|Sources of Income|
|Types of income: Capital gains and dividend income|
|Capital gains: Profit earned when a capital asset is sold at a price higher than its cost of acquisition|
|Dividend income: Profit distributed by a company to its shareholders|
|Taxability of income: discussed in detail in the following paragraphs|
|Dividend: Distribution of profits by a company to its shareholders|
|Date of receipt: Not material in the case of final dividend|
|Interim dividend: Chargeable to tax on receipt basis|
|Tax treatment: Depends on whether the dividend is received from a foreign or domestic company|
|Place of accrual: Dividend payable by an Indian company is deemed to accrue or arise in India|
|Tax on dividend: After the abolition of Dividend Distribution Tax, dividend income is taxable in the hands of shareholders or unit-holders|
|Profit arising from the sale of a ‘capital asset’ is chargeable to tax as a capital gain|
|Income from capital gains is computed by deducting the full value of consideration from expenses incurred and cost of acquisition/improvement|
|Exemption under Sections 54 to 54GB to the extent of the net result of above calculation|
|Long-term capital gains: Taxable at concessional rates of 20% or 10%|
|Short-term capital gains: Generally added to total taxable income and are chargeable to tax as per the applicable tax rate|
|Topic: Tax on Inter-corporate Dividend|
|– Dividend from companies taxed to shareholders|
|– Section 80M introduced to remove cascading effect|
|– Inter-corporate dividend reduced from total income|
|– Dividend income from foreign company taxed at 15%|
|– Tax computed on gross amount of dividend|
|Topic: Period of Holding for Listed Equity Shares|
|– Gains treated as long-term/short-term capital assets|
|– Short-term: held for not more than 12 months|
|– Securities sold through broker date considered|
|– Securities sold directly, contract date considered|
|– Securities held in demat form determined by FIFO|
|Topic: Securities held in Demat Form|
|– FIFO method for determining period of holding|
|– Securities first in demat account first to be sold|
|– Contract note/Broker’s note considered for period|
|– Multiple accounts, FIFO method applied account-wise|
|– Old physical stock dematerialized, FIFO based on date|
Tax on Long-Term Capital Gains as per Section 112A
|Taxability||Rate of Tax||Applicability|
|Exemption Limit||Nil||When the aggregate long-term capital gains during the year are less than or equal to INR 1,00,000.|
|Concessional Rate||10% + applicable surcharge and cess||When the aggregate long-term capital gains during the year exceed INR 1,00,000.|
|Conditions for Concessional Rate||Securities Transaction Tax (STT) must be paid at the time of acquisition and transfer of equity shares, except in certain specified cases.||If STT is not paid, the concessional rate of tax is not available. However, the CBDT has relaxed this condition in certain cases.|
|Cost of Acquisition||Higher of Actual Cost or Lower of Fair Market Value (FMV) as on 31-01-2018 or Full Value of Consideration||Applicable for equity shares acquired on or before 31-01-2018.|
|Cost of Acquisition – Bonus Shares||Computed in the same way as equity shares, if the conditions prescribed in Section 112A are met.||Applicable for bonus shares.|
|Cost of Acquisition – Equity Shares||Actual cost for which it is acquired by the assessee.||Applicable for equity shares acquired on or after 01-02-2018.|
|Cost of Acquisition – Shares Acquired before Listing||FMV of shares = Cost of acquisition x CII of 2017-18 (i.e., 272) / CII for the year in which shares were first held by the assessee (or previous owner) or 2001-02, whichever is later.||Applicable for equity shares listed on a recognized stock exchange at the time of transfer but not listed at the time of acquisition.|
Tax on Long Term and Short Term as per sections 112 & 111A
|Topic||Tax on long-term capital gain||Tax on short-term capital gain|
|Rate||20% (10% with indexation)||15% (concessional rate)|
|Applicable to||Equity shares||Listed equity shares|
|Benefit of indexation||Available||Not available|
|FPIs||10% (without indexation)||Not applicable|
|Deduction allowed||Not allowed||Not allowed|
|Additional taxes||Surcharge and health & education cess||Securities transaction tax (if applicable) or transaction in foreign currency on recognized stock exchange located in an International Financial Services Centre.|
Taxes on Unlisted Shares-
|Tax Treatment of Unlisted Equity Shares||– Tax treatment depends on whether gains are long-term or short-term.
– Unlisted shares held for less than 24 months are treated as short-term capital assets.
– Unlisted shares held for more than 24 months result in long-term capital gains.
– Sale consideration is determined as per section 50CA if less than fair market value.
|Tax on dividend from unlisted shares||Taxability is the same as in case of listed equity shares.|
|Tax on long-term capital gains from unlisted shares||Taxable at 20% plus surcharge and health & education cess. Indexation benefit available to resident taxpayers, but not to non-residents.
– Tax treatment is same even if shares are sold over the counter.
|Tax on short-term capital gains from unlisted shares||Taxable at normal slab rate.
– FPIs are taxed at a flat rate of 30%.
– No deduction under Chapter VI-A allowed.
|Tax treatment of Capital Gains when unlisted shares sold after listing on recognised stock exchange||Shares allotted through Initial Public Offer (IPO) may not have paid STT.
– Shares sold on the stock exchange are subjected to STT.
– Transactions are governed by section 112A and taxed at 10% plus surcharge and cess.
Tax Treatment of Preference Shares
|Definition||Shares with priority rights over ordinary dividends|
|Preference share capital||Part of issued share capital with preferential rights|
|Tax on dividend||Same as equity shares|
|Tax on long-term capital gain||Listed shares held > 12 months: 10% without indexation or 20% with; unlisted shares held > 24 months: 10% without indexation or 20% with|
|Tax on short-term capital gain||Listed shares sold/redeemed < 12 months: normal rate; unlisted shares sold/redeemed < 24 months: normal rate; FPIs: flat rate of 30%|
|Conversion to equity shares||Not regarded as transfer; cost of acquisition and holding period of preference shares added to equity shares|
|Example||Mr. X: Listed preference shares sold after > 12 months|
|Option 1: 20% tax rate with indexation|
|Option 2: 10% tax rate without indexation|
|Tax saving: Rs. 75|
Tax Treatment for GDR/ADR
|Definition||Depository receipts or certificates issued by overseas depository banks against the issue of ordinary shares or FCCBs of Indian issuing company||US dollar-denominated stock that represents equity ownership in a non-US company|
|Markets||Euro market and US market||US market|
|Listing||London Stock Exchange, New York Stock Exchange, American Stock Exchange, NASDAQ, Luxemburg Stock Exchange etc.||US stock exchanges|
|Dividend income||Concessional rate of 10% under section 115AC of the Income-tax Act.||Concessional rate of 10% under section 115AC of the Income-tax Act.|
|Long-term capital gain||Exempt from tax under section 47 for transfer between two non-resident persons. Capital gain arising from transfer by a non-resident liable to tax at 10% if gains are long-term. 20% tax rate for others.||Exempt from tax under section 47 for transfer between two non-resident persons. Capital gain arising from transfer by a non-resident liable to tax at 10% if gains are long-term. 20% tax rate for others.|
|Short-term capital gain||Taxable at normal rates. FPIs taxed at 30%.||Taxable at normal rates.|
|Capital gain on conversion||Capital gain is computed by reducing the cost of acquisition/indexed cost of acquisition of GDRs from the value of shares.||Capital gain is computed by reducing the cost of acquisition/indexed cost of acquisition of ADRs from the value of shares.|
Tax Treatment of Shares Warrants
|Conversion of warrants||Short-term capital gains taxed at applicable rates|
|into shares||Full value of consideration = fair market value on conversion|
|FPIs taxed at 30% + surcharge and health & education cess|
|Transfer of warrants||Short-term capital gains taxed at applicable rates|
|to another person||Full value of consideration = sum received from buyer|
|FPIs taxed at 30% + surcharge and health & education cess|
|Forfeiture of premium paid||No tax treatment, loss ignored for calculation of taxable income|
- Share warrants are options issued by companies that give the warrant holder the right to subscribe to equity shares at a predetermined price and time period.
- The strike price is the price at which the warrant becomes exercisable, and the warrant holder must pay at least 25% of it upfront.
- The tenure of share warrants cannot exceed 18 months from the date of their allotment.
- If the warrant holder does not exercise the option to take equity shares within 3 months from the payment of full consideration, the consideration made for the warrants shall be forfeited.
- Transactions possible with share warrants include conversion into shares, transfer to another person, and forfeiture.
- The conversion of share warrants into shares is treated as a transfer of share warrants and is subject to short-term capital gains tax.
- The resultant capital gains arising from conversion will always be deemed as short-term capital gains and taxed at applicable rates.
- The full value of consideration is the fair market value of shares on the date of conversion of warrants into shares.
- The transfer of share warrants to another person is subject to short-term capital gains tax.
- The resultant capital gains arising from transfer will always be deemed as short-term capital gains and taxed at applicable rates.
- The full value of consideration is the sum received from the buyer of the warrant.
- If the warrant holder is an FPI, the tax rate is 30% plus surcharge and health & education cess under Section 115AD.
- Loss arising from the forfeiture of the premium paid for share warrants has no tax treatment and is ignored for the calculation of taxable income.
Tax Treatment of Mutual Funds
|Mutual Funds||Funds that collect money from investors and invest the same in the capital market for their benefit. Managed by Asset Management Company through fund managers. Registered with SEBI.|
|Equity Oriented Funds||Mutual funds that invest more than 65% of their corpus in equity and equity-related securities.|
|Fund of Funds (FoF)||Mutual fund scheme that invests in other schemes of mutual funds. Minimum 90% of the total proceeds of such fund is invested in the units of another fund.|
|Equity Linked Saving Scheme (ELSS) Funds||Category of mutual funds that encourage long-term equity investments. Tax-deductible investment in equity-based mutual funds. Has a compulsory lock-in period of 3 years.|
|Systematic Investment Plan (SIP)||Mutual fund tool that allows investors to enter the stock market by investing a fixed amount of money in a particular mutual fund at every stipulated time period.|
|Systematic Withdrawal Plan (SWP)||Plan used to redeem the investment from a mutual fund scheme in a phased manner. The opposite of SIP. Pays investors a specific amount of payout at pre-determined time intervals.|
|Systematic Transfer Plan (STP)||Plan that allows the investor to transfer amount from one scheme to another scheme of the same mutual fund house. Transfers a fixed amount of money from one mutual fund to another.|
Taxation of Mutual Funds
|Capital Gains||Profit arising from redemption or sale of units of mutual fund.|
|Tax on dividend from equity-oriented mutual funds||Income distributed by mutual funds to a resident unit-holder is taxable in his/her hands as per applicable tax rates.|
|Tax on long-term capital gains from equity-oriented mutual funds covered under section 112A||Long-term capital gains are taxable at 10% if they exceed Rs. 1 lakh. The period of holding should be more than 1 year. No indexation benefit is available.|
Tax Treatment of Derivatives-
|Tax Treatment of Derivatives||–||Derivatives are financial products whose value is derived from real assets. Trading in derivatives is popular among stock market investors.|
|Futures & Options (F&O)||– Future contracts: buying or selling underlying security or index or commodity, at a specified price on a future date.|
|– Option contracts: gives the right but not the obligation to buy or sell the underlying asset on or before a specific date at a stated price.|
|– Derivative transactions are not treated as speculative if carried out through recognised stock exchanges via registered intermediaries.|
|Types of Derivative Contracts||Futures Contracts||– Agreement between parties to buy/sell underlying assets at a fixed price in the future.|
|Options Contracts||– Two types: Call option (buy asset by a certain date for a certain price) and Put option (sell asset by a certain date for a certain price).|
|Forward Contracts||– Customised contracts between two parties to settle on a specific date in future at a predetermined price.|
|Swaps||– Private agreements to exchange cash flows in the future.|
|– Interest rate swaps: swapping interest related cash flows.|
|– Currency swaps: swapping principal and interest between parties with cash flows in different currencies.|
|Currency Derivatives||– Exchange-based futures and options contracts that allow hedging against currency movements.|
|– Used by corporates with significant exposure to imports/exports.|
|Interest Rate Derivatives||– Derivative contract with value derived from benchmark interest rates or interest rate indexes.|
|– Traded on recognized stock exchanges or over-the-counter (OTC).|
|Commodity Derivatives||– Contract to buy or sell a commodity at a preset price for delivery on a future date.|
|– Commodities Transaction Tax (CTT) introduced in 2013 on non-agricultural commodities.|
|– Trading regulated by Securities Contract (Regulation) Act, 1956 (SCRA) and conducted on national and regional commodity exchanges.|
|Nature of Derivative Income|
|– Gains or losses from F&O trading are taxable under PGBP|
|– Speculative and non-speculative income treated differently|
|– Loss from speculative transaction can only be set-off against|
|– Certain derivative transactions excluded from speculative|
|– FPIs’ derivative income taxed as capital gain|
|Computation of Turnover|
|– Total of favourable and unfavourable|
|differences considered as turnover|
|– Premium received on sale of options|
|included in turnover|
|– Difference on reverse trades included|
|Scheme of Taxation|
|– F&O income can be taxed under normal or presumptive scheme|
|– Presumptive scheme applicable for turnover < Rs. 2 crores|
|– Profit declared at 6% or 8% of turnover|
|– No further expenses allowed or disallowed|
|Set-off and Carry Forward of Losses|
|– F&O losses can be set-off against income from other heads|
|– Business loss cannot be set-off against income from salary|
|– Unabsorbed loss can be carried forward up to 8 assessment years|
|– Loss can be set-off only against business income|
|– Return of income must be filed on or before the due date|
- Dividend stripping is a tax evasion strategy used by investors in securities and mutual fund units to reduce their tax liability.
- It involves buying securities or units just before the record date for dividend distribution and then selling them at a lower price after receiving the dividend, incurring a short-term capital loss.
- The investor gets tax-free dividend income and can set off the short-term capital loss against any other capital gain.
- To curb this practice, Section 94(7) was inserted in the Income-tax Act, which ignores the loss arising from such purchases and sales to the extent that it does not exceed the dividend income received.
- However, with the Finance Act 2020 abolishing the provisions of dividend distribution tax, any dividend income received after 01-04-2020 is not exempt from tax, making dividend stripping redundant from that date.
Bonus stripping is a practice where an investor buys mutual fund units just before the record date to receive bonus units and sells the original units at a price lower than the purchase price after the record date, incurring a short-term capital loss. To discourage this practice, the Income-tax Act has Section 94(8), which states that if a person acquires mutual fund units within three months before the record date and is allotted bonus units on that date, any loss arising from the transfer of the original units will be ignored for tax calculation if the person transfers those units within nine months after the record date while holding all or some of the bonus units.
The amount of loss ignored will be deemed to be the cost of acquisition of the bonus units held by the investor on the date of the transfer of the original units. Here’s an example:
Example: Mr. Ravi purchased 1,000 equity-oriented mutual fund units at Rs. 106 per unit on 01-07-2019. On 01-09-2019, the mutual fund declared a 1:1 bonus unit allotment, meaning that for every unit held, Mr. Ravi received one bonus unit. After receiving the bonus units, Mr. Ravi sold the original 1,000 units on 01-04-2020 at Rs. 95 per unit.
Solution: As Mr. Ravi sold the original units within nine months after the record date and continued to hold the bonus units, any loss on the sale of the original units would be ignored for tax calculation. The loss on the sale of the original units is Rs. 11,000, and the cost of acquisition of the 1,000 bonus units is deemed to be Rs. 11,000, so the per-unit cost of the bonus units is Rs. 11.
Benefits not allowed from Capital Gains
|Type of Capital Gain||Benefits not Allowed|
|Long-term capital gain chargeable to tax at 20%||No deduction under Sections 80C to 80U|
|Long-term capital gain chargeable to tax at 10%||No benefit of indexation, no computation in foreign currency, no deduction under Sections 80C to 80U, no Section 87A rebate|
|Short-term capital gain chargeable to tax at 15% (section 111A and 115AD)||No computation in foreign currency, no deduction under Sections 80C to 80U|
Note that the benefits not allowed depend on the type of capital gain and the applicable section of the Income-tax Act. For example, long-term capital gain chargeable to tax at 10% (section 112A) from the transfer of specified listed securities does not allow for the Section 87A rebate.
Adjustment of Exemption Limit from Capital Gains:
- The exemption limit for a resident individual or HUF is not chargeable to tax up to a maximum limit.
- If the total income of a resident individual or HUF (excluding long-term capital gains referred to in Section 112 and 112A or short-term capital gains covered under section 111A) is less than the maximum exemption limit, the amount of such capital gains shall be reduced by the amount that would enable the individual or HUF to fully claim the maximum exemption limit.
- For example, if the total income of a resident individual is Rs. 1,85,000 (excluding long-term capital gains) and the long-term capital gain from the sale of unlisted shares is Rs. 2,50,000, the tax shall be computed on Rs. 1,85,000 after reducing the long-term capital gain by Rs. 65,000.
- In the case of Mrs. R, a resident and ordinarily resident, who purchased a listed equity share worth Rs. 1,00,000 in June 2019 and sold it in January 2021 for Rs. 2,60,000, her long-term capital gain on listed equity shares is Rs. 1,60,000. As her total income (including interest income of Rs. 25,000) is below the minimum chargeable limit of Rs. 2,50,000, she does not need to pay any long-term capital gains tax.
- However, if Mrs. R were a non-resident, she would not be eligible for the exemption limit. Therefore, she would need to pay tax on the long-term capital gains exceeding Rs. 1,00,000 at the rate of 10% as per section 112A, plus cess at 4%.
|Resident/Non-resident||Eligibility for Exemption Limit||Tax on Long-term Capital Gains|
|Resident||Eligible if total income is less than maximum exemption limit||Not applicable if total income (including capital gains) is below the minimum chargeable limit; otherwise, tax shall be computed after reducing the long-term capital gain by the amount that would enable the individual or HUF to fully claim the maximum exemption limit.|
|Non-resident||Not eligible||Tax on long-term capital gains exceeding Rs. 1,00,000 at the rate of 10% as per section 112A, plus cess at 4%.|