How Capital Gains Tax on Shares and Mutual Funds Is Calculated in India

What exactly is a capital gain?

The easiest way of looking at it is that a capital gain is the profit obtained when an investment is sold at a price higher than its relevant cost.

When shares which cost ₹1,50,000 are sold at ₹2,00,000 the amount of gain is ₹50,000.

It doesn't necessarily mean that the amount subject to tax is ₹50,000; other elements can affect the calculation such as deductible expenses and the presence of capital losses from other transactions.

The next step is to look at the length of time for which the investment was held.

Holding period changes the tax treatment

The one-year milestone is important for listed equity shares and equity-oriented mutual funds.

An investment which is eligible and held for 12 months or less is usually regarded as a short-term capital asset, while one held for over 12 months is usually considered a long-term capital asset.

The extent of that difference can affect the rate at which the gain is taxed.

One important limitation applies to mutual funds: not all mutual funds are subject to the same tax treatment as equity shares. Mutual funds that are debt-oriented and some other specially designated funds have their own set of rules, and the date when the units were purchased can also be relevant.

Just looking at the name of the fund is not sufficient.

How short-term capital gains are taxed

Eligible listed equity shares and units of equity-oriented mutual funds are usually subject to a tax of 20% on short-term capital gains provided that the relevant conditions, including the requirement to pay the applicable STT, are fulfilled.

Take a simple case.

You purchase shares amounting to ₹2 lakh and then sell them for ₹2.5 lakh during the relevant short-term holding period.

Your gain is ₹50,000.

At 20%, the basic tax works out to:

₹50,000 × 20% = ₹10,000

This is prior to including the Health and Education Cesses and any surcharge that may apply.

The 20% rate applies to eligible transfers which are covered by the provisions coming into effect from 23 July 2024, and the present framework used by the Income Tax Department also treats short-term capital gains as being taxable at 20% under Section 111A.

Long-term gains have a different calculation

Eligible listed equity shares and equity-oriented mutual funds are currently subject to a long-term capital gains tax rate of 12.5%.

Section 112A also includes a yearly limit of ₹1.25 lakh relating to eligible long-term gains.

Let us assume that the total of your eligible long-term capital gains for the financial year amounts to ₹2 lakh.

The broad calculation would be:

Total long-term gain: ₹2,00,000

Annual threshold: ₹1,25,000

Amount above threshold: ₹75,000

Hence the tax rate would be:

₹75,000 × 12.5% = ₹9,375

Cess and surcharge, in all cases where they apply, are considered separate.

The present filing instructions of the Income Tax Department still take into account long-term capital gains up to ₹1.25 lakh within the relevant return framework under Section 112A.

Mutual funds can be a little more complicated

It is here that many online explanations turn confusing.

An equity mutual fund and a debt-oriented mutual fund should not be placed in the same tax category.

Generally, equity-oriented mutual funds apply the equity capital-gains framework when the relevant conditions are met. There are, nevertheless, some particular mutual funds which may be covered by different provisions.

The date of the acquisition can be relevant in this case as well.

That is the reason why an investor who is holding a number of mutual fund schemes should examine the tax treatment of each type rather than using a single rate for the whole portfolio.

The same applies to older investments since tax rules have changed over time and therefore an article published several years ago might quote rates or provisions which no longer apply to a current transaction.

What if you do incur a loss?

The stock market doesn't give profits every time.

Imagine that you bought shares for ₹1.8 lakh but sold them for ₹1.5 lakh; in that case you would have a capital loss of ₹30,000.

The amount of such losses can be important if you are working out your total capital gains for the year.

The rules concerning income tax allow eligible capital losses to be set off against specified capital gains, the way in which this is done depending on whether the loss in question is a short-term or a long-term one.

Losses which are eligible and cannot be entirely adjusted in the same year may also be carried forward, provided that the relevant conditions are met.

Therefore, if your portfolio includes both profitable and losing transactions, focusing just on the winning ones will not give you a full picture of your tax situation.

A quick calculation using shares

Suppose an investor purchased listed shares for ₹3 lakh.

The investor disposed of the shares after 18 months for a price of ₹5 lakh.

The gain is:

₹5,00,000 – ₹3,00,000 = ₹2,00,000

Because the shares had been held for a period of more than 12 months the gain would usually be classed as long-term, provided that the other conditions are satisfied.

Apply the ₹1.25 lakh threshold set out in Section 112A now:

₹2,00,000 – ₹1,25,000 = ₹75,000

Tax at 12.5%:

₹75,000 × 12.5% = ₹9,375

The calculation given here is a simplified one; an investor's final liability may vary according to other gains and losses as well as the applicable cess, surcharge and the particular provisions that relate to the transactions.

Dividends are a separate matter

Capital gains and dividends are frequently mentioned in connection with one another, but they are in fact not the same thing.

A capital gain occurs when you sell an investment and earn a profit.

A dividend is the income that you get from a company or mutual fund when you hold the investment.

Dividend income is usually treated as a separate item when it comes to the relevant income-tax rules and must therefore not be added to either the purchase price or the sale price in order to calculate a capital gain.

Keep your investment records handy

It is much easier to work out tax figures when the paperwork is in order.

An investor may need information such as:

• Purchase date
• Purchase value
• Sale date
• Sale value
• Number of shares or units
• Transaction-related expenses
• Capital gains and losses
• Contract notes
• Mutual fund transaction statements

This is especially useful in the case of a person who has carried out a number of investments during the year.

A digital platform makes it easier to keep track of it by putting all the investor's transactions and information in one place. For example, Ashika Dhanush 2.0 incorporates a number of investment products into a single digital ecosystem, which in turn makes it simpler to monitor holdings and transactions.

It doesn't indicate that the platform has a say in the final tax liability since tax filing continues to be based on the investor's full financial information and the rules that apply to each transaction.

One thing investors should not overlook

Tax is based on realised gains, not merely because the value of a share or mutual fund has increased on the screen.

If you bought a stock for ₹1 lakh and it is currently worth ₹1.4 lakh, you have an unrealised gain of ₹40,000. If you have not sold the investment, there has generally been no capital-gains tranWhen a sale takes place, there will be a gain or a loss which must be taken into account for tax purposes. It is useful to make use of this distinction when looking at a portfolio at the end of the financial year. Then I'd like to ask you, how much tax will you really have to pay? There is no single universal answer.

For eligible equity investments, the broad current framework is:

Short-term capital gains: The rate for long-term capital gains is generally 12.5 per cent. The annual threshold under Section 112A for eligible long-term capital gains is ₹1.25 lakh.Yet the figures by themselves are not sufficient for working out a person's final tax bill.

The type of mutual fund, acquisition date, holding period, capital losses, transaction details and the investor’s wider tax position can all affect the result.

For someone building a portfolio through stocks and mutual funds, keeping proper records throughout the year is far easier than trying to reconstruct every transaction when it is time to file the return.

And when the transactions become complicated, checking the latest Income Tax provisions or speaking to a qualified tax professional is the safer approach.