Income Tax India: Do we need to pay tax on Shares or Mutual Funds?

Summary:

If you hold Shares or Mutual Funds for more than one year, no tax is payable. This is assuming STT(Securities Transaction Tax) is applied on all your stock market transactions.
If you did not hold Shares or Mutual Funds for one year, profit becomes part of gross total income and normal tax rate applicable. If you have purchased stocks through ESOP (Employee Stock Exchange Program), you are liable to pay tax on profit because don't pay STT while purchasing stocks.


What if you have received loss in sale of shares?

Capital loss (short-term or long-term) can be set off against ONLY capital gains (short-term or long-term). You can ensure carrying forward of loss on sale of shares by filing tax return in time. The loss left over after set-off, can be carried forward for eight years in the case of short term assets and for four years in the case of long term assets, for similar set-off.

Do we need to pay tax on Dividend received from MFs or Shares?

Dividend income (as referred u/s 115-O of the I.Tax Act) paid by Companies and Mutual Funds are exempt from tax. A 15% dividend distribution tax and surcharge of 3% is paid by companies before distribution. Equity mutual funds (with more than 65% of assets invested in equities) do not pay a dividend distribution tax, though other funds do. Liquid and Money Market funds pay 25% dividend distribution tax.01123

Details:

Definition of capital asset :

Capital Asset means all moveable or immovable property except trading goods, personal effects, agricultural land other than within municipal areas or within 8 kilometers from it wherever notified and gold bonds. Jewelry and ornament are not personal effects and their sale will attract capital gains.

Distinction between short term and long-term asset:

Capital Assets are of two types i.e., long term and short term. Long-term capital assets are assets held for more than 36 months before they are sold or transferred. In case of shares, debentures and mutual fund units the period of holding required is only 12 months.  Different rates of tax apply for gains on transfer of the long term and short-term capital assets. Gains on short-term capital asset are taxed as regular income.

Computation of Capital Gains :

Capital gains are to be computed by deducting the following three amounts from the consideration money received on transfer of the asset.

i)     The actual cost of the asset or its estimated market value as on 1.4.81, if acquired earlier;
ii)    The cost of improvement, if any, for the asset;
iii)   Expenses incurred on transfer of the asset; and In case of a long-term capital asset, the costs are increased as per a Cost inflation index for the year.

Shares and Mutual Funds becomes 'long term capital assets' after one year of holding. Sale of such long term assets gives rise to 'long term capital gains'. As per 'Section 10(38) of Income Tax Act, 1961', long term capital gains on shares or securities or mutual funds on which Securities Transaction Tax (STT) has been deducted and paid, no tax is payable. STT has been applied on all stock market transactions since October 2004 but does not apply to off-market transactions and company buybacks; therefore, the higher capital gains taxes will apply to such transactions where STT is not paid.


For companies abroad, the tax liability is 20% of such gains suitably indexed (since STT is not paid).

All capital gains that are not long term are short term capital gains, which are taxed as such:

- Under section 111A, for shares or mutual funds where STT is paid, tax rate is 10% From Asst Yr 2005-06 as per Finance Act 2004. For Asst Yr 2009-10 the tax rate is 15%.
- In all other cases, it is part of gross total income and normal tax rate is applicable.

Exemptions from Capital Gains (such as sale of residential house) :

In case of Individuals and HUF, long-term capital gains are exempt if the sale proceeds are reinvested in certain assets.
Some examples:
A)        Profits on sale of residential house is reinvested in a new residential house.
B)         Long term capital gains are invested in notified bonds
These exemptions are subject to certain conditions and the reinvestment has to be made within the prescribed time.


FAQs from www.incometaxindia.gov.in about 'What if you have received loss in sale of shares?' :

WAT IS THE LAW ON SET OFF OF LOSS ON SALE OF SHARES?
    Capital loss - short-term or long-term, can be set off only against capital gains - again, short-term or long-term. Obviously would first offset capital loss against short-term gains as these are taxed at higher rates. Remember, capital loss cannot be set off against other income.

WHAT IS THE LAW ON CARRY FORWARD OF LOSS ON SALE OF SHARES?
    The loss left over after set-off, can be carried forward for eight years in the case of short term assets and for four years in the case of long term assets, for similar set-off.

HOW TO ENSURE CARRYING FORWARD OF LOSS ON SALE OF SHARES?
   By filing your tax return in time.



Further Information and References:
-----------------------------------------
http://en.wikipedia.org/wiki/Income_tax_in_India
http://www.incometaxindia.gov.in/general/computation.asp#c3
http://www.incometaxindia.gov.in/publications/1_Compute_Your_Salary_Income/3_Income_from_capital_gains.asp