Perspectives #4: Taxation For Investors
We're not taught taxes in school so I am breaking down taxations for investors in this newsletter. Read on!
Dear Investors,
I hope you were able to get some sleep the last few nights after the Madam Finance Minister announced the budget. I mean, the hike in capital gains taxes. As the budget speech started, we all saw the markets go on a little see-saw ride. It was all sunshine and rainbows with initiatives in agriculture, employment, and more, but then came a sudden crash at 12:17 when the STCG hike was mentioned. Tell me if your portfolio skipped a beat because mine sure did. :((
I know you can’t wait to talk about the tax hike and honestly, neither can I. However, the said changes only come into effect from the assessment year 2024-25 but with the deadline for Income tax filing coming up this month, let’s talk about the present.
P.S.: Our team and Divam (our CEO and your fund manager) had a little discussion about the budget and I have squeezed some bits of that conversation in today’s edition. Read on and find it!
Perspectives #4
India has over 7.4 crore tax filers and nearly 10 crore investors, and since it’s ITR season, I thought I’d combine these all and talk about investment taxes today. With this edition:
You’d develop a clear understanding of taxes that all major investment classes are subject to, and
Have an unbiased opinion on whether the changes introduced in the recent budget are fair.
The Firsts Of Taxation
Did you know that the Pharaohs of Egypt charged taxes on grain over 5000 years ago and the Britishers were not the first set of rulers to charge “Lagaan” in India? Taxation systems have been in existence since ancient times but formal taxes in India were only introduced in 1860 via the very first Union budget by Sir James Wilson.
Fun Fact: India celebrates 24th July as the Income Tax Day!
Cut to a hundred and sixty years later in the 2020s, we have seen a great number of reforms to simplify taxes (as they say). The biggest reform that sits right in front of us is the GST reform. Introduced to eradicate double taxation and bring more economic activity into the taxation system, GST has massively raised the government's tax collections and is the biggest reform in indirect taxes.
The direct taxation system, however, has not yet seen a reform as magnificent as GST, but all the governments have made changes very slowly and mostly strategically. Back in 1950, the highest tax slab for personal income tax was 25% and by 1974, the highest tax slab had been raised up to a maddening 97.75%. In case you don’t believe me, here’s a fact check with more background. As of today, we’re back to 30%.
I’m not going to talk more about personal income taxes. I’m sure you know which bracket you fall into, I’m here for the investment bit.
P.S.: I hope you are already taking CA's help in filing your taxes because this is just for education purposes and not legal advice.
Investment Taxation: Only What Really Matters
With so many asset classes from equity and gold to real estate, and no education around finance and taxes, it is very hard for us individual retail investors to understand the taxation around our investments and make better financial decisions.
We have multiple types of taxes. Now, you don’t need to master them all because all of it is not directly under your control. First up, STT - Securities Transaction Tax.
Securities Transaction Tax
Whenever you make a trade on any of your brokerage accounts, you would see a small amount as an excess of your trading amount, usually called “trades and charges”. This fee can have a lot of components like brokerage fees, depository participant charges, GST, stamp duty, and STT. It’s levied differently on transactions:
For equity delivery, 0.1% STT is charged on both buy and sell transactions.
For intraday, an STT of 0.025% is levied, but only while selling.
0.001% on mutual funds while selling.
If you are an individual investor like myself, I wouldn’t worry about the STT. There’s no way to escape it. Whether you place an order with a trading value of a hundred bucks or a crore, STT will be levied. No scope for exemptions either!
However, if you trade in derivatives, FM Sitharaman delivered some bad news for you yesterday. Here’s the proposal:
“It is proposed to increase the rates of STT on the sale of an option in securities from 0.0625 per cent to 0.1 per cent of the option premium, and on sale of a futures in securities from 0.0125 per cent to 0.02 per cent of the price at which such futures are traded.”
That’s a 1.6x increase! But, why? Well recently, the trading activity in derivatives has increased. NSE has been the world's largest derivatives exchange for three years and the retail investor wants to be a part of it. Back in 2018, retail participation in derivatives used to be just 2% of the total volume, and now it has risen to 41%. That's a 20 times increase (I wish my stocks saw such a rise). This rise in activity means household savings are going into derivatives. Now, here’s the problem - nearly 90% of individual traders in derivatives end up suffering losses, over Rs.1 lakh on average. See how the volumes have increased lately:
Thus, the government seems to be afraid that retail investors who don’t have enough knowledge of the markets will fall into the pit of “traders who lost money investing in futures and options”. How do you feel about this move? Would penalizing F&O with more taxes help or does SEBI need to do more? I have mixed feelings, to be honest.
Capital Gains Taxes
Finally, right? I know you have been waiting for this one, because how the heck do you make sense of the sudden hike in tax rates, but there’s still some time before I get to that (my apologies). So, first off, the basics:
It’s levied on sold assets.
There are two kinds of capital gains taxes - Short Term Capital Gains Tax or STCG, and Long Term Capital Gains Tax, or LTCG.
The holding period for STCG is less than one year i.e. less than 12 months, and that for LTCG is more than a year.
Unlike STT, both the taxes have to be paid while filing ITR, they’re not deducted upfront.
For the assessment year 2023-24, STCG is levied as 15% of profits and LTCG as a 10% charge on profits of over one lakh rupees. No tax for gains less than that!
Breaking Down The Math: LTCG
Let’s understand this with an example. Suppose you invested Rs. 10,00,000 lump sum in our Smallcap Compounders smallcase in July 2021 and sold your holdings in January 2024.
I am making an assumption here to simplify things for you:
We did no rebalance during this whole time (even though we do quarterly + need-based rebalances, but just assume none for now).
So, by January 2023, your money would’ve grown to Rs. 19,40,000 (I’m not trying to brag here, this was really our past performance!). Since you sold the shares in Jan ‘24, your assessment year would be 2024-25. Here’s what the capital tax calculation would look like for you:
That’s LTCG for you, let’s see what happens in the case of STCG.
And What About The Short Term?
Suppose you invested Rs. 1 lakh in our DiviGrowth Capital smallcase in July 2023, exactly one year ago, and sold your positions during the rally in February 2024.
In this case, you held the shares for about 7 months, so you need to pay STCG during AY 2023-24. In this time, your money would’ve grown to Rs. 1,38,000 in just 7 months (again, not a brag, just facts!).
Here’s the deal now, you don’t get any exemptions for STCG and you have to pay a 15% charge on profits. So, taxable gains = Rs. 38,000, and taxes payable = Rs. 5,700.
The same rule applies to equity mutual funds and ETFs, where equity allocation in the fund is more than 65%. If the weightage of equity decreases, the tax rules change too. I won’t go into the details of that but read more about it here if you want to.
For Green Portfolio’s Investors
But, but, but…. you don’t have to do any of these calculations figuring out the holding period, tax rate, exemption, etc. yourself.
Because you hold individual shares in your demat when you invest in a smallcase, all of this is calculated and put into a sheet by your broker. All you need to do is download your Tax PnL statement from the broker’s website and share it with your CA.
As for PMS, you get the PMS-specific report on your custodian’s login portal. If you need any help finding or downloading the report, just let us know and we’ll help you out. And, if you’re an NRI invested in our PMS, it’s even more simple for you, taxes are deducted at source by us for you and you just have to file them while filing returns!
Mentioning NRIs got me curious about the capital gains tax rates around the globe and I did a little search to find that India seems to have it better than most other markets. See for yourself:
Income or Capital Gains?
A very important thing that can change the way you’re filing your taxes is whether you consider profits on equity as your income or as just capital gains. For traders or those who have returns from their investments as the primary source of income, tax rules are different. Then, you don’t need to pay capital gains tax but personal income taxes as per the tax slabs. So if your investment returns are your primary income, I’d suggest you stop reading and get in touch with a CA.
And What About Dividends?
Our investors, particularly those invested in the dividend-themed smallcase and PMS are often confused about taxation on dividend income. For us as investors, the math is straightforward. Dividend income received is added to our total income and taxed at the respective personal income tax slab rate. So, if your salary is 20 lakh rupees, and you receive dividends worth Rs. 50,000 in a year, you would need to pay 30% tax as per your total income of Rs. 20,50,000. Now, there are some cases where tax is deducted at source by the company on the dividend being paid, but I’d leave that to the companies, nothing for us here.
Now you know how investment taxes work when you’ve made profits, but what if you end up suffering losses? I hope you don’t lose but we can’t just turn a blind eye to the risk.
Losses and Exemptions
If you suffer losses in equity, you can set those off against your gains. Short-term losses can be set off against short and long-term capital gains, while long-term capital losses can be set off against long-term capital gains only. These can’t be set off in other income though, so if you have capital losses and gains from business income, you cannot set it off. However, you can carry the losses forward for 8 years!
We, as your asset management company, help with this too. There’s a concept called tax loss harvesting. With that, your fund manager books losses on underperforming securities just before the end of the assessment period. Unrealized losses are booked which then offset your gains, thus reducing the tax liability.
Oh, and you can get exemptions on gains too, if you invest in real estate or some specific bonds, read more about the exemptions here.
Okay enough about equity, let me get to some other asset classes now.
Gold and Real Estate
The traditional safe-haven assets. These OGs of investing existed even before the term “investment” was coined. Let’s understand how these are taxed.
First up, gold. We can invest in gold in multiple ways - jewelry, bars and coins, digital gold, sovereign gold bonds, gold ETFs, and more. Taxation rules differ for all of these mediums. The most tax-friendly way to invest in gold is through sovereign gold bonds. Hold the SGB till its maturity of 8 years and enjoy tax-free capital gains at the end! However, selling before maturity is taxable. Let me explain. STCG is levied on profits at respective income tax slab rates when selling the bond within three years of buying, LTCG at 20% with indexation benefit on profits after three years. And the interest received is just added to your income and taxed at your PIT rate. But, what does the indexation term that I just used mean?
Well, indexation is a way of moderating capital gains to account for inflation and rise in asset prices. Indexation helps reduce the tax burden on capital gains. It uses the CII - Cost Inflation Index to adjust for inflation. So if you wish to sell an asset that you bought for Rs.10,000 twenty years ago, your purchase price will be increased by a certain amount based on the CII. Say the selling price is Rs.30,000 and the initial value after indexation is Rs.20,000. Then you would only need to pay taxes on a profit of Rs.10,000 instead of Rs.20,000.
We have the indexation benefit for digital and physical gold and real estate (immovable property) too. Rules of taxation for all three assets stay the same, except that it’s never tax-free to sell because there’s no expiry in holding land or jewelry.
Note: Everything mentioned until now is applicable for the assessment year 2023-24. The tax rules change from now on.
Post Budget Breakdown
Now the part that you must have been waiting for. What we saw in the parliament session on Tuesday is a populist budget. Investment is a capitalist concept. With major reforms for youth and agriculture, the government is trying to please the common Indian citizen. As for the tax hikes, this was expected given the increasing market activity.
For some more context, here are the changes announced:
STCG tax rates to rise from 15% to 20%
LTCG rates to rise from 10% to 12.5%
STT rates have risen for futures and options
LTCG on non-financial assets has gone from 20% with indexation benefit to 12.5% without indexation
LTCG tax rates that markets have seen before:
A marginal tax hike will not keep us, investors, from creating wealth with markets anyway. We now have to share an extra bite of our pie, but we still get the 87.5% right!
Divam’s Take
And here’s the note from Divam I promised:
“The tax hikes on capital gains are in line with the expectations with the existing and potential gains financial assets offer and we expect the continuity of liquidity to the markets unlike in 2018. The FM has increased the threshold amount for taxation to seemingly compensate for the increased taxes but that isn’t of much relief to investors. Investors surely are disappointed but markets however will be fine soon. This is nothing new for the Indian markets having seen even 20% LTCG tax two decades ago. So, while the investor sentiment will stay a bit dull for some time, it will soon recover.
With good allocation to manufacturing, infrastructure, and more, the economy is poised to grow, and as we’ve seen, the markets grow when the economy does.”
If you want to hear more from Divam, he was live on our YouTube channel to talk about the budget and much more. Join the conversation here.
Also, you can join our Official WhatsApp Channel here where we share all the important updates, facts, and news.
From the Wise Investor 🤓
"Behind every stock is a company. Find out what it's doing." - Peter Lynch
Opinion Corner
With the budget tweaks, will you be re-evaluating your investment strategies or sticking with the old playbook?
Tell me at isha.bansal@greenportfolio.co.
See you again soon!
Yours truly,
Isha Bansal
Very detailed explanation and info about current boiling issues post-budget - Thanks i