We all want to make that extra money on the side, and if you really put your mind to it, you can make your ends meet. Do you think, the beggars on the road have no choice to make a living for themselves? They do have a choice. We giving them money, when they come to beg, is only encouraging them more, to continue begging. Even the road side vendors, may not have their shops registered or may not even pay income tax, two main reasons could be literacy and corruption. Literacy because, they wouldn’t know the importance of declaring their income and getting themselves registered and corruption because, if they get caught, they pay bribes to be let off the hooks. One way you can’t really blame them, because that is their only source of income and that is how they make their ends meet, they don’t have much of a choice. So basically everyone has needs, but what we are willing to do, to fulfill those needs, is what separates us from the beggars. Salary is not enough to make ends meet, as our demands keep on increasing. So what other choices do they have?
Well, there are many more ways to earn that extra income, it can be done through investments. You invest a certain sum of money in any investment instrument, and give it time to grow through the interest earned, in other words, your invested capital is being appreciated, this capital appreciation is also known as capital gains. We all know, where there is income, there is tax, some investments have more advantages over the other investments. Also, duration is one more important factor that decides,’ how much tax you pay’ and also if you have incurred a long term or short term capital gain. The longer the investment kept, the better it is for you, since you save more tax. Let us now look at how a short and long tern investment is categorized:
- Short term investment in case of Equity, debt and real estate: For equity, if the investment asset is held for less than 12 months and attracts gain, then it is considered as short term capital gain and will be taxed at a flat rate of 15% + educational cess at 3%.
For debt, real estate and physical gold, gold ETF, the short term capital gain will arise, only if the asset is held for less than 36 months and will be taxed according to their slab rates + educational cess at 3%.
- Long term capital gain in case of Equity, debt and real estate: If the investment is held for more than 12 months, the amount withdrawn will be tax free in the hands of the investor.
For debt, real estate and gold, the long term capital gain will arise, only if the asset is held for more than 36 months and will be taxed at 20% with indexation benefit + educational cess at 3%.
One more term that we need to understand before we move ahead is ‘Indexation Benefit’. What is indexation benefit? Say Mr. Paul bought a house 5 years back for Rs. 60 lakhs, he wants to sell his house now for Rs. 1 Crore, what will be the capital gain he earns? Now, I’m sure many of you will say Rs. 40 lakhs. But that’s wrong, because in those 5 years, the value of the house has also appreciated to say Rs. 80 lakhs, so Mr. Paul has made a capital gain of only Rs. 20 Lakhs. So indexation is a technique to adjust the income payments, through a price index and the benefit is given, just to maintain the purchasing power of the people, after taking inflation into consideration.
As you can see for your self, investing for a longer term is better than investing for a shorter term. Now let us look at the 5 categories, where you can incur long term capital gain and as we have already seen you can save maximum tax, when your capital assets are long term in nature:
This is a very risky type of investment, as it has direct exposure in the market. Under equity, there are again numerous instruments in which you can invest in, namely shares, mutual funds, etc. Since the risk is very high, the tax implication on equity investments is also very lenient. In fact, a person can save more tax, if they invest in equity and it could be tax free, if these investments are held for more than 12 months. However, there is only one equity mutual fund, which is known as Equity Linked Saving Scheme, which is available for deduction under section 80C. This fund’s lock in period is for 3 years, as it is the only fund available for deduction.
For example, If a person has invested in 100 shares for Rs. 50000/-, he now wants to sell off those shares for Rs. 80000/-, within 6 months from the date of purchase, he has attracted short term capital gain, so now he has to pay 15% + 3% on that profit of Rs. 30000/-. Let us say he has kept it for 12 months and wants to sell it now at Rs. 100000/-, the whole amount of Rs. 50000/- will be tax free in the investor’s hands.
This is a safer option as compared to equity funds in terms of risk, so the tax levied on debt instruments is also more as compared to equity investments. But the same logic of the holding period of the investments is applied here as well, the longer the investment held, more of your tax gets saved. Unlike equity investments, after 36 months of holding the investment, the amount withdrawn will not be tax free, but the person will get the indexation benefit. So once the indexation benefit is deducted from the sale consideration, 20% + 3% will be deducted from the remaining amount.
This is another asset, held by an individual, which can attract capital gains. If a person sells his house, the profit that he makes on the sale of his property will be taxed on, for how long he has held that property. Again if it is a short term capital gain, it will be taxed as per the individual’s slab rate. On the other hand, if it is a long term capital gain, then tax will be charged at 20% with indexation benefit + 3% educational cess. Now, an exemption on the long term capital gains is available under section 54. But to claim this deduction, the following has to be fulfilled:
- To claim this exemption, a residential property must be bought, it could be either old or new or constructed.
- To claim this deduction, only one house property can be bought and it should be in the name of the seller too.
- If the cost of the new property is less than the sale consideration, then the exemption will be allowed proportionately and to claim exemption for the remaining amount, you can invest them, within 6 months, in certain bonds which are available for exemption, under section 54EC.
- Also in case the builder does not hand over the property to the individual, within 3 years from purchase, the exemption will still be allowed.
- This property has to be situated in India, this deduction available cannot be claimed for properties bought or constructed out of India.
Please keep in mind that, if the long term capital gains are not invested in a new house property, before the date of tax filing or 1 year from the date of sale, then the same amount can be deposited in a Capital Gains Account, as per the Capital Gains Account Scheme, 1988. Also note that, if the property bought is sold before the completion of 3 years, then the exemption will be reversed and now the gains acquired from the sale will be taxed as short term capital gains. So like equity, in real estate also, there is a chance for your long term capital gains to be tax exempt.
This is a completely different category and the long term gains taxed, is also different from the rest. So if these bonds or debentures are sold before the completion of 12 months, then it falls under short term capital gains and will be charged as per the individual’s slab rate. However, if it’s sold after the completion of 12 months, then it is taxed at a flat rate of 10%. So again here, you have long term gains having the upper hand.
There are different ways in which people can invest through gold. Buying gold is a common way of investing in it. It is however, more of an asset than an investment. For gold, only after the completion of 36 months, will it be considered long term and will be taxed at 20% + 3% with indexation benefit. If it doesn’t complete 36 months, then it will be charged according to the individual’s slab rate. It is better not to hold gold physically, it is a more safer option to buy paper gold. Recently the Government has proposed that, Sovereign Gold Bonds, issued by the Reserve Bank of India, will be exempt from capital gains tax, but this proposal will come into effect only in April, 2017. Another exemption which has already come in to force, since April 2016 is, under Gold Monetisation Scheme, the deposit certificates issued, will also be exempt from capital gains tax.
Note: In case of SIPs, in mutual funds, each of your SIP has to complete, the relevant months to fall into the long term capital gain category. For example, SIPs in equity mutual fund, have to complete 12 months individually to be tax free. So if I invest Rs. 1000/- every month, starting from January 2016, then the SIP of January 2016 ONLY will complete 12 months in Jan 2017 and that amount plus the interest earned on it will be tax free (i.e. Rs. 1000 + interest amount). So February’s 2016 SIP will be tax free only in February 2017 and so on. In case of Equity Linked Savings Scheme, each SIP will have to complete 3 years.
So it’s very clear now, that the longer you stay invested, the better it is for you. It is very easy to dream, but the hard part is putting that dream into action, you have the above options to guide you also, what are you waiting for? We all crib about how we have to pay tax for all the incomes we earn; well now we have a choice to reduce that tax payment.