Long term capital gains & STT

Many retail investors are looking to take advantage of the soaring indices by selling their stock and mutual fund holdings. They are doing this to not only book profits but also to try and adjust such profits against any loss making investment thereby minimizing the tax on capital gain.

In fact last week a client who has become a good friend emailed me some questions on this topic. Since his queries encompass a number of issues relating to capital gains and losses and the tax treatment thereof.

Admittedly the topic is a bit technical but if you if you stay with it would be of immense benefit for your tax planning.

I understand long tern capital gains (LTCG) on shares and equity mutual funds (MFs) are exempt from tax provided securities transaction tax (STT) has been paid on the transaction. LTCG is payable at the rate of 10% or 20% with cost indexation which ever is lower. Also, on assets other than shares and equity MFs, LTCG is payable either at 10% or 20% as the case may be. Am I right on this?

Say during the current year one incurs some long term capital loss (LTCL) and LTCG on various sale transactions of equity shares. Can the LTCL be set off against LTCG? If not then what can be done about such LTCL?

Also advise if setting off is permitted against any other income – sat short term capital gain (STCG) or salary or business income, if for any reason the loss cannot be set off fully can it be carried forward to next year for a possible set off?

Lastly, for most of my mutual fund investments, I had chosen the dividend option. Now, if I were to switch to the growth option, will there be any tax incidence? There is no tax for such switching in unit linked insurance plans of insurance companies. Is similar tax exemption available to MF switches?

Your understanding contained in the first point above is perfect. Any LTCG arising out of sale effected on after October 1, 2004 of equity shares is tax exempt provided such transaction has taken place on a recognized stock exchange in India and the investor has borne the STT. The LTCG earned from sale of units of equity oriented MF schemes is also exempt from tax:

Therefore to summarize –

1) LTCG is exempt and consequently not available for set off of LTCL or STCL or the carried forward losses of yesteryears.
2) As a corollary LTCL is also exempt and cannot be set off against LTCG
3) STCG earned shall be charged to tax @ 15% flat;
4) LTCL was never allowed to be set off against STCG either before for after October 1, 2004.
5) STCL can be set off against any STCG, or taxable LTCG (say on non equity units or property etc).

The point regarding set off requires further discussions. The Income Tax Act draws a boundary around capital gain incomes and losses. In other words, capital losses can only be set off against capital gains – other incomes like salary or business income cannot be used for set off. Now, LTCL can only be set off against taxable LTCG. However, STCL can be set off against both STCG as well as taxable LTCG. This rule existed much before the exemption to LTCG was brought in. The reason is that setting off long term loss against short term gains created a sort of tax arbitrage since STCG is taxable at a higher rate (30% in most cases) than LTCG. Therefore it has been provided by the law that LTCL shall only be set off against taxable LTCG while STCL may be set off against both taxable LTCG as well as STCG.