Investment in securities listed on the stock exchanges such as equity shares, mutual funds, debt instruments and derivative instruments constitutes an integral part of most investors’ portfolio. The income from such investments comprise two kinds of income: dividend income or interest income and capital gains or profit on sale or redemption of such securities.
In India, the tax rates for individuals and Hindu Undivided Families (HUFs) are taxed at multiple slabs— nil, 5%, 10%, 15%, 20%, 25% and 30%—which along with surcharge and cess result in effective tax rates ranging from 5.2% to 42.7% depending on the level of your income. Hence, an understanding of the taxation of such income and capital gains is crucial.
How Are Equity Instruments Taxed?
The returns generated from equity instruments are usually by way of capital gains and/or of dividends. The most common forms of equity instruments are equity shares and equity-oriented mutual funds. The way they are taxed includes:
How Are Domestic Equity Shares Taxed?
The capital gains derived from the sale of listed equity shares in India are categorized into long-term and short-term gains depending upon the period of holding. The period of holding refers to such a period for which the shares are held by the investor i.e., the period from the date of acquisition to the date of sale of such shares.
If the investor holds the listed equity shares for more than 12 months before selling them off, the gains derived from such shares would be long-term in nature, else they are categorized as short term.
How Are Capital Gains Taxed?
Short-term capital gains are subject to tax at the rate of 15% in accordance with Section 111A of the Income Tax Act, 1961 (referred to as the ‘IT Act’). Long-term capital gains are exempt up to the threshold limit of INR 1,00,000. According to Section 112A, the income tax on long-term capital gains exceeding INR 100,000 is at the rate of 10%, without the benefit of indexation (the adjustment in the purchase price for the impact of inflation for which the index is notified by the government).
Long-term capital gains on investments made before January 31, 2018 are entitled to the benefit of grandfathering, a concept in which the investor is not liable to pay tax on long-term gains that are accrued till January 31, 2018. The rationale for the grandfathering benefit is that long-term capital gains on sale of listed securities were exempt from tax until January 31, 2018.
For instance, in case an individual acquired listed shares via the stock exchange in 2016 at INR 100 per share and the price as on January 31, 2018 was INR 160 per share and now the individual sells the shares through the stock exchange for INR 200, he would be subject to long-term capital gains tax on INR 40 (INR 200 minus INR 160), even though his actual gain is INR 100.
What Is Securities Transaction Tax (STT)?
Transactions which are carried out through the stock exchange are usually subjected to STT under Section 111A and 112A. However, in case, the transaction is not subject to STT for any reason, the short-term capital gains are taxed as per the slab rates applicable to the investor whereas long-term capital gains are taxed under Section 112 of the IT Act. In accordance with Section 112 of the IT Act, the investor can either opt to be taxed at the rate of 20% (with indexation) or 10% (without indexation), whichever is more beneficial to them.
How Are Dividends Taxed?
Dividends from listed shares are taxed as per the income tax slab rates applicable to the investor. The benefit of tax deducted at source (TDS) on the dividends paid (at 10% in financial year 2021-22) that are available as tax credit.
How Are Equity-Oriented Mutual Funds Taxed?
The capital gain derived from the sale of units of an equity-oriented mutual fund is either long-term or short-term gains depending upon the period of holding of such units. The taxation on capital gains derived from equity-oriented mutual funds is the same as that of listed domestic equity shares.
Long-term and short-term capital gains: The threshold holding period for long-term and short-term period also remains at 12 months in case of such mutual funds.
Dividends: Taxation on dividends of equity-oriented mutual funds is the same as dividends earned from domestic equity shares.
How Are Foreign Equity Shares Taxed?
Investments made in foreign shares are treated at par with investments in unlisted shares for the purpose of taxation in India. Resident investors in India can invest in stocks that are listed on the foreign stock exchange under the Liberalized Remittance Scheme (LRS) of the Reserve Bank of India (RBI) where an Indian investor can invest up to $250,000 (about INR 18.75 million) per financial year.
Long-term and short-term capital gains: If foreign shares are held by an investor for more than 24 months, gains arising from the investment are long-term in nature, otherwise such gains are treated as short-term. Long-term gains are taxable at 20% whereas short term capital gains are taxed as per the slab rates applicable to the investor.
Dividends: Taxation on dividends from foreign shares are taxed as ‘income from other sources’ as per the normal rates.
Taxation in foreign country of residence
The investor may also be subject to taxation in the foreign country that they reside in. Relief or tax credit for such taxes paid in the foreign country may be available in accordance with the Double Tax Avoidance Agreement (DTAA) between such a foreign country and India. Even in the absence of any DTAA, the Indian investor can claim unilateral relief for the foreign income tax paid against the Indian income tax in accordance with Section 91 of the IT Act.
TCS application on remittances towards foreign stocks under LRS
The amount that is remitted by the Indian investor for the purpose of investment in foreign stocks is subject to tax collected at source (TCS) at the rate of 5% provided the same exceeds the threshold limit of INR 700,000 in a particular financial year. Such TCS rate may also be enhanced to 10% in case of non-availability of PAN card or Aadhar card. The credit for TCS can be claimed by the investor at the time of tax return filing.
How Are Debt Instruments Taxed?
Debt instruments are fixed income-based securities that cast an obligation on the borrowers to make interest and principal payments to the investors. Pooled funds which invest in debt instruments are referred to as debt mutual funds.
Some examples of debt instruments are corporate debentures, bonds, government securities (G-Secs), debt-oriented mutual funds among others. The tax treatment of income from debt instruments in the form of capital gain on sale or redemption and interest income is as follows:
How Are Debt Mutual Funds or Debt ETFs And Gold ETFs Taxed?
The tax treatment of debt mutual funds, debt ETFs or gold ETFs is also determined on the basis of the period of holding. The period of holding refers to such a period for which the units of a debt mutual funds or ETFs are held by the investor i.e., period from the date of acquisition to the date of sale or redemption of such units.
Long-term and short-term capital gains: In case of debt mutual funds, the gains are short term in nature if the holding period is up to 36 months, otherwise, they are long-term.
Short term capital gains are subject to tax at the applicable slab rate of the investor. Long-term capital gains are taxed at 20% under Section 112 of the IT Act. In case of computation of long-term capital gains tax, the investor can avail the benefit of indexation.
How Are Debt Securities Taxed?
Long-term and short-term capital gains: In the case of listed debt security instruments such as debentures, G-secs, corporate bonds among others, the holding period threshold for classification of gains into long-term or short-term is 12 months. Thus, if such investment is held for more than 12 months, such gains are classified as long-term, otherwise short-term.
The short-term capital gains are subject to tax as per the income tax slab rates of the investor whereas the long-term capital gains are subject to tax under Section 112 of the IT Act, either at 20% (with indexation) or 10% (without indexation), whichever is more beneficial to the investor.
However, the benefit of indexation is not available in case of debentures or bonds except capital-indexed bonds issued by the Government or Sovereign Gold Bond issued by the Reserve Bank of India under the Sovereign Gold Bond Scheme, 2015 or Zero Coupon Bonds.
Gains derived by an individual investor from redemption of Sovereign Gold Bonds issued by the RBI are exempt from capital gains tax under Section 47(viic) of the IT Act i.e., only if such bonds are redeemed. However, the gains arising from transfer on the stock exchange are subjected to capital gains.
Interest: Interest earned from such debt securities are subject to tax as per the income tax slab of the investor. However, any interest derived from specified tax-free bonds are exempt under Section 10(15)(iv)(h) of the IT Act in the hands of the investor.
How Are Derivative Instruments Taxed?
Derivative instruments are instruments whose value is derived from one or more underlying assets in the form of commodity, currency, metals, bonds among others. In case of derivative instruments, the gains are generally in the nature of business income or income from other sources.
In accordance with the provisions of Section 43(5) of the IT Act, transactions of trading in derivatives carried out in a recognized stock exchange are not treated to be speculative in nature. The capital gains from derivative instruments being in the nature of income from business or income from other sources, are subject to tax at the slab rates applicable to such individuals.
Taxation of Listed Securities In A Nutshell
A snapshot of the tax implications is provided as below:
Notes: Tax rates above are excluding the applicable surcharge and cess. Surcharge is levied on income tax at rates ranging from nil to 37% depending on the income slab. Cess is levied at 4% of the income tax and surcharge amount in all the cases.
For example: individuals with taxable income exceeding INR 5 crore are subject to surcharge of 37% and the applicable slab tax rate is 30%, which results in an effective tax rate of 42.74% [{30%+ (37%*30%)}*1.04].
Bottom Line
The selection of appropriate investments is crucial for both preservation and appreciation of your capital. The choice of the right investment instrument when it comes to investment in listed securities would depend upon various factors such as your investment goal, time horizon, risk reward analysis and risk appetite, liquidity, tax incidence and value buying.
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