Tax-loss Harvesting is the selling of securities at a loss to offset capital gains earned to reduce your overall tax liability. This allows you to offset the capital gains you made on some equity holdings against a capital loss on other equity holdings resulting in a lower tax bill in your hands in a financial year.
Some of the ways in which this can help you reduce your tax bill are:
1. Capital Gains in a year
If you have Capital gains in a year and you are holding securities with marked to market losses, you can offset them. For example, You have sold some Equity Mutual Funds resulting in Long Term Capital Gains to the extent of INR 1,50,000. This will attract a tax of INR 15,000 at 10%. If at the same time you are holding Equity shares worth INR 350,000 which you had bought for INR 500,000, you can sell these shares and book a Long Term Capital Loss of INR 150,000. As a result of this transaction, your Capital Gains of INR 150,000 are set off against your Capital loss of INR 150,000 resulting in a Zero Tax bill for you. After you book the losses if you plan to maintain your positions in the loss-making shares you can buy and take your long positions on the stocks.
2. Carry Forwards losses:
Capital Losses can be carried forward for a maximum period of 8 years. If you have carried forward Capital losses that are set to expire, you can book capital gains to utilize them. For Ex: If you have carried forward losses of INR 200,000 from the sale of Equity Shares in the past and you are holding Equity Mutual Funds/shares whose value is worth INR 650,000 which was purchased for INR 450,000, you can sell them and book a capital gain of INR 200,000 in the current year. This will be set off against the carry forward losses resulting in Nil Capital Gains Tax.
3. Long Term Capital Gains exemption:
Long Term Capital Gains on the sale of Equities come with an exemption of INR 100,000 per year. The way you can take advantage of this and save on taxes of INR 10,000 per annum is by selling equities (Stocks/Mutual Funds) that you own and booking gains to the extent of INR 100,000 each year. To maintain your overall position in the equities sold, you can buy them back the next day.
4. Transaction costs:
While the above options do result in saving you taxes, you must be aware of the transaction costs associated with the entire process. If you buy and sell equities shares on which you incur a brokerage cost of 0.20%, once you add up the exchange transaction costs, stamp duty, and STT involved, your total transaction cost can go up to 0.40% of the turnover for each leg of the transaction. In Example (1) above you save taxes to the tune of INR 15,000 but will incur a cost of 0.80% of INR 350,000 or INR 2,800 resulting in reducing your total savings to that extent.
Every year, the month of March is a good time to take stock of your capital gains positions and do the necessary transactions to reduce your overall tax bill. Be sure to take the advice of your Chartered Accountant so that you are clear about what can be setoff (Ex: Long Term Capital Gains can be setoff against Long Term Capital Losses only) and what can be carried forward (Ex: Speculative losses from equity transactions are treated differently from capital gains).