If you have invested in stocks or IPOs by taking a loan, the tax liability can go up substantially.
Praveen Sharma was very excited when he was allotted 199 shares of Coal India Limited (CIL). The 32-year-old saw it as an opportunity to make some quick buck.
And, he was not disappointed. A day before Diwali, the CIL stock listed at Rs 287, and Sharma gained 17 per cent or Rs 8,358. Although there will be a tax of Rs 1,253.7 (15 per cent on short-term capital gains) when he files his income-tax returns, he would still have made a neat Rs 7,000 within ten days.
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Enthused with the success, Sharma wants to invest in the upcoming initial public offerings (IPOs) and follow-on public offerings (FPOs). He is even willing to borrow to invest in these. But this excitement can cost him dear.
Classified as business income
Buying and selling equities frequently can bring you on the taxman’s radar. Consequently, the capital gains made from the transactions will be added to your income and taxed, according to the income-tax (I-T) slab.
Income tax experts believe as there are no hard and fast rules on this, and it differs on a case-to-case basis, one runs the risk of paying tax under business income if the amount is reasonably high. For instance, the I-T department will not bother for a gain of Rs 50,000 or Rs 1 lakh. But if the capital gains are substantial, say Rs 10 lakh in a financial year, there is a strong chance that it will be classified under ‘business income’.
The clincher for the taxman: If you borrow regularly to make investments in IPOs and FPOs. Or, if you avail of margin funding to do daily trading in shares or indices.
Homi Mistry, tax partner at Delloite, Haskins and Sells, says, “If these conditions are applicable to you, your profits are re-categorised as business profit, according to the I-T Act.” Interestingly, the Act refers to regular trading in shares as ‘an adventure in the form of trade’.
According to the Act, capital gains are proceeds received from selling capital assets, which were bought to hold and not make immediate profit. “Say you bought and sold shares within six months, the capital gains would be considered passive income and taxed accordingly,” says Kaushik Mukherjee, executive director, PricewaterhouseCoopers.
For a broker, the classification of his/her income under ‘business income’ is fine. But for a salaried individual such as Sharma, it could hurt badly. Say Sharma makes capital gains of Rs 10 lakh. In addition, his taxable salary is Rs 6 lakh. The tax officer can club these two incomes and tax Sharma at the rate of 33 per cent. That would mean a flat tax of Rs 5.3 lakh.
However, if the two incomes were to be divided – capital gains and taxation – Sharma’s tax liability would be much lesser.
He would have paid Rs 1.5 lakh for capital gains and Rs 1.2 lakh, according to the 20 per cent slab. His outgo, therefore, increases by Rs 2.6 lakh or almost 50 per cent.
Even gains from intra-day trade are termed as speculative gains and come under business income, because the shares are not delivered to you on that particular day.
There is respite, though
Those who want to pursue this aggressively may get some tax benefits as well. One can set-off their business income against expenditure you incur to gain the income.
For instance, if you took a personal loan to buy shares and paid interest of 12 per cent, you can request the officer to take the cost into account and reduce the tax liability accordingly. However, you will not be allowed, if you are earning tax-free income from the expenditure you incur such as dividends from shares.
