I recently ran into my friend, Kanika, a full-time homemaker but active in the stock market. Kanika shared that she enjoys the highs of the stock market, but confessed to being a little hazy on taxation of income she earns from the stock market. This was my cue to launch into a monologue on taxation of capital gains on transfer of shares by individuals and here’s how it went:
When to pay taxes? Capital gains arise on transfer of shares and “transfer” has been defined in the law to include sale, gift, redemption and exchange. However, the unrealized gains/losses being reflected in demat account statements are merely notional and not real income and, hence, not taxable.
Short- or long-term? The holding period of a share from the date of its purchase to the date of its sale decides whether the gain arising on its transfer is short- or long-term. If a share is held for at least 12 months, it qualifies as a “long-term asset”, else it is a “short-term asset”. Accordingly, income earned from transfer of shares—capital gains—can be long-term capital gains (LTCG) or short-term capital gains (STCG).
Computation of capital gains: Capital gains are the difference between the “sale consideration” and the “cost of acquisition”.
The sale consideration is the sales proceeds minus the brokerage or commission paid by the seller. However, it is to be noted that the securities transaction tax (STT) paid on the sale or purchase is not considered an expense that can be reduced from the sales consideration nor can it be added to the cost.
For a short-term asset, the cost of acquisition refers to the actual purchase price. Any amount incurred on brokerage can be added to it. But for a long-term asset, the cost may be “indexed” for inflation—the cost is proportioned on the basis of the Cost Inflation Index (CII) between the year of purchase and sale.
For bonus shares, the cost of acquisition is taken to be nil as there is no cost incurred. For employee stock options, the cost of acquisition is the fair market value on the date of exercise of options. In case of rights shares issued by a company, the cost of acquisition would be the actual price paid to acquire these. But if one transfers the rights in favour of another instead of acquiring them, the capital gains would be the entire sale consideration.
Are all capital gains taxable? LTCG on transfer of equity shares listed on a stock exchange in India, where STT has been paid, is tax exempt, while STCG in the same situation is taxed at a concessional rate of 15.45% (including education cess).
As for unlisted equity shares, STCG is taxable at the slab rates prescribed for individuals ranging from 10.3% to 30.9% and STCG is taxable at a concessional rate of 20.6%. However, exemption is available for LTCGs if the capital gain is invested in bonds issued by the National Highways Authority of India or the Rural Electrification Corp. Ltd within six months of the transfer, subject to other conditions.
For example, Kanika bought shares on 20 January 2009 for Rs10,000 and sold it on 20 November 2009 for Rs12,000, the income of Rs2,000 (Rs12,000 minus Rs10,000) would be STCG as the period of holding is less than 12 months. But had Kanika sold these share on 15 March 2010, that is after 12 months, the income earned will be LTCG with the cost being indexed. So, in this case, the indexed cost of acquisition will be Rs10,000/582 (CII for FY09) multiplied by 632 (CII for FY10), which comes to Rs10,589 and LTCG will be Rs1,411 (Rs12,000 minus Rs10,589). Kanika pays no taxes if the LTCG arose on the sale of listed equity shares, where STT has been paid or pays only 15.45% on STCG. If these were unlisted shares, then for STCG she may pay tax at the applicable slab rate but for LTCG, at 20.6%.
Are gifted shares considered income? Any gifts received by an individual after 1 October 2009 in the form of shares will be taxable in the hands of the recipient, if the market value exceeds Rs50,000. However, there are some exceptions in the case of individuals to exclude gifts received from a relative or on the occasion of marriage or in contemplation of death or through a will. The change in law seeks to plug bogus transfers, but exceptions have been provided to protect genuine transfers.
And when these shares are sold, the cost of acquisition for calculation of capital gains will be that of the previous holder who had gifted the shares.
What are the tax implications on capital loss? In case of loss on transfer of shares, all is not lost; the same can be set off from other capital gains or carried forward to the future years for set off against capital gains. Long-term capital losses can’t be set off with STCG, while short-term capital loss may be set off against LTCG.
The proposed Direct Taxes Code: The tax laws are in for a big change with the Direct Taxes Code expected to be effected from 1 April 2011. The categorization of assets into short term and long term has been done away with. Therefore, all the gains will be aggregated with other incomes earned and taxed as per the slab basis applicable to the individual taxpayer.
Further, LTCG on transfer of listed equity shares or units of equity-oriented funds would be eligible to a deduction at a specified percentage. Any loss arising on the transfer of such assets would also be reduced.
Here is wishing Kanika and the readers good tidings at the stock exchange and remember to get the taxes right even as you make money.
Sonu Iyer is tax partner, Ernst & Young.
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