With tax filing season in full swing, investors are closely examining how taxes have impacted their net returns from stocks and mutual funds. Many are seeking effective strategies to reduce their tax burdens and maximize their investment gains. One such strategy is tax harvesting, a legal method to optimize financial outcomes by strategically managing investment. Using this strategy, investors can maximize their returns by minimizing their tax liabilities.

In this article, we will delve deep into how investors can save tax on Equity shares and Mutual funds in India, and the role tax harvesting plays in this process:

Let us first understand about Capital Gains Tax:

Capital gains from equity shares and Equity oriented mutual funds are categorized into short-term capital gains (STCG) and long-term capital gains (LTCG) based on the holding period:

– Short-term capital gains (STCG): Short-Term Capital Gains (STCG) Tax on Equity or mutual funds is a tax levied on the profits earned by selling stocks or mutual fund units that have been held for less than one year.

– Long-term capital gains (LTCG): Long-term Capital Gains (LTCG) Tax is a tax levied on the profit earned from the sale of long-term investments in mutual funds, stocks, and other securities. Long-term investments are defined as investments held for a period of more than one year.

 Below table shows the taxation for the Equity shares and Equity oriented MF:

Leveraging Tax Harvesting:

Tax harvesting, also known as tax-loss harvesting, is a strategy where investors strategically sell investments that have experienced a loss to offset capital gains and minimize taxes. Here’s how it works:

– Offsetting Gains: Investors can sell investments that have incurred losses to offset capital gains from profitable investments. This helps in reducing the taxable amount of gains, thereby lowering the overall tax liability.

– Carry Forward Losses: If the capital losses exceed the gains in a particular financial year, the excess losses can be carried forward for up to eight subsequent years. These losses can be utilized to offset future capital gains, effectively reducing tax liabilities in the future.

The capital losses realized from selling underperforming investments can be used to offset capital gains made on other investments. Long-term capital losses can offset long-term capital gains, while short-term losses can offset short-term and long-term gains.

Let us understand this with help of examples:

Example (I)

Investor A earns Rs.3 lakh as short-term capital gains in a financial year. This means he will be liable to pay 20% of the income as taxes. Thus, the STCG will be Rs.60,000. Investor A also has short-term capital asset in his portfolio that has an unrealized loss estimated at Rs.1 lakh. In such a scenario, he can go for tax harvesting as below.

If Investor A sells these loss-making stocks, the net STCG goes down to Rs.2 lakhs. Thus, the 20% tax will be applicable on Rs.2 lakhs, bringing down the tax liability to Rs.40,000. Investor A will save Rs. 20,000 in taxes.

Example (II)

Investor B earns Rs.3 lakh as long-term capital gains in a financial year. Thus, the applicable tax rate will be 12.5% in excess of threshold of Rs.1.25 Lakh. This makes LTCG tax at Rs.21,875 on the net income of Rs.1,75,000. Investor B has listed stocks and mutual fund units held for both long term and short term that have an unrealized loss of Rs.1 lakhs, then he can go for tax harvesting as below.

By selling loss-making stocks or mutual fund units whether held for short term or long term, Investor B can arrive at the net LTCG of Rs.75,000. The 12.5% tax will now be applicable on Rs.75,000 and therefore the tax liability will be Rs.9,375. Thus, the Investor B saves Rs.12,500 in taxes.

However, it is important for investors to consider their long-term investment strategy and whether the assets are likely to recover in value.

Conclusion:

Investing in equity shares and mutual funds not only offers opportunities for wealth creation but also provides avenues for tax savings through informed strategies like tax harvesting. Navigating the complexities of tax-saving strategies for equity shares and mutual funds requires expertise. Consulting with tax advisors or financial planners can help an investor get personalized advice based on individual financial goals and circumstances. It is essential to stay updated with changing tax regulations and seek professional guidance to make informed investment decisions aligned with long-term financial objectives.

To understand more on the topic as well as to start investments please feel free to contact us:

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The article is authored by Ms. Ritika Sharma from Team RichVik.