Save up to Rs 10,000 every year in Equity LTCG taxes with Tax Gain Harvesting


How are Equity Long Term Capital Gains (LTCG) taxed?

Before 1st April 2018, Long Term Capital Gains from stocks and equity Mutual Funds (i.e. gains on equity investments that have been held for 1 year or more) were tax free.

From 1st April 2018, equity LTCG is taxable at the rate of 10% flat (irrespective of income tax slab).

However, there are two adjustments to this:

a) Grandfathering of equity long term gains accrued before 1st February 2018 (i.e. the day the new tax was announced in the budget).
b) Exemption of the first 1 lakh of equity LTCG at PAN level from this tax every financial year.

So, if you have Equity LTCG of less than 1 lakh in any FY, you will not have to pay any tax on that.

Similarly, if you have Equity LTCG of say 1.5 lakhs in a given FY, then the tax liability will only be on Rs 50,000 (1.5 lakhs - 1 lakh) and tax payable will be 10% of Rs 50,000 = Rs 5,000.

You can read more about the new LTCG tax and the adjustments here.

What is Tax Gain Harvesting (TGH)?

Tax Gain Harvesting (TGH) refers to the process of systematically utilising the 1 lakh equity LTCG exemption available every financial year to lower the overall tax liability.

It applies to stocks and Equity Mutual Funds (including Balanced Mutual Funds since they are classified as equity funds for taxation). It does not apply to other types of Mutual Funds e.g. Debt Mutual Funds. Also this does not apply to short term capital gains.

Tax Gain Harvesting (TGH) refers to the process of systematically utilising the 1 lakh equity LTCG exemption available every financial year to lower the overall tax liability.

TGH can be used by resident Indians as well as NRIs since the exemption is applicable to both.

Let's say you have Rs 1 lakh of unrealised LTCG in the current financial year. If you don't book these gains ('harvesting'), they will be carried forward to the next financial year.

Now let's say in the next year also your investments gain by another 1 lakh.

So at the end of the second year, you have unrealised Equity LTCG of 2 lakhs.

Now if you redeem all your investments, the tax liability on 2 lakhs of equity LTCG will be 10% of (Rs 2 lakhs - Rs 1 lakh) = Rs 10,000 since only 1 lakh of gains is exempt from tax.

However, if at the end of the first year itself, you had booked ('harvested') your LTCG gains of 1 lakh then the unrealised LTCG at the end of the 2nd year would have been only 1 lakh which again would have been completely tax exempt upon redemption.

So with Tax Gain Harvesting, the tax liability would have been 0 instead of Rs 10,000.

The 1 lakh LTCG Tax exemption per financial year works on a 'if you don't use it, you lose it' basis as the unrealised LTCG then gets added to the subsequent year's LTCG.

Hence by systematically using it every financial year, we can lower our final tax bill.

How much can I save using Tax Gain Harvesting?

Since the exemption is for up to Rs 1 lakh of equity long term capital gains per financial year and the tax rate is 10%, so if one keeps booking the entire exempt amount every year, one can save upto Rs 10,000 of prospective LTCG taxes every year.

Here is an illustration for 10 years assuming Rs 1 lakh is invested at the start of every year in equity and returns are 15% per annum.

Table-Tax-Gain-Harvesting

In this example, over a period of 10 years, a total of Rs 77,424 in taxes was saved by Tax Gain Harvesting.

How to do Tax Gain Harvesting?

You can implement Tax Gain Harvesting yourself as follows:

a) For each of your investments, compute your realised and unrealised Capital Gains for that year. Ensure that you are only looking at long term capital gains for this. Typically this information will be a part of Capital Gains report.

b) Compute the remaining exemption limit for you for that year as follows:

Remaining exemption  = 1 lakh - (Sum of Realised Equity Capital Gains for the current FY)

c) If the remaining exemption is positive i.e. you have not yet exhausted the 1 lakh LTCG exemption limit then look for those investments where you can book some or all of the unrealised long term equity capital gains without crossing the 1 lakh limit.

d) Repeat step (c) till you have completely exhausted the 1 lakh limit.

e) Sell/redeem the investments identified in (c) so that the gains will get booked.

f) [Important] Since we don't actually want to be out of our investments, so we also need to buy the same investments asap after selling them (to minimise the time gap between buying and selling).

There are some more optimisations that can be done on top of this basic process but for someone doing it manually this is good enough.

At Goalwise, we have automated the Tax Gain Harvesting process and it is a part of our rebalancing feature itself. Our Tax Gain Harvesting algorithms automatically does all the above calculations and computes the most optimum set of redemptions and purchases for utilizing the LTCG exemption.

Are you using Tax Gain Harvesting for your investments? Do you know of other smart tax-saving strategies that one can implement? Let us know in the comments below.