How to reduce Capital Gains Tax Liability using Tax Loss Harvesting

Article originally published in Guajrati Mid-day newspaper on April 13, 2021. Here is the transcript of the same.

When one earns profits on sale of capital assets it is taxed as Long Term Capital Gains (LTCG) or Short Term Capital Gains (STCG) based on the holding period. The tax on such profits can be cut down to some extent by using a sophisticated tax planning mechanism known as tax loss harvesting.

Tax-loss harvesting is the selling of Stock/Mutual funds at a loss to offset a capital gains tax liability and normally such investments are bought back to maintain the same asset allocation/portfolio.

Let’s say You invested Rs 6 lakhs in listed shares and Rs 3 lakhs Equity oriented Mutual Funds in April 2018. The value of the shares is Rs 4.5 lakhs in April 2020 and the value of the Mutual Funds is Rs 5 lakhs. You want to liquidate the mutual funds. The LTCG on redemption of MF is Rs 2 lakhs (Sale value Rs 5 lakhs - Cost Rs 3 lakhs). Out of this, Rs 1 lakh is exempt and you pay 10% plus cess of 4% as LTCG tax i.e. Rs 10,400.

Prior to 31.03.2018, there was no tax on LTCG on shares and equity oriented mutual funds, therefore long term loss on such transactions was considered as a dead loss. After 31.3.2018, the scenario changed, profits/gains on long term shares or equity oriented mutual funds are now taxable in excess of Rs. 1 lakh. Every coin has 2 sides. The positive side to this tax provision is that if you have incurred a long term capital loss on sale of shares or equity oriented mutual fund units then you can set them off against any Long Term Capital Gains.

So, in the above example, even though you want to keep holding the shares for long term, for the purpose of tax planning you sell the shares and re-invest the sale proceeds in the same shares within next 2 to 3 days. This sale and reinvestment is a legal transaction and does not affect your investment amount or returns generated. Rs 1.5 lakhs Long Term Capital Loss on sale of shares can be set off against the LTCG of Rs 2 lakhs on redemption of MF and the balance LTCG of Rs 50,000 being less that Rs 1 lakh is exempted. Thus you pay no tax.

Also, in case the losses from sale of capital assets exceed the gains from such assets after setting off losses and gains of a particular year, you can carry forward such losses for setting off in later years up to 8 assessment years. However, keep in mind losses for a year cannot be carried forward unless that year’s return has been filed before the due date.

It is pertinent to note that LTCG can be set off against long term capital loss and short term capital loss whereas STCG can be set off only against short term capital loss. There is no asset class restriction on the set off. Hence losses in equities can be set off against gains in debt, real estate or gold.

Question : During the year, I sold plot of land for Rs 5 lakhs which was purchased by me in April 2001 for Rs 1 lakh. The LTCG on this sales after benefit of indexation is Rs 1.99 lakhs. Can I reduce my tax liability in this case? Also, before 8 months I purchased 1500 listed shares in Company A at Rs 200 per share. The share is now trading at Rs 20 per share. Is any action required for these shares?

Answer :

Since you have sold plot of land which was held by you for more than 24 months the sale is liable for tax as LTCG. Tax on LTCG of Rs 1.99 lakhs will be Rs. 41,392 (20% LTCG tax plus 4% cess).

Assuming that you do not want to buy a house or invest this amount in Capital Gains Bonds of the government, you can save tax by selling off the 1,110 shares of Company A and booking loss of Rs 1,99,800 (Sale Value of 22,200 – cost of 2,22,000) which can be set off against LTCG of Rs 1,99,000. Thus tax liability will be Nil. You will carry forward STCL of Rs 800 and set it off against capital gains in the next 8 years.

Also, if you want to continue your holdings in company A reinvest the sale proceeds of Rs 22,200 in Company A’s shares within the next 2 to 3 days. Thus, you will continue your investment holdings and also save on tax.