holding of shares or mutual funds is for a long period (more than 12 months).

Tax IncidenceFor Long Term Capital Gain:

conditions

1

2

Tax payer is an individual, HUF, or any other person(Whether Resident or Non-Resident)Securities(Shares or mutual funds units) are held for long term

If both the above conditions are satisfied than LTCG will be charged either under option 1 or option 2

Option 1:i. Find out the sale considerationii. Deduct: indexed cost of

acquisition, modification, expenses on transfer

iii. Balance amount---(i-ii)---is LTCGiv. Tax Shall be 20% of (iii)

+EC+SHEC

Option 2:i. Find out the sale considerationii. Deduct: Cost of acquisition

(without Indexation), modification, expenses on transfer

iii.Balance amount---(i-ii)---is LTCG

iv. 10% of (iii)+EC+SHEC

TAX INCIDENCE

Equity shares & Equity oriented Mutual funds held for long term which are subject to Securities Transaction tax are Tax exempt.

Capital loss computed from source with indexation can be set off against capital gain computed without indexation from another source.

The tax payer has liberty to choose option 1 for some transactions and option 2 for other Transactions.

All the transactions of share transfer through stock exchange are Subject to STT.

Tax Incidence of Short Term Capital Gain

1

2

3

Tax payer is an individual, HUF, or any other person(Resident or not) .During the year there is a transfer of short term capital assets (here shares or mutual funds). Transactions are subjected to securities transaction tax.

If all the above conditions are satisfied than. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Short Term

Capital Gain is taxable @ the

rate of 15 %+ EC + SHEC

Allied Issues related to

Right shares Bonus shares Futures & Options(F&O) Dividend on shares Stock splits Demat account Day trading General Deductions

shares

Right shares

Rights issue to shareholders is generally made on the basis of proportionate holding(e.g. One subscription right for one share held).When additional shares are offered to existing shareholders at a price(usually less than original price), it is termed a rights issue.

Cost of Acquisition :The price at which the rights issue is made is treated as cost of acquisition. Right Issue is normally at a discount to the market price.

Date of acquisition: The date of allotment of right shares is treated as the date of purchase. It will attract tax depending on the tenure for which it is held.

If a person transfer the rights to subscribe for shares, the cost of acquisition of such rights

is to be taken as ‘Nil‘. The entire amount of

consideration of such transferred rights will be taken as capital gain.

Period of Holding : It is Computed from the date of offer, made by the company to the date of renouncement.

Bonus Shares Shares are given to the

shareholders without any consideration.

Date of Acquisition : The holding period is calculated from the date of allotment of Bonus shares.

Cost of acquisition :the cost of acquisition is zero.

Depending on the period for which it is held, it will be treated as short term or long term.

Bonus Stripping In bonus stripping, investors

buy shares of companies which have announced bonus issues, and subsequently, sell the original holding at a loss once the stock becomes ex-bonus.

This loss can’t be adjusted against capital gains on other holdings if it is transferred with in a period of 9 months.

Futures & Options(F&O)

The provision of the Income Tax Act, 1961 treats income from futures & options (F & O) as normal business income.

Incase of F & O for Tax Audit u/s 44AB turnover is determined by grossing up of the difference of all the trades entered, whether positive or negative. Premium received on sale of option is to be added. Difference on reverse trades is also to be considered.

As income from futures & options (F & O) will be treated as normal business income and not speculative business income, so, one can set off the loss from F & O against normal business income, including short-term capital gains.

Dividend on Shares

It is not taxable in the hands of the recipient, however, the company declaring dividend has to pay Dividend Distribution Tax.

Dividend stripping

Dividend stripping is the purchase of shares just before a dividend is paid, and the sale of those shares after that payment, i.e. when they go ex-dividend.

Loss that may arise on sale of shares shall not be allowed to be set-off against the other short term capital gain to the extent of dividend, provided such transfer takes place within a period of 9 months from declaration of dividend.

Stock Splits This refers to reduction in the

denomination of the shares by reducing the face value of the share. That will result in a corresponding change in the market value.

Date of Acquisition : The date of buying the original shares is treated as the date of acquisition and the gains are taxed in the same proportion as the split.

Demat Account In case of Demat accounts, the

capital gains on sale of shares will be computed on the basis of the FIFO with reference to the particular account from where the shares are sold.

Why?:-The FIFO method was introduced to bypass the process of determining the cost on one to one basis with the particular DP(depository participant).

Day Trading If one is paying STT on

daily trading of shares (Provided shares are delivered through Demat Account), it would be considered as short term capital gain and subject to tax @ 15%.

When the income from trading can be called as speculation

income?

A Speculative transaction is a transaction in which a contract for purchase or sale of a commodity including stocks or shares is periodically or ultimately settled otherwise than by actual delivery or transfer of the commodity or scrip.

Exceptions A contract in respect of Raw material

or merchandise entered in the normal course of business to guard against loss due to price fluctuations.

A contract in respect of stocks and shares entered into by a dealer or investor to guard against loss through price fluctuations.

A contract entered into by a member of forward market or a stock exchange in the course of jobbing or arbitrage to guard against loss in the ordinary case.

Whether to treat shares as investment or stock in

trade ? The Central Board of Direct Taxes

(CBDT) through Instruction No.1827 dated August 31, 1989 had brought to the notice of the assessing officers that there is a distinction between shares held as investment (capital asset) and shares held as stock-in-trade (trading asset). In the light of a number of judicial decisions pronounced after the issue of the above instructions, it is proposed to update the above instructions for the information of assesses as well as for guidance of the assessing officers.

CBDT also agree on that, it is possible for a tax payer to have two portfolios (it is more desirable to have multiple Demat account to satisfy this aspect), i.e., an investment portfolio comprising of securities which are to be treated as capital assets and a trading portfolio comprising of stock-in-trade which are to be treated as trading assets. Where an assessee has two portfolios, the assessee may have income under both heads i.e., capital gains as well as business Income.

TAX PLANNING- TIPS

As long term capital loss can’t be set off against short term capital gain, one will be able to minimize his tax liability if he sell a security incurring short term losses in the same year.

While calculating net gains, take the transaction cost of buying and selling into consideration.

Income from Shares transactions earned by different family members thereby splitting the income and lowering the overall tax.

Shares/Investments Received through Inheritance or Gift or Will

Investment in the Name of Spouse

Investment in the name of the Minor Children

Transfer of Funds from One Account to another within family members

Wealth Tax

  A capital loss (short-term/long-

term) can be carried forward for a maximum period of 8 years from the assessment year in which the loss was first incurred.

Short-term capital loss can be set off against any capital gain (long-term and short-term). However a long-term capital loss can be set off only against a long-term capital gain.

Deductions Deduction available in sec

54EC and 54F of income tax act 1961

54EC: Benefit of deduction is available only in respect of long-term capital gain. (Ex. Long Term Capital gain on sale of shares/debentures of unlisted company etc.)

Purchasing Asset : Any Bonds specifically notified under this section and

1. Issued by National Highway Authority of India (NHAI).

2. Issued by Rural Electrification Corporation Limited (RECL).

Lock in Period: All the bonds should be redeemable after three years, only.

Once a person avail the deduction u/s 54EC, he can't claim deduction u/s 80C for the same amount.

If the long-term specified asset is transferred at any time within a period of three years from the date of its acquisition, then the amount exempt from Capital Gains will be chargeable to Income tax in the year in which it is transferred.

54F: This benefit is only in respect of long-term capital gain.

What should be done to avail this deduction?:

One have to construct a new residential house within Three years from the date of transfer, or

One should have purchased a residential house One year before, or

One have to purchase a residential house Two years after the date of transfer

Other conditions to satisfy

Equity Oriented Scheme

1.Short Term Capital Gain: Short term capital gain arising from the transfer of equity oriented scheme are taxed at 15 % provided STT has been charged.

2. Long Term Capital Gain: long term capital gain arising from the transfer of equity oriented scheme are exempt from tax in the hands of unit holder provided STT has been charged.

Other than Equity Oriented Scheme

1.Short term capital gain: Short term capital gain arising from the transfer of scheme other than equity oriented scheme are added to the total Income of the tax payer and taxed at the applicable slab rates of the assessee.

2. Long term capital gain: Long term capital gain arising from the transfer other than equity oriented scheme are taxed as normal provisions of long term capital gain tax.

Specific explanations for

1. Short term capital gain : Short Term Capital Gain is taxable @ the applicable slab rate.

2. Long term capital gain:  LTCG on sale of Debentures is not exempt from tax. It is taxable at special rate of 20 %.

Debentures-Unlisted

Dividend distribution tax domestic companies that declare,

distribute or pay dividends are subject to dividend distribution tax at 16.2225% on the amount of such dividends

specified company or mutual fund is taxable at differential rates as follows :Income distributed from the Money market/liquid funds is taxable at 27.0375%Income distributed from other mutual funds to individuals or HUFs is taxable at 13.51875% and to others at 32.445%.

Securities Transaction Tax on Sale and Purchase of Securities

Market Type

Current Rate (2012-13)

Futures & Options 0.017%

Capital Market (Delivery) 0.1%

Capital Market (Intra-Day) 0.025%

Investment in shares offers double advantage of earning tax free dividend and securing tax free capital appreciation over a long period of time. Thus it is an ideal way to beat inflation and if rightly handled it can turn out to be one of the finest avenues of Investment.

Proposed Changes (Direct Tax Code)

1. Income classification done away

2. Concept of long term & short term and differential tax rate done away

3. Indexation benefit will be available if the assets are held for a period exceeding one year

4. All types of capital gains would be taxable at normal rates of tax

5. If the STT is chargeable on transfer of equity shares/units in equity oriented funds, 100% deduction would be allowed if investment is held for more than one year and in other cases 50% deduction will be allowed.

CA (Dr.) Alok ShahPartnerContractor, Nayak & KishnadwalaChartered AccountantsEmail: alok@cnkindia.com