Calculating long-term capital gains tricky, service providers can help

The government started imposing a 10 per cent long-term capital gains tax (LTCG) on sale of listed stocks and equity mutual funds after one year from FY19

For the first time, equity investors will have to declare details of stocks and mutual funds sold in their income tax returns. And calculating the gains/losses is a tricky process, and quite different from other instruments. It is especially complicated if you have received bonus shares or a systematic withdrawal plan (SWP) in a mutual fund.

In the previous financial year (FY 2018-19), the government started imposing a 10 per cent long-term capital gains tax (LTCG) on sale of listed stocks and equity mutual funds after one year. While capital gains of Rs 1 lakh are tax-free, any amount above that would be fully taxable. “It was to ensure that long-term investors don’t get adversely hit due to the new regime,” says Archit Gupta, founder and CEO, ClearTax.

For investors, the choice is to calculate the gains themselves. However, there are a slew of service providers which help achieve the same end, but they may come at a price. Many stockbrokers offer this service and also tax filing platforms.

What does the new rule entail? There are three critical numbers in the calculation –original cost of acquisition, fair market value (FMV) of the stock as on January 31, 2018, and the selling price (See table: Complicated calculation). According to the formula, an investor needs first to compare FMV and selling price and choose the lower of the two values. Then, take this figure and compare it with the original cost of acquisition and take the higher of the two values.

Say, a person bought stocks of a company for Rs 500 on January 1, 2017. On January 31, 2018, the stock price was Rs 1,000. He sells the stock for Rs 1,500. If the gains were to be calculated based on the original cost of acquisition and selling price, the investor would have had to pay a higher LTCG tax. To lower the tax outgo, the Central Board of Direct Taxation (CBDT) introduced the FMV. The FMV of stocks or units of a mutual fund as of January 31, 2018, rationalises the cost of acquisition and, thereby, lowers the capital gains tax.

In the example, the FMV of Rs 1,000 is lower than the selling price. In the second step - when you compare it with the original buying price of Rs 500 – the FMV is still higher. The cost of acquisition of the stock, therefore, will be the FMV. Subtract it from the selling price, and you will get the gains (Rs 1,500 – Rs 1,000 = Rs 500). And the tax, at 10 per cent, will be Rs  50 per share. 

If the taxpayer incurs a loss on selling the equity investment, he can carry forward the loss or set it off against the gain. If you have sold long-term equity investments between January 31, 2018, and March 31, 2018, the tax liability will be zero as the new provisions are applicable from April 1, 2018, onwards. Similarly, if you have incurred losses before the start of the financial year 2018-19; they cannot be carried forward or set off. For stocks bought from after April 1, 2018, the “grandfathering” provision does not apply. The gains will be calculated based on the buying and selling price.

Bonus shares and stock split: Explains Samir Kanabar, tax partner, EY India: “For bonus and stock split, the calculation would differ based on the date they happened. If they happened before January 31, 2018, the price on this day is considered as cost of acquisition.”

For split and bonus after February 1, 2018, the calcualtion is as follow. ­­An investor does not pay any money to acquire bonus shares. The cost of acquisition is, therefore, zero. But the CBDT clarified that bonus shares would be taxed. The same formula has to be followed to calculate the cost of acquisition of bonus shares. The original buying price would, however, be zero. The investor has to consider the lower of the fair market value and selling price to get the cost of acquisition.

In case of a stock split, the original cost of acquisition will change depending on the number of stocks allotted. If a person had initially purchased, say, 100 shares of a company at a total price of Rs 10,000. Each stock would cost Rs 100. After the stock split, he has a total of, say, 500 shares. The cost of purchase will be divided among by the units held (Rs  10,000 / Rs 500 = Rs 20). The original purchase price for each will be Rs 20. And gains on the sale of stocks will be calculated, accordingly.

Systematic withdrawal are complicated: Usually, an individual invests in mutual funds using a systematic investment plan (SIP). He puts little money regularly over a period of time. Now, if he opts for an SWP, the calculation of gains can be complicated and lengthy as well. Say, the investor had purchased 100 units and paid Rs 10 for each unit in the first month and Rs 12 in the second. Later, he is withdrawing only 30 units each month through an SWP. “He needs to follow the first-in-first-out (FIFO) method to compute the original price of purchase. In the LTCG formula, the investor has to take the purchase price as Rs 10 until he withdraws the first 100 units. For the next 100 units the buying price will be Rs 12 and so on,” says Naveen Wadhwa, a chartered accountant with Taxmann.com.