Tax Loss Harvesting is the practice of selling your loss-making shares and mutual funds before the end of the financial year by converting these unrealised losses into realised loss. It helps reduce the tax liability.
What is Tax Loss Harvesting?
- At the end of a financial year, some shares and mutual funds you are holding have an unrealised loss. Unrealised Loss means the stock has not yet been sold but if it is sold, there would be a loss since the average market value is less than the average buy value.
- Similarly, by the end of a financial year, some shares and mutual funds you have sold have a realised profit. Realised Profit means the stock has already been sold at a profit (Marke Value > Buy Value).
Let us understand how Tax Loss Harvesting works from this example:
- The stocks that have an unrealised loss are sold and a loss is realized before the end of the financial year.
- This loss can now be set off against other profits and therefore it will reduce the tax liability.
- Thus, it is the harvesting of unrealised loss to save taxes.
If the trader wants to hold the stock, he can buy the stock again so that the portfolio remains unchanged. Generally, when looked at the difference, a trader would prefer to incur the transaction cost of entering into these transactions rather than paying higher taxes.
Below is a snapshot of the P&L Statement of a trader as on 28.03.2020. The tab refers to short term equity trades.
Before Tax Loss Harvesting
|Realised Profit||Rs. 3,85,000|
|Unrealised Loss||Rs. 1,27,500|
|Total Income||Rs. 3,85,000|
|Tax Liability||Rs. 20,250
[15% of Rs. 1,35,000 (385000-250000)]
After Tax Loss Harvesting
The trader can sell 300 shares of Crest and 250 shares of Deepakfert to realise the loss of Rs.1,27,500
|Realized Profit||Rs. 3,85,000|
|Realized Loss||Rs. 1,27,500|
|Total Income||Rs. 2,57,500
Loss set off against Profit
|Tax Liability||Rs. 1,125
[15% of Rs. 7,500 (257500-250000)]
The trader can thus reduce the tax liability by doing Tax Loss Harvesting. Additionally, if the trader wants to keep the portfolio unchanged, he/she can buy 300 shares of Crest and 250 shares of Deepakfert again.
Taxation on Trading Income
The trader who plans to practice Tax Loss Harvesting should be able to calculate the income tax on trading income and the applicable tax rates. Based on the calculation of tax liability, the trader can decide whether to opt for it or not. The trader should analyse whether converting unrealised loss to realised loss will result in a reduction in taxes or not.
Below are the applicable tax rates:
A. Trading Income considered as Capital Gains
|Equity Shares & Equity Mutual Funds||Debt Mutual Funds and other Securities|
|LTCG||10% in excess of Rs. 1 lac||20% with the benefit of indexation|
B. Trading Income considered as Non-Speculative Business Income
- Income is taxable at slab rates as per the Income Tax Act
An opportunity for Tax Loss Harvesting is available in case of trading in equity delivery and mutual funds. It is not available in the case of equity intraday, equity F&O, commodity trading, and currency trading since the position is squared off on the same day (intraday) and on last Thursday of the month (F&O).
Rules for Set-Off
The trader who plans to practice Tax Loss Harvesting should be able to analyse which loss can be set off against which profits as per the set-off rules of Income Tax Act. However, the decision whether to convert the unrealised loss to realised loss should be made after analysing against which incomes can this loss be set-off. Therefore, if the loss cannot be set off against any existing profits, then the trader should not opt for it.
Equity Trading Income considered as Capital Gains:
- Long Term Capital Loss (LTCL) can be set off against only Long Term Capital Gains (LTCG).
- Short Term Capital Loss (STCL) can be set off against both Short Term Capital Gains (STCG) and Long Term Capital Gains (LTCG).
- LTCL and STCL cannot be set off against any other income.
Equity Trading Income considered as Non-Speculative Business Income:
- The Non-Speculative Business Loss can be set off against any income except Salary Income.
Note: Trader having Salary Income cannot set off Non-Speculative Business Loss against such income. Thus, if there are no other incomes except Salary, the trader should not go for Tax Loss Harvesting.
If you opt for Tax Loss Harvesting by selling the shares held for more than a year, it would be a Realised Long Term Capital Loss (LTCL). Additionally, LTCL cannot be set off against STCG (Short Term Capital Gain). Thus, in this case, Tax Loss Harvesting is not beneficial.
A trader can opt for Tax Loss Harvesting by selling the existing holdings on which there is an Unrealised Loss. Thus, the loss can be adjusted with realised profit to reduce the tax liability. However, if the trader wants to continue holding the stock to keep the portfolio unchanged, you can buy the shares again on the next trading day. However, you must ensure that the transaction cost of entering into buy and sell transaction is less than the amount of taxes saved from Tax Loss Harvesting.
The loss from equity trading cannot be adjusted with Salary Income. Thus, the trader should not opt for it since it would not reduce the tax liability.