Taxes have got to be one of the most annoying things invented by mankind. Though the system makes sense or at least tries to be useful the fact is that those who have to pay for it just don’t like it. And there’s not just one tax waiting to be paid, you have an income tax, service tax, direct tax and indirect tax. Capital Gains Tax is also on the list of taxes that you have to pay. In this article, we will answer questions like how to avoid capital gains tax on stocks, when do you pay capital gains tax on stocks and do I have to pay capital gains tax immediately.
What do Capital Gains mean?
To understand the concept let’s assume that you have gone ahead and gotten yourself a car or some stocks of a company. Now let’s say that either was priced at 4 lakh rupees when you purchased it. When you go to sell them there is a good chance that the stocks have gained value or in the case of a car you have modified it or it has gotten vintage status and again it is now valued more than the price you purchased it at. This increase in the value of the asset is called capital gain. Similarly, if the value of the asset had gone down then it would have been a capital loss. How to avoid capital gains tax on stocks in India?
The gain you make can be a short-term gain or long-term does not matter, both are taxable. However, for the gain to be taxable, it needs to be realized or received. The perceived increase in value is not subject to taxation, only when you get this amount in hand after selling the asset does the capital gain become taxable.
How to avoid Capital Gains tax on Stocks? A Guide
There are a few ways that could work when it comes to avoiding capital gains tax. As mentioned above there are two types of capital gains, short-term gain, and long-term gain. Of these, short-term gains cannot be avoided. A short-term gain is a gain made from an asset that was purchased and sold within a year, whereas long-term gains are those where you purchase an asset and don’t sell it within a year. The latter are the ones that can be avoided. However, you can get some relief on short-term gains by deducting any expenses you incurred on the purchase or sale of the asset, like brokerage or something else. So, how to avoid short term capital gains tax on stocks?
Up until the year 2018, the long-term gains were free from any sort of taxes as it was used to promote cash liquidity. However, in that year itself, a rate of 10% was put in place to tax long-term capital gains. However, there were still some ways that people could be exempted from taxes and mentioned below are the ways of how to avoid capital gains tax on stocks.
Income tax section 112A saves any capital gains from being taxed if the amount of profit is less than 1,00,000. So with this section in place, you could be making gains up to 99,999 rupees and be worry-free about having to cut your profit. This would mean that you need to make small gains and realize them timely to avoid paying taxes.
Apart from this section 54F states that you can avoid tax on capital gains from stocks if you choose to invest the profit somewhere else. However, even somewhere else is mentioned in this case, so how to avoid capital gains tax on stocks? Simple, you either use the money earned to invest in a property within two years of making the profit and then don’t sell the property for at least three years.
If you have purchased a property and then sell the shares within one year for profit, then you can ask for a deduction of investment cost from the capital gains as long as you don’t sell the property for three years. Lastly, you can invest your long-term capital gains in a construction project that will be ready in three years. Next, we should see some country-specific cases, such as how to avoid capital gains tax on stocks in India. Let us now learn when do you pay capital gains tax on stocks.
When do you pay Capital Gains tax on Stocks?
Capital gains tax is not at all that complicated. Above we saw how to avoid capital gains tax on stocks but when exactly do we need to apply this? What is the situation where you see yourself paying a capital gain tax? Do I have to pay capital gains tax immediately? The answer is simple, capital gain tax comes into place when selling an asset for a profit or a price higher than the acquisition cost. Here again, you have two situations that you need to be aware of, the first being the case of short-term gains and the second long term-gains.
Specifically talking about stocks, you could hold an equity share for years or you might be a trader and dispose of them quickly for small and quick profits. Now if you get rid of them within a year of the purchasing period they become eligible for being taxed as per how the short-term gains are taxed. On the other hand, holding them off for more than one year gets them special treatment where they can now be taxed according to the more lenient long-term gains rules.
Let’s say you purchased shares worth 40,000 rupees in January 2022 and decided to sell them in December 2022 for 4,00,000 rupees. The capital gains you have made here are worth 3,60,000 rupees. Remember when do you pay capital gains tax on stocks? You pay them after realizing the sale and not just when you think of selling shares or on their perceived value. Now after you sell these shares you are liable to pay 15% tax on your short-term capital gains if they come under section 111A. No matter what tax slab you belong to this is the standard that everyone is expected to abide by.
However, you can exempt any amount spent on buying or selling the share. Let’s say you paid 500 rupees on buying the shares and 4,500 to sell them, so you cut off 5,000 rupees from your capital gains. Now you have to pay 15% of 3,55,000 rupees as tax. This comes to 53,250 rupees. This leaves you with 3,51,750 rupees in profit.
Now if we look at this same situation in a long-term capital gain scenario then what do we do? The long-term gain is only taxable at 10% for equities irrespective of your tax bracket. So you would see yourself paying only 35,500 rupees in the case mentioned above. However, if your asset was purchased before 31st January 2018 then there is a Grandfather rule coming into the picture.
Here the amount payable further decreases as your capital gains taken into account consider the value of the asset on January 31st, 2018. Let’s say you purchase stock on 1st January for 5,000 rupees. On the 31st they are valued at 6,000 rupees and when you sell them, they are valued at 10,000 rupees. Now you get capital gains of 5,000 rupees from which you remove 4,000 rupees (10,000 – 6,000) which leaves you with 1,000 rupees that are not taxable. The tax you pay is 10% of 4,000 rupees which comes to 400 rupees.
Note: This is just an example for an understanding purpose, no capital gains under 1,00,000 rupees are taxed for long-term gains, only after crossing the sum does the tax come into the picture.
Also Read: Tax on Dividend Income: What You Should Know
Do I have to Pay Capital Gains tax immediately?
Before you can focus on how to avoid capital gains tax on stocks and when do you pay capital gains tax on stocks, you need to know when exactly is this tax due. Is it due when you sell the stocks, is it due in the next quarter, next year, or when exactly? The simple rule in this case states that capital gains are due when you have made a profit from selling any asset.
Each asset comes with its rate of interest charged and period which means different assets command different percent of charge and need to be held for varying amounts of time in certain conditions. Above we have seen how to avoid capital gains tax on stocks but to be able to use this provision we need to know when exactly the charge is due. So, how to avoid capital gains tax on stocks in India?
So you ask yourself, do I have to pay capital gains tax immediately? The answer is no. You do not. Capital gains are due after the sale of an asset and are usually filed along with income tax returns which means that you file them before the end of March each year. So you segregate your short-term gains and long-term gains, calculate both of them, club the items in the respective areas and calculate the amount due. You should also know how to avoid short term capital gains tax on stocks.
How to avoid Capital Gains tax on Stocks in India?
Above we saw how to avoid capital gains tax on stocks but is that about it? Aren’t there more ways to go about it? Is there something specific to India when it comes to avoiding such taxes on capital gains? Let’s figure it out.
Firstly, a short-term capital gain is unavoidable no matter what. Long-term gains on the other hand are exempt up to 1 lakh rupees or under certain circumstances. Long-term capital losses can also be set off against long-term capital gains or income whereas short-term capital losses can be set off against short-term capital gains or long-term capital gains.
A long-term capital gain can be charged only after a profit of more than 1 lakh is made, so the answer to how to avoid capital gains tax on stocks in India becomes very simple. You make sure that you cash out on your profits before they hit the figure of 1 lakh rupees. Now you might wonder if this is a bad idea because you might have seen yourself make much more money from an asset but were forced to sell it to avoid being taxed. What do you do then? How do you make sure to avoid going down such a path?
Again, simple, a lot of families have members who don’t invest or have no Demat accounts altogether. You create a Demat account for all such inactive users and distribute your funds and investments in different portfolios. What this does is get you an exemption of up to 1 lakh per account. This means the more accounts you have the more money is exempt from taxes. There is also one other way to go about it which we now look at.
Again, when wondering how to avoid capital gains tax on stocks, the second method that comes to the rescue is setting off capital gains against capital losses. So, let’s say that one of your stocks is down and you are making a loss of 50,000 on it and don’t see it getting any better, on the other hand, you have a stock that has seen you gain 1,50,000 on your capital. Now you book your 50,000 loss and set it against the 1,50,000 gains. This means now your capital gains stand only at 1 lakh rupees and that makes it non-taxable. This way you end up saving tax money.
Note: While this can be done with equity shares the same can’t be done with cryptocurrency as the government has stated that losses cant be set off against gains when it comes to crypto and so you might want to be a bit more cautious when dealing with cryptos.
How to avoid Short term Capital Gains tax on Stocks?
We have looked at how to avoid capital gains tax on stocks but that mostly covered long-term capital gains, how to avoid short term capital gains tax on stocks? The answer is you can’t. There is no way to escape tax on short-term gains; you can either set off short-term capital losses against them or get some sort of exemption but there is no way of erasing the whole amount.
To get these exemptions you need to sell your equity shares through an unrecognized stock exchange which looks shady and almost impossible to go ahead with. Next, you can get an exemption on short-term gains if you are selling any shares other than equity shares. These are the two ways to apply in case you want to know how to avoid short term capital gains tax on stocks, however, other short term gains can get exemption using other ways mentioned below.
If you sell immovable properties like gold, silver, etc. for making short-term capital gains then you could get an exemption. Selling government bonds, securities, and debentures also makes you eligible for an exemption from short-term capital gains. Also if you sell mutual funds which are not based on equity then again you get exempted from tax on your short-term capital gains.
Other ways to get an exemption come into the picture in the scenario of assets like houses. Under section 80C you can apply for a reduction in the taxable amount based on having paid for certain purchases that help you qualify for this special section like when you pay a premium on your insurance.
Also under section 80U, you can get a taxable amount deducted as it is made to help people with disabilities. However, these provisions are subjective and only usable for certain sections of the people. Not anyone and everyone is subject to special treatment so make note of stuff like this before you realize your short-term capital gains or set them off against your short-term losses.
Some Important Points
It is now known do I have to pay capital gains tax immediately. To earn capital gains from an asset it needs to be a non-inventory asset that is sold for a price higher than what it has been purchased for. Stocks, precious metals, bonds, and real estate are a few examples of assets that are usually those that get you capital gains.
The Cayman Islands, Isle of Man, Jamaica, New Zealand, Singapore, Bahrain, Barbados, Belize, Singapore, and Sri Lanka do not ask for tax on capital gains. New Zealand and Singapore instead ask for business income which is the profit earned by traders through trading.
In the United Kingdom, the tax gains were taxed at 10% in the tax year 2021-22 if you earned less than 50,000 pounds post that it becomes 20%. Like that each country has its percentages and amount threshold over which they charge taxes. Each country has different percentages and ways to decide what asset should be charged at what rate.
In India, shares need to be held for less than 12 months to be eligible for short-term capital gains, and more than that to be considered for long-term capital gains. These are taxed at 15% on a short-term basis and 10% on a long-term basis if the amount exceeds 1,00,000 rupees. Equity-oriented mutual funds need to be held for less than 12 months to be eligible for short-term capital gains, and more than that to be considered for long-term capital gains.
These are taxed at 15% on a short-term basis and 10% on a long-term basis if the amount exceeds 1,00,000 rupees. Debt-oriented mutual funds need to be held for less than 36 months to be eligible for short-term capital gains, and more than that to be considered for long-term capital gains. These are taxed at income tax slab rate on a short-term basis and 20% with indexation on a long-term basis.
Bonds need to be held for less than 12 months to be eligible for short-term capital gains, and more than that to be considered for long-term capital gains. These are taxed at income tax slab rate on a short-term basis and 10% with indexation on a long-term basis. Property needs to be held for less than 24 months to be eligible for short-term capital gains, and more than that to be considered for long-term capital gains.
These are taxed at income tax slab rate on a short-term basis and 20% with indexation on a long-term basis. Gold needs to be held for less than 36 months to be eligible for short-term capital gains, and more than that to be considered for long-term capital gains. These are taxed at income tax slab rate on a short-term basis and 20% with indexation on a long-term basis.