There is no worse tyranny than to force a man to pay for what he does not want merely because you think it would be good for him. Robert A. Heinlein
Trading income is simply the gain on capital employed or the investments made in the stock market. Thus capital gain is the profit made by an investor or trader on the sale of shares, bonds, debentures, etc. Tax on capital gain is a kind of direct tax that you need to deposit directly to the government. Hence it becomes an important topic of discussion for profitable investors or traders. The capital gain is broadly classified into two categories namely, Long Term Capital Gain (LTCG) and Short Term Capital Gain (STCG). These two categories not only have different nomenclature but also have substantially different tax rates. In this article, you would understand the difference between the two and the taxes involved in both categories. You would also learn a few ways to reduce your taxes on trading income.
Short Term Capital Gain
In the case of Equity, if an investor/trader holds shares for less than one year then the profit he makes is considered as STCG. He is liable to pay a tax of 15% on these profits.
In the case of Debt markets that is, Bonds, Debentures, Debt Mutual Funds, Gold ETFs, etc., if an investor/trader holds these financial instruments for less than three years he will have to pay taxes as per individual income tax slabs.
Long Term Capital Gain
In the case of equity, if an investor/trader holds shares for more than one year then the profit he makes is considered as LTCG. Before 2018, investors did not have to pay any taxes on LTCG but at present, they are liable to pay 10% on profits exceeding one lakh. It means they still don’t have to pay any tax on LTCG of up to one lakh.
In the case of debt markets, if an investor/trader holds bonds, debentures, etc. for more than three years he will have to pay 20% tax on his gains.
It should be noted that there are indexation benefits for investments made in debt markets. In such cases, the taxable gains are calculated according to the Cost of Living Index provided by the government. None of the equity investments have indexation benefits.
Speculative Vs Non-Speculative Trading
The trading done without the intention of taking delivery is known as speculative trading. Intraday trading comes under this category. Any income from such an activity is considered speculative and shown under the head of business income. Since it is not treated as capital gain, hence taxed as a business income. This profit is added to the total income of retail traders and tax is paid as per individual tax slabs (refer to table below).
|Annual Income Slabs||Tax Rates for FY 2020-21|
|Up to 2.5 lakhs||Exempted|
|2.5 lakhs – 5 lakhs||5% (rebate u/s 87a available)|
|5 lakhs – 7.5 lakhs||10%|
|7.5 lakhs – 10 lakhs||15%|
|10 lakhs – 12.5 lakhs||20%|
|12.5 lakhs – 15 lakhs||25%|
|Above 15 lakhs||30%|
On the other hand, Futures and Options (F&O), Buy Today Sell Tomorrow (BTST), or Sell Today Buy Tomorrow (STBT), Equity investments for the long term are treated as non-speculative trading. Income from F&O is considered as non-speculative business income. Income from other activities mentioned above would be listed under the head of capital gain. It should be noted that in the case of BTST or STBT and short-term trading (holding period less than one year), frequency of trading would be considered as a deciding factor. If the frequency of trading is very high, then it will also be categorized as business income. In such cases, it is assumed that you are carrying out trading as a business activity and hence taxed accordingly.
Tax on Dividends
Companies regularly pay a sum of money from their profit to their shareholders. This sum is known as a dividend. Before 2020 companies deducted Dividend Distribution Tax (DDT) from dividends and pay the rest of the amount to the investors. The investors did not have to pay any tax on this income. But presently there is no DDT on dividends so this income is treated as income from other sources and investors are liable to pay tax on it as per their tax slab. Companies would still deduct a TDS of 10% on dividends if the sum is more than 5000 and pay the rest to the investor. This 10% would be deducted from your taxable income before arriving at net taxable income.
FIVE SMART WAYS TO SAVE ON YOUR TAXES
Set-Off Your Losses
Losses from Speculative trading can be set-off against speculative gains made during a year. An investor can carry forward such a loss for 4 years. Speculative losses can’t be set-off against non-speculative trading income.
Losses from Short Term Non-Speculative trading can be set-off against STCG as well as LTCG for the same year. However, losses from Long Term trading can be set-off against LTCG only. An investor can carry forward such losses for a period of 8 years.
Plough Back Your Profits
An investor can plow back his LTCG of up to one lakh. Say you invested capital of 5 lakhs and have a profit of one lakh on it by the end of one year. You can realize this profit after a full year. Since there is an exemption of up to one lakh profit from LTCG, you won’t have to pay any taxes. You can buy these shares the next day but this time your capital would be 6 lakhs. You can do it at the end of each year to plow back your profits while compounding your investments.
In the above example, say you did not plow back your profits then if by the end of two years your book a profit of 2 lakhs, you will be liable to pay LTCG on one lakh (remember that you don’t have to pay any tax unless you book your profit).
2lakhs (LTCG) – 1lakh (Exemption) = 1lakh (Taxable LTCG)
Book Your Short Term Losses
Now that we know that STCG can be set-off against STCG as well as LTCG for the same year. So it would be prudent to look for those loss-making stocks in your portfolio which have been bought during the current financial year and book loss on them before 31st March. By doing so you will have to pay less tax.
As an example, say you bought shares of companies A and B in May 2020. You are having a profit of 5 lakhs in A and a loss of 2 lakhs in B. If you book a loss of 2 lakhs before 31st March 2021 then you are setting off your losses in B against profit in A.
Net Taxable Gain = 5 lakhs (Gain in A) – 2 lakhs (Loss in B) = 3 lakhs
You can again buy those shares (of company B) back if you like after a couple of days.
It should be noted that you will be able to take advantage of the above provisions only if you file your income tax return on time as late submissions will make you ineligible to fetch these advantages.
Open Multiple Demat Accounts
If you want to reduce your taxes, then there is nothing wrong with opening multiple Demat accounts. You can open one or two Demat accounts on the names of your family members. This would reduce your tax burden to a great extent. On a single account, you get a tax rebate on an income of 2.5 lakhs but with two accounts this goes up to 5 lakhs. Also if you come under a higher tax slab but your spouse or another family member comes under a lower tax slab, then two Demat accounts will help in distributing the tax burden as some of the investments can now be diverted to the other account.
Take Advantage of Business Income Category
Now we know that income from speculative trading is considered as business income. It should also be noted here that whatever expenses have been incurred to carry out a business activity can be deducted from the speculative gains before calculating tax. For example, expenses such as broadband charges, computers, office rent, salaries paid, cost of books/subscriptions, depreciation of your conveyance etc. can be deducted from your business income to calculate net gains. This may reduce your tax liability. This provision is not there for LTCG or STCG as they are not considered as business income but capital gains.
Although an attempt has been made in this article to cover most of the basic elements related to trading income taxes, for an individual/retail trader, yet it’s always better to consult your financial advisor before filing an Income Tax Return.