In this world, nothing can be said to be certain, except death and taxes.
In this world, nothing can be said to be certain. Except for two.
1 - Our death. 2 - The tax we owe. No one can escape from these two.
We have to pay tax on the income from our investment as well.
When we invest in Equity and Debt, how much do we have to pay as tax in India and in US?
We will take a closer look at those in this episode.
Hi. My name is Vijay Mohan. You are watching Investment Insights.
Let’s start from capital gains tax in India.
What is capital gains? Let’s say that I am investing Rs. 10 Lakhs in a fund.
After a year, it has grown up to 11 Lakhs. That 1 Lakh profit is called Capital gains.
I have not realised this capital gains yet as I have not sold it yet. That means, this is unrealised capital gains.
We don’t have to pay tax for unrealised capital gains. We will be paying the tax only when we sell and realise the profits.
Now I don’t have to worry about paying tax till I sell that Rs. 11 Lakhs.
Let’s say that I am selling the whole 11 Lakhs after a year, what would be my realised gains?
That is, how much money did I earn as profits from this investment? 1 Lakh.
I have to pay tax on that 1 Lakh. What if I have sold just the half of it?
Then my earnings would have been half of the profit, Rs. 50,000.
That is, my realised gains would have been Rs. 50,000 and unrealised gains would have been the other Rs. 50,000.
I have to pay the tax only on that realised gains.
In short, we will be paying taxes only on the profits that we gain from selling an asset.
If we have not sold the assets yet, then we do not have to pay tax even if it is in gains.
OK. How much do we have to pay as tax?
That depends on two things. 1. Tax rate changes depending on the type of assets.
Equity has a tax rate that is different from Debt’s tax rate.
Second difference is, the tax rate changes depending on how long we held the assets.
Let’s check out the equity tax rate first.
Stocks or Equity mutual funds, if we have held it for more than a year and sell, then the profit is long term capital gains.
In India, that is 10%. But in India, this long term capital gains has another benefit.
We don’t have to pay tax on the first 1 Lakh Rupees.
Let’s say that our realised gains is Rs. 2 Lakhs for that year. We will be paying tax only on Rs. 1 Lakh gains leaving 1 Lakh out.
As long term capital gains tax rate is 10%, we have to pay 10% of 1 Lakh, Rs. 10,000 as tax.
What if we have sold within a year? The gains from that would be short term capital gains.
In India, that is 15%. Short term capital gains does not have that 1 lakh benefit.
If this Rs. 2 Lakh gains was short term, then we would have paid, 15% of 2 Lakhs, Rs.30,000 as tax.
Ok then. what is the tax rate for debt funds?
For debt funds, the tax rate is different and also the definition of long term and short term is different as well.
Only if we have held a debt fund for more than 3 years, then it is long term. Less than 3 years is short term.
If the long term capital gains for equity is 10%, it is 20% for debt funds, but with indexation. What is that indexation?
The rise in inflation for the period we held the fund, can be reduced from our gains. That is called as Indexation.
Cleartax site has explained this with example. Let’s say that we have bought a debt fund for Rs. 10,000.
It has grown up to Rs. 20,000 in 3 years.
If we sell the fund at that time, then our actual realised gains would have been Rs. 10,000.
If it is not for indexation, we would have paid the 20% tax for those gains. That is, we would have paid Rs. 2,000.
But in these three years, the cost inflation has risen from 264 to 289. We can add that rise % to our buying cost, Rs. 10,000.
When we add that, our cost now becomes Rs. 10,947. Now our profit is, Rs. 9053.
So because of this indexation, our gains has reduced by 10% and so the tax.
This indexation will change depending on the inflation during the period we were holding our debt fund.
This is long term capital gains for debt funds. But if we hold a debt fund for less than 3 years, then the gains are short term capital gains.
The tax rate for that is, our ordinary income tax rate. That is, this gains would have been added to our normal salary from work and we pay tax on that.
To understand this, we should understand our tax slabs. Here we are looking at income tax slab rate in India.
There is no tax for the first 2.5 Lakhs we are earning. 5% tax for the next 2.5 Lakhs.
10% tax for the next 2.5 lakhs. As the income rises, the tax rate for each additional income rises as well.
Any earnings over 15 Lakhs has 30% tax.
So if our normal salary earnings is Rs. 8 Lakhs, then we have to add the earnings Rs. 10,000 from the debt fund to it.
Then, what would be the tax rate for this Rs. 10,000? 15%. So for this profit, we have to pay 15% of those profits as short term capital gains tax.
Wow, this 15% is less than the long term capital gains 20%… Yes. If our total income is less, then the short term capital gains could be lesser than long term capital gains.
Another important thing to note. In India, funds investing in foreign stocks are considered as debt funds for tax purposes.
That means, gains from funds based on foreign indices like S&P500 and Nasdaq 100, will be treated same as gains from a debt fund and so we have to pay tax like in a debt fund.
Till now, we were looking at the profits from one single fund. But in reality, we will be adding all the long term capital gains together.
Short term capital gains calculation is same as well. We will be adding all the short term capital gains together.
How about losses? How do we account for them? We can reduce them from our gains.
Long term losses can be reduced only from long term capital gains.
But a short term loss can be reduced from either short term capital gains or long term capital gains.
But if our loss is bigger than the profits, then we can carry forward that loss for next 8 years.
That means, we can potentially reduce this loss from gains in next year.
OK. Now we know the tax rules. What about Tax Loss harvesting?
Strategically selling stocks or funds so that we can minimize the capital gains tax is called Tax Loss harvesting.
Let’s say by the end of the year, I am sitting on huge gains on a stock or a fund.
But I am also sitting on a loss on another stock or fund.
If I have decided to sell the stock that is in loss as it has no scope in the future, then I can sell the profitable stock/fund along with that as well to minimize the capital gains.
After two days, I can buy back that same profitable stock or fund. This is allowed in India.
We cannot do this in US. To do this in US, we can only buy back 30 days after selling.
If we buy within 30 days, it is called as Wash Sales in US. Anyways, as there is no restriction like that in India, we can definitely do this in India.
This is one strategy. Another is, remember that India allows to take long term capital gains of upto 1L for free without any tax?
We can take advantage of it. Let’s say that I have Nifty 50 Index fund.
And let’s say that I have a gain of over Rs. 1 Lakh on that after a year.
I could sell the fund units selectively so that I realise a capital gains of Rs. 1 Lakh and then buy back after 2 days.
If I do that, then I have effectively saved 10% tax on Rs. 1 Lakh, Rs. 10,000. If we do this every year, the long term savings will be significant.
If the same was done by both husband and wife, then it is double gains.
Till now, we reviewed the capital gains tax in India. How about US?
It is almost the same, but with some differences.
First difference is tax rate. Here we are looking at the long term capital gains tax rate chart.
For married filing jointly, first $80,800 has 0% tax.
What does that mean? If my whole year income, including the long term capital gains is less than $80,800, then there is no capital gains tax.
This could be another motivation for early retirement. Because if our income is only from this capital gains after retirement, then upto $80,000 of capital gains can be realised with 0% tax.
Long term capital gains for income between $80K and $500K is 15%. Most of the salaried folks come under this category.
Anyone with income more than 500K has 20% as long term capital gains tax rate.
This is for long term capital gains. Short term capital gains has same tax rate as our standard income tax rate.
If our annual income is $100K, then for married filing jointly, it comes under 22% tax bracket.
So we will be paying a tax of 22% for our short term capital gains.
Another difference between India and US is, short term losses can be reduced only on short term capital gains.
We cannot reduce it in long term capital gains like in India. Another difference is, like I mentioned earlier, Wash Sales Rules.
We cannot sell a stock or a fund for showing losses in tax and then buy back immediately. If we want to show that loss in tax, we can only buy back after 30 days.
Also in US, there is no difference between Equity and Debt capital gains tax rate. Both have same Long term and short term capital gains tax rate.
Likewise, there is no difference in the holding period as well. For both equity and debt, anything held for more than a year is Long term and less than a year is short term.
I am saying this in general. Some specific bond funds could have different tax rate. Some local municipal bonds may not even have capital gains tax.
So if you are buying bond funds, make sure that you understand its tax rules before buying them.
Now I believe you have a good idea about capital gains tax. It is impossible to cover all the scenarios in a 10 min video.
If you know any tips and tricks that I have missed here, please share that in the comments below. It will be useful for others.
Also, do not assume that everything that I have shared here is right. I am human as well. There is a good chance that I have made some mistakes here.
So for a proper tax planning, consult a tax advisor and make the right decision.
We will soon meet again in the next episode. Thank You.