At a fundamental level, we can grow our wealth by either saving more money or earning more money. One of the most popular ways that salaried professionals save in India is by investing in tax saving instruments. Majority of us, especially, in the first couple of years just think about the saving part and all the research is around the multiple tax savings instruments. You know the ones, Section 80C, House Rent Allowance, Leave Travel Allowance etc.
However, there are other tax saving avenues which we overlook, and they are the ones that really can make the difference. Let us pick one such category that is not usually considered but can be a great source of tax savings. You must have heard the term capital gains? It is the profits we earn through sale of capital assets like stocks, mutual funds, gold, property etc. For taxation purposes, the capital gains are classified as Long-Term Capital Gain and Short-Term Capital Gain depending on the holding period of the capital asset.
The minimum holding period for each of the capital assets for the gains to be classified as long term is as follows:
(a) Stocks and Equity Funds: 1 Year
(b) Debt Oriented Funds: 3 Years
(c) Gold ETF’s and Gold Funds: 3 Years
(d) Immovable Property: 2 Years
Now for the interesting part, tax rates for capital gains are different, based on how they are classified. if you understand and apply the concept explained below, you will accrue tax savings potentially in lakhs over your working life.
For example, consider two individuals Shruti and Amit, both in the highest income tax bracket of 30%. Shruti has a long-term view and usually does not touch her investments and Amit always looks to time the market. It is April 1, 2018, both Shruti and Amit have surplus income of Rs 10 Lakhs to invest and they decide to invest all of it in equity mutual funds. For simplicity, let us assume that both of them invest in exactly the same set of funds.
In the next 11 months, the amount invested grows to Rs 11 lakhs. Shruti does not touch the money but Amit lured by the gains in his investment, redeems all the funds and pockets the gain. Since Amit sells before 12 months, his gain is treated as a ST Capital Gain. The tax outflow for Amit is Rs 15,000 (15% of the Rs 100,000 gain for equity). In the example, the after- tax returns for Amit works out to 8.5% (Gain of Rs 85,000 on Rs 10 Lakhs) but had he sold after April 1, 2019 i.e. after a year of holding, his returns would have been 10% (Gain of Rs 100,000 on Rs 10 Lakhs) a full 1.5% more or Rs 15,000 in absolute terms. This is because the gains are treated as Long Term and as a result, the tax outflow is 0% (LT capital gain tax of 10% is applicable only if the gain is above 1 lakh).
An extra return of 1.5% for an additional month of holding is pretty significant to overlook especially, if the amount invested is high. However, an oversight on our part does happen especially, if we have a lot of asset classes to track and do not have the time to either record or review all the transaction dates.
Although, we have taken an example of equity funds above, the same logic applies to the other asset classes like gold, real estate and debt funds. In fact, the impact would have been even more significant for the latter as the short-term capital gains on these assets is taxed at your current tax slab rate which in all probability is 30%.
In conclusion, though we should definitely continue to save our hard-earned money by leveraging the popular tax savings instruments, we should also be mindful of the other avenues of saving taxes. Particularly, the opportunity to save taxes by holding on to our capital assets long enough for the capital gains to be classified as long term.
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