Unlimited income, zero tax. That's right... That's the magic of long-term capital gain from equity shares. Noted investment expert, N J Yasaswy suggests two approaches to profit from this tax haven. And, how to spread the joy of tax-free gains to your entire family.
Tax planning through long-term capital gains from equity shares
Shares held for more than 12 months are treated as long-term capital assets. Long term capital gains arising out of securities sold on the stock exchange are exempt u/s 10(38).
Thus, equity shares of well managed companies afford excellent opportunities for tax planning through long term capital gains. The only condition is that you should sell your shares after holding them for 12 months, or more.
Otherwise your gains will be taxed as short term capital gains. With the insertion of a new Section 111A, short term capital gains arising from the sale of securities are taxable at the rate of 15 per cent, plus relevant cess.
Please note, however, that Securities Transaction Tax at the rate of 0.125 per cent is to be levied on the value of all transactions of purchase of securities that take place in a recognized stock exchange in India. But in the context of our discussion here, this is but a marginal irritant.
Mr. Kapoor purchased 1,000 equity shares of ABC Ltd. in July 2008 at Rs. 600 per share and sold them in June 2009 at Rs. 3,000 per share.
June 2009 Sale Value Rs. 30,00,000
July 2008 Cost of Acquisition Rs. 6,00,000
Short- term Capital Gains Rs. 24,00,000
Capital Gains Tax @ 15% Rs. 3,60,000
Cess @ 3% (for the AY 2010-11) Rs. 10,800
Total Tax Payable Rs. 3,49,200
Now, if the above shares had been held for two more months and sold in the month of August 2009, or there after, Mr. Kapoor would have had to pay ZERO CAPITAL GAINS TAX , instead of nearly Rs 350,000 as in the above example, since long term capital gains arising from equity are tax exempt without any upper limit.
From the perspective of tax planning it is better to invest in shares based on their potential for capital appreciation over a period of at least 13 months rather than selling within 12 months. That one extra month opens up the doors to India's biggest tax-free haven. If you can hold the shares for a longer period it is even better.
Tax planning through established growth stocks
Investing in established growth stock is even more beneficial because the power of compounding also works in your favour. Typically, an established growth oriented company ploughs back its profits to earn more profits. This implies that the return is not only on the amount invested but also the return on the principal, i.e., return on return. The longer the time horizon of the investment, the more the investment appreciates.
Since one invariably invests in established growth stocks more for long-term growth and less for current income, there is scope for considerable tax planning through such growth stocks. Thus, if you can hold such stocks for a longer period, you are exempt from tax on long term capital gains. The longer you hold these assets, the more the benefit. Let us see how with the help of a simple Example 2.
Mr. Q has Rs.1,00,000 available for investment in established growth stocks in 2008 and would like to invest his money in such a way that it yields an annual compounded return of 30% per year in the next 10 years. Mr. Wizard, an investment consultant assures him that this is possible through established growth stocks.
His family includes Mrs. Q (wife), Master Q (minor son aged 10) and Ms. Q (minor daughter, aged 8). As of now, his wife, son and daughter are not assesses.
Mr. Q should loan Rs.50,000 to his wife, Rs.25,000 to his son and Rs.25,000 to his daughter, the loans carrying a simple interest @10% p.a. as far as possible, the portfolios should not be shuffled during the 10-year period to get maximum advantage of tax-deferment. Unless you sell shares and realize your profits, there is no liability towards capital gains.
Thus, at the end of 10 years, the portfolios of wife, son and daughter will be as shown below:
Wife Son Daughter
Rs. Rs. Rs.
2008-Value 50,000 25,000 25,000
2018-Value with compounded growth rate of 30% p.a. 6,89,000 3,44,500 3,44,500
Less: Loan & Interest @10% p.a. (simple) 1,00,000 50,000 50,000
Net Value in year 2018 5,89,000 2,94,500 2,94,500
In the year 2018, a part of their portfolios will be sold by Mr. Q's wife, son and daughter to Mr. Q to settle his loan with interest.
With the help of such a plan, in the year 2018, Mr. Q's wife will own a portfolio of Rs.5,89,000, his son and daughter (by then, majors) portfolios of Rs.2,94,500 each.
The exact value of these portfolios may vary, depending upon specific tax planning to be done from year to year, the growth rate of portfolios and the future tax structure, etc.
Let us ignore the specific numbers because they have been indicated more by way of an example. Let us, instead, understand the key points which emerge in relation to tax planning through growth stocks:
- Lend money to non-assessees (or assesses with lower income levels) in your family at around 10% p.a. simple interest.
- The family members should invest the funds in selected growth stocks which can generate impressive growth in value in the next 10 years.
- Do not sell the shares during the 10 years.
- At the end of 10 years, repay the loan and interest by transfer of shares.
- After a year or so, the shares obtained by way of repayment of loans can be gifted to son and daughter (who would be majors by that time) without attracting the clubbing provisions.
Please note that the 10-year period is only indicative, it could be 5, 7, or 12-years.
It may be possible to improve upon this plan depending on the specific issues involved in each case. You would be well advised to seek expert advice on this.
(Excerpt from Personal Investment & Tax Planning Yearbook (F.Y. 2009-2010) by N J Yasaswy. Published by Vision Books.)
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