NRI investments 2021 AHR Wealth Management
Tax Harvesting is a simple yet effective way to bring down taxes you pay on your equity investments Image Credit: Shutterstock

Dubai: You may be a Non-Resident Indian (NRI) that recently raked in gains from your equity or stock investments in India, given that the markets have gone up around 90 per cent in the past one year.

If you are, it is vital to plan your long-term capital gains in equities as they are no longer tax free. 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).

Long-term gains from equity funds are taxed at 10 per cent. Tax Harvesting is a technique that reduces this impact. It utilises the Rs100,000 (Dh4,974) annual LTCG exemption by selling and buying back part of your investment such that you “realise” net gains every year.

Tax Harvesting: A way to reduce your LTCG taxes for higher returns
In 2018, a 10 per cent Long Term Capital Gains (LTCG) tax was introduced 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.
A man walks past the Bombay Stock Exchange (BSE) building in Mumbai. Picture used for illustrative purposes.

When do investors use this technique?

Most of the investors prefer using this 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.

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 LTCG Tax Harvesting works.

Let’s say 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.

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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 are 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.

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However, experts advise that tax harvesting is a good technique to save taxes, but investors have to be mindful of the fact the money should be invested immediately after the gains are booked.

Besides evaluating the LTCGs correctly, experts also advise that it is crucial to reinvest the amount immediately without wasting any time.

Market consultants also noticed that either people 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 such an action 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.

Indian rupee falls 47 paise to 69.82 against US dollar in early trade
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Is there a cost involved in tax harvesting?

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.

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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Tax Loss Harvesting: Another way to save tax

In Tax Loss Harvesting, you book losses and offset gains in any other instrument to bring down your tax liability.

Let’s say you have invested Rs200,000 (Dh9,948) in a fund on January 15, 2020. And now, on September 27, 2021 your investment value is Rs184,000 (Dh9,152). In this scenario, your long-term capital loss is Rs15,000 (Dh746).

Now, if you sell this investment, you are booking the losses (but do remember to reinvest this money immediately), and you can use this to offset any long-term capital gains you might have received in the year.

If you cannot use your capital loss to reduce your capital gains in one year, you can carry forward the losses for up to 8 financial assessment years.

For example, 2 years down the line, you sell a long term equity mutual fund investment and make Rs150,000 (Dh7,461) in capital gains. Since you are Rs50,000 (Dh2,487) above the limit, you have to pay tax.

However, you can remove this Rs15,000 (Dh746) from the Rs150,000 (Dh7,461) gain for tax calculation. So your effective LTCG will be Rs150,000 (Dh7,461) – Rs15,000 (Dh746) = Rs135,000 (Dh6,715), and you will pay tax only on Rs35,000 (Dh1,741) as against Rs50,000 (Dh2,487) you would have paid otherwise.

This is how tax-loss harvesting acts as a critical strategy to save tax for many investors. A good way to use tax-loss harvesting is to remove underperforming funds from the portfolio and not exit from good funds that might have seen a small blip in the short term.

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Bottom Line?

Tax gain and tax loss harvesting are simple yet effective ways to bring down the taxes you will pay on your equity investments. Remember, you have to 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.