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Edelweiss Insights Use capital losses smartly!

Use capital losses smartly!

Let’s find out how to reduce your taxes payable on these profits.
Edelweiss Feature Feb 20, 2019

You can reduce your taxes with some planning. Profits you make when you redeem your mutual fund investment are taxable in some cases. Let’s find out how to reduce your taxes payable on these profits.

Under the tax laws, capital gains or losses can be long term or short term depending on how long you stay invested. In case of debt funds, if you hold your investment for less than 3 years, the gains are short term capital gains. If you hold your investment for longer than 3 years, your gains are long term capital gains.

In case of equity funds, if you hold your investment for less than 12 months, the gains are short term capital gains. If you hold your investment for longer than 12 months, then the gains are long term capital gains. A balanced or hybrid fund is treated as an equity fund if equity forms at least 65% of its portfolio. If the equity component is lesser than 65%, it is treated as a debt fund.  

*Indexation increases your investment cost to adjust for inflation. This, in turn, reduces the taxable capital gains. In other words, it reduces the tax payable.

Use losses to reduce tax

The tax laws allow you to adjust losses you have made on your investments against capital gains. By doing this, your net capital gains are lower and therefore, you pay lesser tax. There are however, some restrictions:

  1. Long term capital loss can be set off only against long term capital gains (for example, long term capital loss incurred on a debt fund can be set off against long term capital gains earned on a debt fund investment).
  2. Short term capital loss can be set off against short term capital gains or long term capital gains (for example, short term capital loss incurred on equity shares or equity fund can be set off against short term capital gains earned on equity shares or equity fund or long term capital gains earned on a debt fund).

Here are some examples of how to set off your capital losses against capital gains:

 

(A)

(B)

(C)

(D)

Nature of capital gains/loss >>

Long Term Capital Gain

Long Term Capital Loss

Short Term Capital Loss

Short Term Capital Gain

 

Equity mutual fund (A)

Debt mutual fund (B)

Equity mutual fund (C)

Debt mutual fund (D)

Purchase date

1 December 2017

1 December 2015

1 December 2018

1 December 2018

Purchase NAV

Rs.100

Rs.100

Rs.100

Rs.100

Purchase cost

100,000

100,000

100,000

100,000

No of units

1,000

1,000

1,000

1,000

Redemption date

31 January 2019

31 January 2019

31 January 2019

31 January 2019

Redemption NAV

Rs.125

Rs.40

Rs.80

Rs.130

Redemption value

Rs.1,25,000

Rs.40,000

Rs.80,000

Rs.1,30,000

Capital gains/loss

Rs.25,000 (W)

(-) Rs.80,236^ (X)

(-) Rs.20,000 (Y)

Rs.30,000 (Z)

Set off capital loss

(-) Rs.25,000^

From the loss of Rs.80,236 (X), Rs.25,000 is set off against the gain of Rs.25,000 (W); hence, tax payable is NIL

Loss of Rs.25,000 set off against long term capital gains (W)

Balance loss of Rs.55,236 can be carried forward for 8 years to set off against future gains

Loss of Rs.20,000 set off against long term capital gains (Z)

 

(-) Rs.20,000 (short term capital loss set off (Y)

 

Taxable capital gains

Nil

NA

NA

Rs.10,000 (Rs.30,000 (Z) – Rs.20,000 (Y))

Tax payable

Nil

NA

NA

At rate applicable to the investor’s total income

^Based on cost inflation index (the government publishes a Cost Inflation Index (CII) table based on which the investor can inflate his cost of investment in debt funds; this helps lower the amount of capital gains/increases the capital loss for set off. CII is only available for investments in debt funds held for 3 years and above). Here is how the loss in Column B has been calculated:

CII number for FY18-19 = 280

CII number for FY15-16 = 254

Indexed cost: Rs.100 x Rs.280/Rs.254 = Rs.110.236

No of units = 1,000

Total indexed cost = Rs.1,20,236 (1,000 units x Rs.110.236)

Redemption value = Rs.40,000

Long Term Capital Loss = Rs.80,236 (Rs.90,000 – Rs. 1,20,236)

Note:

  1. Long term capital gains up to Rs.1 lakh are tax-free. The above example does not consider this clause.
  2. If the investor cannot set off all the capital losses incurred, he can carry forward the losses for 8 years to set off against future capital gains.
  3. Exit loads have been ignored.

Use your capital losses smartly to reduce the tax on your capital gains! To plan your taxes, seek professional guidance from your financial advisor.

 

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