How to make tax gains on stock market losses

Stock markets have tanked big time, spreading widespread, contagious panic, pain and gloom the world over. 

For equity investors, the pain is, of course, real though not unusual given that share prices routinely go through bullish and bearish cycles. 

An array of preferential tax treatment on equity investment offers some balm to investors bloodied by capital losses. 

Tax gains on capital losses 

Your investments may not always result in capital gains. A loss from the sale of a long-term capital asset (such as investment in equity or equity mutual funds held for more than 12 months) can only be set-off against long-term capital gains. 

On the other hand, a loss from short term capital asset is allowed to be set-off against both short term and long-term capital gains. 

How to set-off capital losses 

Accordingly, to obtain the maximum benefit one may use the following order of priority to set-off capital losses: 

First, try setting off against short term capital gains not subjected to securities transaction tax (STT); this will save 30 per cent tax (since slab rates are attracted); 

Second, try setting off against long term capital gains not subjected to STT and thus save 20% tax. 

Last, try setting off against short-term capital gain subjected to securities transaction tax. 

Where capital loss cannot be set-off and tax mitigated during the ongoing financial year, it can be carried forward to the next year provided you file a loss return along with your return of income. 

In fact, you can carry forward such losses for up to eight years 

Zero tax on dividends 

Dividends are the distribution of a portion of a company's earnings to its shareholders in proportion to his / her holding in the company. 

The dividend distribution may be in cash or kind entailing the release of a company's assets. 

For this purpose, dividends mean and include: 

Distribution of debentures or deposit certificates to shareholders, and bonus shares to preference shareholders; Distribution in cash or kind on liquidation of a company to the extent attributable to accumulated profits of the company; Distribution by a company to its shareholders on reduction of its share capital to the extent of accumulated profits of the company. 
All such 'dividends' received from a domestic company, whether interim or final, are exempt from tax in the hands of the investor. 

On the other hand, dividend received from an investment in a foreign company is taxable. 

However, an investor can reduce his or her tax burden to some extent by claiming deduction for related expenses, such as collection charges, interest paid on money borrowed to purchase the stock, if any. 

Zero tax on long term capital gains from equity 

Capital gain is the increased value of any capital asset (in this case, shares) in relation to its purchase value. 

However, this gain is said to be realised only when the investment is sold, and not otherwise. 

On the sale of equity or preference shares, securities listed in stock exchange, units of Unit Trust of India or units of mutual funds, or zero coupon bonds, the nature of capital gain (difference between the sale consideration received and the purchase price plus costs incurred to realise the proceeds) depends on how long you held the security concerned. 

If you held it for 12 months or less, the sale results in short term capital gains. 

On the other hand, if the security was held for more than 12 months, its sale results in long term capital gain. 

Any short term capital gain arising from the sale of equity shares or units in a recognised stock exchange, and on which securities transaction tax is charged, attracts a flat short term capital gain tax @15%. 

However, if the sale is effected through an unrecognised stock exchange, the short-term capital gain is added to the investor's total income and attracts tax at the appropriate income tax slab rate applicable to the investor. 

A tax free investment 

Long-term capital gains arising from the sale of equity shares are exempt in the hands of an investor if: 

the sale is effected through a recognised stock exchange, and also when units of equity-oriented funds are sold back to a mutual fund, and has been charged with securities transaction tax in respect of such sale. If the sale is not effected through a recognised stock exchange then tax @ 10% is levied if the indexation benefit is not availed, and at the rate of 20% if the benefit of indexation is availed. 

Clearly, equity investment held for more than 12 months is more tax efficient; in fact, it's tax-free! Such exemption is applicable to bonus shares and right shares also. 

Also, since any long term capital gain arising from sale in a recognised stock exchange is tax exempt, while no such concession exists in the case of sale in unrecognised stock exchange, it is obviously wiser to sell your investment through a recognised stock exchange by paying the very small transaction tax. 

Tax implications of rights issue 

Right shares are shares issued to its existing shareholders by a company which opts not to approach the public for raising its required capital and instead chooses to do so from its existing shareholders. 

The tax implications of right shares are the same as in the case of any other shares which an investor may acquire. 

Thus the dividends received on rights shares are tax free in the hands of an investor. 

Hence, in addition to the benefit that an investor typically gets rights shares at a price lower than the market price, regular dividends received from them are also currently not taxable. 

However, when these shares are sold in the market they attract tax either as short-term or long-term capital gains depending on the holding period from the date of allotment of the rights shares to the date of their sale. 

Tax implications of bonus issue 

Bonus shares are shares issued by a company to its existing shareholders without any consideration. Such shares are issued to increase the liquidity of a stock, or to adjust its market price resulting by a reduction in the accumulated profits and an increased share capital. 

There is no liability on purchase, no tax liability on dividends received; however, on sale they attract short term or long term capital gains depending on the period of holding (date of allotment of bonus shares to date of sale). 

The tax implications are the same as in the case of rights shares except that the cost of acquisition in the case of bonus shares will be taken to be nil. 

Tax implications of stock split 

While a stock split results in an increase in the number of shares in an investor's hand, the total intrinsic value of the investment, however, remains unchanged. 

The tax implications of dividends received on stock split and the capital gains are the same as tax implications of original shares, while the holding period for the purpose is reckoned from the stock's original date of purchase. 

Tax on investments in MFs 

In the case of equity oriented mutual funds with growth option, no dividends are declared, and the tax obligation arises only on sale of the units. 

The capital gains tax arising from the sale may either be: 

short-term capital gains taxable at 15% (chargeable to STT), or long-term capital gains chargeable either at 10% (without benefit of indexation), or 20% with indexation if the sale is through unrecognised stock exchange. 
In the case of sale through a recognised stock exchange, no tax is payable on long-term capital gains. 

Tax on equity-oriented MFs 

In the case of equity-oriented mutual funds with dividend payout option, any dividends received in the hands of investors are tax exempt. 

The tax implication on capital gains arising on sale of units is the same as in the case of equity oriented mutual funds with growth option. 

In the case of debt-oriented mutual funds, dividends declared are tax free in the hands of an investor while long term capital gains are taxed at 10% without indexation, or 20% with indexation. 

In the case of short term capital gains the rate corresponding to the tax bracket in which the investor falls becomes payable.