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It is vital to plan your long-term capital gains in market investment as they are no longer tax free. Image Credit: Bloomberg

Dubai: You may be a Non-Resident Indian (NRI) who recently raked in gains from your equity or stock investments in India, given that the markets have gone up around 20 per cent in the past one year.

If you are, it is vital to plan your long-term capital gains in market investment as they are no longer tax free, reminded Masher Suleiman, a global tax planning associate based in Abu Dhabi, and Brijesh Meti, a UAE-based consultant who decodes tax norms for residents in India and abroad.

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Capital gains earned over and above Rs100,000 (Dh4,974) on selling equities, including shares and mutual funds, after one year are called long-term capital gains (LTCGs). Such long-term gains from such funds are taxed at 10 per cent.

Simply put, ‘Tax Harvesting’ is a technique that reduces this tax impact. It utilises the Rs100,000 (Dh4,974) annual long-term tax exemption, by selling and buying back part of your investment such that you “realise” net gains every year.

Tax Harvesting: A way to reduce long-term taxes on stock investments for higher returns
In 2018, a 10 per cent Long Term Capital Gains (LTCG) tax was introduced on market investments in India, where none existed before. The LTCG tax, however, came with a tax break. The first Rs100,000 (Dh4,974) of LTCG is exempt from 10 per cent taxes.

Like mentioned above, Tax Harvesting is a technique that utilises the Rs100,000 (Dh4,974) annual LTCG exemption by selling and buying back part of your investment such that you 'realise' gains and not pay taxes on the exempt Rs100,000 (Dh4,974) of LTCG.

At a 10 per cent LTCG tax rate, you could save up to Rs10,000 (Dh500) in LTCG taxes every year by doing this diligently. Let’s explore this further and understand how.

When do investors use this tax saving technique?

“Most of the investors prefer using the ‘Tax Harvesting’ strategy at the end of the financial year when they need to file returns. But you can use it throughout the year in a planned manner to keep your capital gains at a relatively lower level,” added Meti.

“Tax Harvesting starts with the sale of the stock or an equity fund which is experiencing a consistent price decline. You feel that the asset has lost most of its value and chances of a rebound are bleak. Once the loss is realised, you offset it against capital gains that your portfolio has earned over the period.”

Let’s see a simple example of how Tax Harvesting works on the long term gains you make on your money. Assume your investment yields gains of Rs100,000 (Dh4,974) every year. After 3 years, the gains are Rs300,000 (Dh14,923) and you decide to sell.

Tax Harvesting
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Let’s take another example to understand how Tax Harvesting works. Suppose you bought 10,000 equity mutual fund units at Rs50 (Dh2.50) each in March 2018. There is a clause in case of equity instruments under which LTCG till January 31, 2018, is tax free.

So, in case a person has invested in equities before this date, the higher of either the value of shares or equity mutual funds as on January 31, 2018, or the actual purchase price will be considered the cost of acquisition. So, in this case, as the investment is made after January 31, 2018, this clause will not apply.

So, if the net asset value (NAV) of the equity mutual funds is Dh75 (Dh3.7) now, the person can sell around 4,000 units, where LTCG will be around Rs100,000 (Dh4,974). So, one can book gains in these units and reinvest the same.

Risks to keep in mind when ‘Tax Harvesting’

However, while experts agree that Tax Harvesting is a good technique to save taxes, Suleiman cautioned that investors must be mindful of the fact the money should be invested immediately after the gains are booked, before going on to explain why.

“Reinvest the tax gains immediately without wasting time. But people either wait too long to reinvest or reinvest only partially. When the money comes in the bank, some routine purchases become essential and the money gets spent, without realising that this can seriously hamper your financial goals.

“Because the money is in the bank, investors try to time the market which is not easy. Finally, they end up not investing or investing unfavourably. Also, it may be practically difficult to reinvest at the same price as, in the case of mutual funds, the proceeds may not be credited on the same day.”

So, the investor may sometimes need additional money for the same. Similarly, in the case of shares, as the prices keep fluctuating, it may not be possible to invest at the same price.

Is there a cost involved when you ‘Tax Harvest’?

While you save 10 per cent on LTCGs amount, you incur small charges in the form of security transaction tax, stamp duty, brokerage and so on, which are most likely not more than 1 per cent of the amount.

“Keep in mind that debt-oriented mutual funds that an NRI holds for more than 36 months are considered as long-term capital assets. The tax liability on capital gains from the sale of such type of funds is 20 per cent after ‘indexation’,” added Meti.

What is indexation?
Indexation is used to adjust the purchase price of an investment to reflect the effect of inflation on it. A higher purchase price means lesser profits, which effectively means a lower tax. With the help of indexation, you will be able to lower your long-term capital gains, which brings down your taxable income

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Bottom Line?

Tax Harvesting have proven time and again to be simple yet effective way to bring down the taxes you will pay on your equity investments. Remember, you must reinvest the money as soon as you get the redemption amount in your account or run the risk of breaking your compounding journey.

Income tax is an unavoidable expense. However, there are provisions under the income tax law that allow taxpayers to reduce their tax liability. However, experts say, people should use these options if these are in line with their overall financial goals. So, take the advice of an expert if you are unable to do it on your own.