Investments: What's taxed & how much

Investors can choose from a variety of instruments and assets. While making the choice, they should also consider the tax axe that will fall on their investment. We take up the tax implications of investments here.

Types of Income: There are two types of income. One is earned from an asset while the investor holds it, say, interest, or dividend. The other is the gains or losses arising due to the transfer  or relinquishment of the investment or asset (See table at the bottom).

Determinants of tax liability: To ascertain your tax liability, you need to ask yourself four questions:

• Is the income from the asset exempt or entitled to deduction?
• For what period of time have you held the investment?
• Under what head is the income taxable: capital gains, business income, or income from other sources?
• What is the rate of tax applicable to the income?

It is the third question that creates the largest number of controversies. If a person treats his asset like a trader treats his stock, he will be assessed under the head business. If not, he will be assessed under the head capital gains or income from other sources.

In this article, it has been presumed that the reader is an investor and not a trader. With this in mind, we analyse some popular categories of investments/assets. Education cess and surcharge, wherever applicable, are charged over and above the rates of tax.

If a special rate does not apply, the income will be included in the income of the person and taxed according to the slab applicable. This has been mentioned as the normal rate.

Equity shares: You earn dividends while you hold an equity share. Dividends distributed by all domestic companies are exempt from tax. The tax on the income from sale or transfer of shares depends on whether they are a capital asset or stock (business asset). Some points that may be considered while deciding whether a person is an investor or trader.

• Intention of the person;
• The frequency of transactions during the year;
• Whether the acquisition is being made with own funds or borrowed funds.

There are no definite guidelines in this regard. If the transactions are numerous and the individual has borrowed, there is a possibility of his being treated as a trader. In this case, the income will be taxed under the head business income and the period of holding will be immaterial.

However, if the person is treated as an investor, the asset will be taxed under capital gains and the period of holding will determine his tax liability. If the share is held for one year or more, it will become a long-term capital asset.

In such a case, if the share is listed and sold through a stock exchange, the transaction will attract the security transaction tax (STT). Apart from STT, the income from the transaction will be exempt. Other shares, like those of an unlisted private limited company, will attract 20 per cent tax. In case the equity share is listed and held for less than 12 months, it will attract 10 per cent tax, or the normal rate of tax depending on whether STT has been charged on the sale or not.

Mutual funds: Income distribution of MFs is exempt from tax. In most cases, an MF unit will be treated as a capital asset and not as stock-in-trade. If the fund is equity-oriented, then a gain on the transfer of a unit held long-term will be exempt. If it is held for short term, the gain will be subject to 10 per cent tax. In case of debt funds, the gains will be taxed at 20 per cent if the unit is held for long term, and at normal slabs if it is held for short term.

Derivatives: A derivative is a contract which confers the right to purchase or sell an underlying asset at a predetermined price at a future date. The asset can be the index (BSE Sensex or NSE Nifty), an equity share or  a commodity.  Such a derivative is called a "future". A derivative in India is required to be settled by receipt/payment of difference.

The settlement of differences in respect of derivatives isn't treated as speculation, and the income is taxed as either business income or income from other sources/capital gain. Derivative contracts need to be settled in less than 12 months and are, therefore, short-term assets. If there is a gain, the head under which the income is taxed is immaterial as no concessional rate of tax will apply and the income will be taxed at the normal rate.

A loss, however, can be carried forward to the next year if treated as a loss under the head business or capital gain.  Taxability will depend on whether the taxpayer is treated as an investor or a trader.

Gold/silver/precious metals: Gold is treated as a capital asset and the gain/loss from its transfer is taxed under the head capital gain. The gain/loss is computed under the head business only in case of jewellers or people who trade in precious metals. Investors will be also liable to wealth tax during the period that they hold gold/silver, subject to the overall exemption limit of Rs 15 lakh (Rs 1.5 million).

Paintings: If a painting is purchased for personal enjoyment, the gain from its sale is exempt from tax. However, if paintings are accumulated systematically with the intention of selling them at a later date, the gain from their sale will become chargeable as a capital asset. If the volume of acquisition or the frequency of sale is substantial, the gains may be treated as business income.

Real estate: Except in rare cases, gains from real estate are taxed under the head capital gains, with the rate depending on whether the period of holding is short-term or long-term. In rare cases, however, the real estate transactions may be treated as a business activity with the consequent gain/loss being regarded as business income.

ALSO READ:

• Part I: Calculate your income in 10 minutes
• Part II: How to pay LESS tax on your income
• Part III: Calculate your TAX in 5 minutes flat!

The author is a member of the Bombay Chartered Accountants' Society. www.bcasonline.org