Navigating the complexities of the tax system in India, especially in relation to Long Term Capital Gains (LTCG) on shares, is crucial for effective financial and estate planning.

This article delves into the details of Long Term Capital Gains, its implications for estate planning, and strategies to minimise tax liabilities while ensuring a secure financial legacy.

Understanding Tax On Long Term Capital Gain On Shares

Understanding the tax on long-term capital gains (LTCG) on equity shares is crucial for anyone involved in the Indian stock market or equity-oriented mutual funds.

LTCG tax applies to the profits earned from the sale of shares or mutual funds that have been held for more than a year.

Reintroduction of LTCG Tax in 2018

In the 2018 budget, the Government of India made a significant change by reintroducing the long term capital gain tax on shares and equity mutual funds.

This was a departure from the previous rule, where Long Term Capital Gains from shares was exempt from tax if the securities were held for more than a year.

The rationale behind this exemption was to encourage long-term investment in the equity market.

Current Tax Rate and Threshold

Under the current rule, Long Term Capital Gains on shares is taxed at a rate of 2.50%. This tax is applicable only if the total gain exceeds INR 1,25,000 in a financial year, and it includes gains from units of equity-oriented funds which need to be calculated separately for income tax computation.

It’s important to note that this tax applies without the benefit of indexation. Indexation is a method used to adjust the purchase price of an investment to reflect the effect of inflation on it.

Calculating Taxable Gains

To calculate your taxable gains:

1. Determine the holding period: Ensure that the shares or mutual funds were held for more than one year.
2. Calculate the total gains: Subtract the actual cost of acquisition (what you paid for the shares or mutual funds) from the sale price. Compare this with the fair market value (FMV) to determine the actual cost of acquisition.
3. Apply the exemption limit: If your total gains exceed INR 1,25,000, the amount over this threshold is subject to a 12.50% tax.

Example of LTCG Calculation

Suppose you purchased shares worth INR 200,000 in January 2017 and sold them in February 2019 for INR 350,000. The total gain is INR 150,000. After applying the exemption limit of INR 1,25,000, the taxable gain is INR 25,000. The LTCG tax at 12.50% would therefore be INR 3,125.

Implications for Investors

This tax impacts investors’ strategies, especially those relying on equity markets for long-term growth.

While the reintroduction of the LTCG tax was seen as a move to bring parity between different investment instruments and to increase tax revenues, it has implications for investment returns.

Investors need to factor this tax into their returns expectations and financial planning, especially when considering large investments in the equity market.

Understanding these nuances helps investors better plan their investment strategies and anticipate their tax liabilities effectively.

Criteria For Long Term Capital Gains Tax

To qualify for Long Term Capital Gains (LTCG) tax on shares in India, certain criteria must be met, ensuring that the gains are treated favourably in terms of taxation. Here’s a breakdown of these key requirements:

1. Listing on a Recognised Stock Exchange:

• The shares involved must be listed on a recognised stock exchange in India. This ensures that the shares are publicly traded and meet specific regulatory standards set by authorities such as the Securities and Exchange Board of India (SEBI). This criterion helps maintain the formal and regulated nature of the investments eligible for LTCG tax.

2. Payment of Securities Transaction Tax (STT):

• The Securities Transaction Tax must be paid both at the time of purchase and sale of the shares. STT is a direct tax levied on every purchase and sale of securities that are listed on the stock exchanges in India. The requirement to have paid STT at both ends of the transaction underscores the government’s approach to tax equity investments in a structured manner, aiming to encourage and legitimize market transactions.

3. Holding Period:

• The shares must be held for more than 12 months to qualify as a long-term capital asset. This duration is critical as it distinguishes short-term holdings (taxed at a higher rate as short term capital gain) from long-term investments, which are given a more favorable tax treatment. The one-year holding period incentivises investors to think long-term, aligning with the government’s objective of promoting stable investment in the market.

Implications

These criteria are designed to encourage regular and structured investment in the equity markets while ensuring that only genuine and significant long-term investments receive the tax benefits associated with Long Term Capital Gains.

For investors, understanding these rules is essential not only for tax planning but also for making informed decisions about when to enter and exit investments to optimise tax liabilities.

By adhering to these conditions, investors can ensure that their gains from equity investments are taxed at the lower Long Term Capital Gains tax rate of 10% over the exemption limit, rather than the higher short-term capital gains tax rates.

This strategic awareness can lead to substantial tax savings and more effective investment growth over time.

Calculation Of LTCG

The calculation of Long-Term Capital Gains (LTCG) on shares in India follows specific rules designed to fairly assess the gains made on investments, particularly considering market value changes and inflation.

Here’s a detailed look at the process:

Step-by-Step Calculation of LTCG:

1. Determine the Sale Price:
   • This is the amount at which the shares are sold. It represents the total revenue generated from the transaction before any expenses are deducted.
2. Identify the Cost of Acquisition:
   • For shares acquired before January 31, 2018, the cost of acquisition is the higher of the actual purchase price or the fair market value as of January 31, 2018. This is significant because it offers a form of tax relief by potentially raising the cost basis if the market value was higher on this date compared to when the shares were bought.
   • For shares acquired after January 31, 2018, the cost of acquisition is simply the purchase price of the shares.
3. Adjustments for Improvements (if applicable):
   • This generally applies to physical assets like real estate, where any costs incurred to improve the asset can be added to the cost of acquisition. For shares, this step is usually skipped unless there were costs directly related to enhancing the value of the shares, such as costs incurred in a rights issue.
4. Subtract the Adjusted Cost of Acquisition from the Sale Price:
   • This subtraction gives the gross Long Term Capital Gains. For shares and equity funds where indexation (adjustment for inflation) is not applied, this step directly results in the capital gain figure.
   • Example: If the shares were sold for INR 250,000, and the purchase price was INR 150,000, the cost of acquisition would be INR 200,000 (since it's higher than the purchase price). The Long Term Capital Gains would therefore be INR 50,000 (INR 250,000 sale price - INR 200,000 cost of acquisition).
5. Apply the Applicable Deductions and Exemptions:
   • If the total Long Term Capital Gains exceeds INR 1,25,000 in a financial year, the amount exceeding INR 1,25,000 is taxable at 12.50% without the benefit of indexation. The first INR 1,25,000 is not subject to tax.

Estate Planning & LTCG

Estate planning involves more than just drafting a Will—it is a critical component of financial management, especially for individuals with substantial investments in shares and securities.

Understanding how Long-Term Capital Gains (LTCG) tax impacts estate planning is essential for ensuring that the maximum possible value is passed on to heirs.

Here’s a deeper look into the relationship between Long Term Capital Gains and estate planning, along with strategies for tax exemption and reduction:

Impact of LTCG on Estate Value

• Net Value of Assets: LTCG tax affects the net value of the shares or securities at the time they are transferred to Beneficiaries. If the assets have appreciated significantly, the taxes due at the point of sale of these securities can reduce the net amount that the heirs receive.
• Strategic Sales: Decisions about when to sell shares can significantly impact the estate's tax liability. Timing the sale of shares to coincide with lower tax rates or available exemptions can reduce the overall tax burden on the estate.

Tax Exemption and Reduction Strategies

1. Claiming Exemptions:
   • Section 54F of the Income Tax Act allows for LTCG tax exemption if the capital gains from the sale of shares are reinvested into purchasing or constructing a residential property in India. This must occur within a specified period and there are conditions regarding the holding period of the new property.
2. Tax Loss Harvesting:
   • This involves strategically selling shares that are underperforming to realise losses. These losses can then be used to offset any gains, thereby reducing the LTCG tax liability. This strategy requires careful planning to ensure that it aligns with overall investment goals and market conditions.

Incorporating LTCG into Wills and Trusts

• Instructions in Wills and Trusts:
  • Estate documents can include specific instructions on the management of shares, such as directives on optimal timing for the sale of shares to maximise tax benefits. This can be crucial for estates that include significant amounts of invested assets.
• Use of Trusts:
  • Setting up a Trust can be an effective way to manage and distribute shares over time. Trusts can own shares and other assets, allowing for the strategic release or sale of these assets under conditions that are favourable from a tax perspective. This setup can help in managing Long Term Capital Gains implications more efficiently, as Trusts can be designed to operate in a tax-efficient manner according to the needs of the Beneficiaries.

Strategic Implementation

To effectively incorporate Long Term Capital Gains considerations into estate planning:

• Regular Consultations: Regular updates and consultations with estate planning attorneys and tax advisors are vital. These professionals can provide up-to-date information on tax laws and help in adjusting strategies as financial markets and personal circumstances change.
• Education of Heirs: It’s also beneficial to educate heirs about the potential tax implications of their inheritance, particularly in relation to shares and securities. This knowledge can prepare them to make informed decisions about managing or divesting assets in a tax-efficient manner.

In summary, integrating Long Term Capital Gains considerations into estate planning not only ensures compliance with tax laws but also maximises the value of the estate for future generations.

By using strategic planning tools like exemptions, Trusts, and tax-loss harvesting, individuals can significantly enhance the effectiveness of their estate plans, ensuring that their wealth serves their families as intended.

Challenges In Managing LTCG

Managing Long-Term Capital Gains (LTCG) on shares involves navigating several challenges that can significantly impact the outcome of financial and estate planning strategies.

Here are some of the key difficulties and how they affect the management of Long Term Capital Gains:

Market Volatility

• Impact on Asset Valuation: Market fluctuations can dramatically alter the valuation of shares, affecting the calculation of capital gains when these shares are sold. Significant market drops can reduce the gains, potentially lowering LTCG tax, while market upswings can increase tax liabilities unexpectedly.
• Timing of Sale: Deciding the optimal time to sell shares to maximize gains while minimising tax implications can be complicated by market volatility. Investors need to carefully time their sale to coincide with favourable market conditions, which can be unpredictable.

Regulatory Changes

• Tax Law Amendments: Changes in tax laws by the government can have a direct impact on Long Term Capital Gains strategies. For instance, amendments in the tax rate, adjustments in exemption limits, or alterations in the rules for indexation benefits can necessitate a complete overhaul of existing financial plans.
• Impact on Planning: Frequent regulatory changes require investors and their financial advisors to stay continually informed and ready to adapt strategies. This can increase the complexity and cost of financial planning, as adjustments may need to be made on short notice to comply with new regulations.

Strategic Responses to Challenges

To effectively manage these challenges, individuals and financial planners can adopt several strategies:

1. Diversification: By diversifying investments across different types of assets and sectors, investors can mitigate the risks posed by market volatility. Diversification helps to stabilise the portfolio and reduce potential drastic impacts on the overall investment value due to fluctuations in a particular market segment.
2. Regular Review and Adjustment: Continuous monitoring and periodic review of the investment portfolio and financial plans ensure that adjustments can be made in response to both market conditions and regulatory changes. This proactive approach allows for the optimisation of financial outcomes under prevailing conditions.
3. Advanced Planning Tools: Utilising advanced financial planning tools and software can help in modeling various scenarios under different market conditions and regulatory environments. These tools can provide predictive insights and help in making informed decisions regarding the timing of asset sales.
4. Professional Guidance: Engaging with financial professionals who have up-to-date knowledge and understand the implications of regulatory changes can provide a crucial advantage. These experts can offer guidance on navigating the complexities of Long Term Capital Gains taxes and developing robust strategies that are flexible enough to adapt to changes.

By understanding these challenges and implementing strategic responses, individuals can better manage the uncertainties associated with Long Term Capital Gains taxes and optimise their financial and estate planning outcomes.

The Bottom Line: How Yellow Can Help

Long-term capital gains tax on shares is a significant consideration in estate planning for individuals with substantial investments in the stock market.

By understanding the tax implications and utilising strategic planning, individuals can ensure that their financial legacy is passed on efficiently and in accordance with their wishes.

Engaging professional help and staying informed about regulatory changes are keys to successful estate and tax planning in India.

At Yellow, we can help you with all aspects of estate planning, including Wills, Trusts, Powers of Attorney, Gift Deeds, Legal Heir and Succession Certificates, and Living Wills. We also offer post-demise and asset transfer services. Our  team of legal experts has more than 50 years of combined experience.

Note: This article is for educational purposes only. Please consult an advisor before taking any action on finances or investments.

We hope you found this article insightful. At Yellow, we understand that managing your finances effectively is the first step towards securing your future. As India's leading digital Will-making and estate planning platform, our mission is to empower you with the necessary tools and resources to make informed decisions that safeguard your assets and your loved ones' future.

Interested in seeing how estate planning can fit into your financial strategy? Yellow offers a seamless and affordable way to create your Will, set up Trusts, and ensure smooth asset transfer, all with expert guidance.