What do we understand by tax shelter on equities - Motilal Oswal
What do we understand by tax shelter on equities - Motilal Oswal

What do we understand by tax shelter on equities?

Why are equities attractive? Of course, they create wealth over the long run, but they also have one more important factor going for them. They provide tax shelters. What do we understand by tax-shelter investments and what are the types of tax shelters that equity investing provides. Of course some of the common tax shelters on equities pertain to investing, receiving dividends and booking profits. Let us understand this with some tax shelter examples..

The tax shelter on dividends declared by equities..
This is the first tax shelter that is available to equity investors. If you are invested in a stock and the stock declares dividend then that dividend is entirely tax free in your hands. Effective, the Union Budget 2016, there is a small change. The dividends in excess of Rs.10 lakh in the hands of an individual will be taxed at 10%. Here is how the working will look like..

ParticularsInvestor AInvestor BValue of ShareholdingRs.5.75 croreRs.4.50 croreTotal equity dividends (FY-18)Rs.9,20,000Rs.11,85,000Tax payable above Rs.1 millionNil10% of Rs.1,85,000Actual tax on dividendNilRs.18,500


As we can see in the case of Investor B, since his dividends for the full year exceed Rs.1 million, he pays 10% tax on the excess as dividend tax. One way to overcome this issue will be to focus more on low dividend yield stocks. As you can see in the above case, the portfolio value of Investor A is much higher but since he has chosen low dividend yield stocks, he is not required to pay dividend tax. On the other hand, Investor B pays dividend tax despite a lower value of portfolio due to his focus on high dividend yield stocks.

Using the tax shelter of write-off and carry forward of short term capital gains..
You are aware that short term capital gains tax is levied on equities at 15% if held for less than 1 year. However, if there is a short term capital loss then what happens? There are two things you can do in this case. If you have short term capital gains then you can write off these losses against those profits and you have to pay the tax only on the reduced profits. Alternatively, if you do not have enough profits to write off your short term capital losses then you can carry forward these losses for a period of 8 years and write them off against your profits at any time in the future. Both set-off of losses and carry forward offer important tax shelters to equity investors.

How to get tax shelters now that LTCG is taxed above Rs.1 lakh per annum?
In the Union Budget 2018, the government imposed 10% tax on long term capital gains held for more than 1 year if the equity capital gains exceeded Rs.1 lakh per annum. That means if you are mid to large sized investor then your long term capital gains are now likely to be taxed. Here is how you can claim tax shelters from LTCG tax..

The current budget announcement of tax announcements gives you the window to book profits and exit your positions free of tax before March 31st. That is a shelter you must utilize. You can also take a fresh view of what to do with the money. But you can at least book your profits free of tax till March 31st this year.

Just as long term capital gains are taxable, long term losses can also be set off.  Hence if you have long term capital losses, it makes sense to use these as shields against your profits. You will pay 10% tax only on the net capital gains so you can make full use of your accumulated losses.

You can plan your profit booking accordingly to just sweep up to Rs.1 lakh per annum and postpone the remaining profits to the next year. This way you can avoid the tax burden. Of course, you need to pay tax only on the net capital gains and you can plan your bookings accordingly.

Selling IPOs could be a good option for you even after March 31st. The LTCG tax stipulation only covers those stocks on which have paid STT. Since there is no STT paid on IPOs, they will not attract the 10% LTCG tax and you need not be in a hurry to book profits on them.

There are more complicated methods like buybacks which can be used to gain tax shelters from dividend tax and from capital gains tax. Investors must look at these tax shelters in detail before investing in equities and equity funds.
 

Ready to invest with us?

Share your Name and Mobile Number with us and get started

  • +91|
scrollToTop