LTCG on Equity Shares India: Example Calculations

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If you have purchased shares before 1st April 2018 and have sold them in the FY 2018-19, based on the date of purchase, you may be expected to pay Long Term Capital Gains Tax on the sale of those shares.The calculation of LTCG tax is complex with words like Fair Market Price and Cost of Acquisition being thrown in.

In this post I am trying to declutter the tax calculation with a few examples. Remember, these are based on my understanding. I am not an auditor and this is not professional advise. Kindly verify the numbers with your auditor.

The key to calculation of LTCG is the 'Cost of Acquisition'. This is calculated as per Formula 1 given below

Formula 1: Higher of Original Purchase  Price and ( Lower of the highest prices on 31-Jan-2018 and the Sales Price)

And LTCG is calculated as Formula 2:  [(Sales Value - Selling expenses) - (Cost of Acquisition + Purchase Expenses)

Little confusing. I request you to read the above two sentences again. First one talks about calculating the Cost of Acquisition and second one talks of using that value to calculate the LTCG.

Let us look at some examples:

Example 1: IPO Purchase and additional purchases in secondary market

Subbu got 199 Shares of  of Coal India allotted on 20-Nov-2018 at an IPO price of 233. Later he purchased 301 shares of Coal India on 22-Sep-15 at an average price of 339.65. The highest price of Coal India on 31-Jan-2018 was 304.55. He sold off the entire 500 shares on 24-Sep-18 at an average price of 278.55.

This set of transactions is eligible for LTCG. Let us calculate the LTC Gain or Loss.

Step 1. For 199 shares received in IPO

1. Original Purchase Price: 233

2. Price as on 31-Jan-2018: 304.55

3. Sales Price: 278.55

4. Lower of 2 and 3: 278.55

5. Cost of acquisition as per Formula 1: Higher of 1 and 4: 278.55

6. Purchase Expenses (Brokerage and Taxes): 0 (IPO purchase)

7. Selling Expenses (Brokerage and Taxes): 491.55

8. LTCG as per Formula 2: [(199*278.55 - 491.55) - (199*278.55+0)] : -491.55

Step 2: For 301 shares purchased on 22-Sep-19

1. Original Purchase Price: 339.65

2. Price as on 31-Jan-2018: 304.55

3. Sales Price: 278.55

4. Lower of 2 and 3: 278.55

5. Cost of acquisition as per Formula 1: Higher of 1 and 4: 339.65

6. Purchase Expenses (Brokerage and Taxes):877.88

7. Selling Expenses (Brokerage and Taxes): 742.98

8. LTCG as per Formula 2: ((301*278.55 - 742.98) - (301*339.65+877.88)) : -20012

Total LTC Gain / Loss: -20012 - 491.55 = -20503.55

Since this is a loss, no tax is applicable. 

2. Bonus Issue

Rahul purchased 100 Shares of Infosys on 12-Apr-2015 at a price of 1640 and the purchase expenses were 1000 rupees. on 22-Feb-2017, the company issued Bonus Shares at the rate of 1:1. The shares were trading at a high of 952 on 31-Jan-18. Rahul sold the 200 shares on 12-Nov-2018 at a price of 840. The selling expenses were 1200 rupees.

Step 1. For 100 shares purchased in secondary market

1. Original Purchase Price: 1640

2. Price as on 31-Jan-2018: 952

3. Sales Price:840

4. Lower of 2 and 3: 840

5. Cost of acquisition as per Formula 1: Higher of 1 and 4: 1640

6. Purchase Expenses (Brokerage and Taxes): 1000

7. Selling Expenses (Brokerage and Taxes): 1200

8. LTCG as per Formula 2: ((100*840-1200) - (100*1640+1000)) :-82200

Step 2: For 100 shares received as bonus shares

1. Original Purchase Price: 0

2. Price as on 31-Jan-2018: 952

3. Sales Price: 840

4. Lower of 2 and 3: 840

5. Cost of acquisition as per Formula 1: Higher of 1 and 4: 840

6. Purchase Expenses (Brokerage and Taxes):0

7. Selling Expenses (Brokerage and Taxes): 1200

8. LTCG as per Formula 2: ((100*840-1200) - (100*840+0): -1200

Total LTC Gain / Loss: -82200 - 1200 = -83400

Since this is a loss, LTCG Tax is not applicable

3. Mix of STCG and LTCG

Venkat purchased 500 Shares of IDFC Bank at a price of 30  and purchase expense of 150 on 01-Sep-15. He added another 300 shares of IDFC Bank on 03-Feb-18 at 40 rupees with a purchase expense of 120. He sold 800 shares of IDFC First Bank on 9-September 2018 at a price of 47 and selling expense of 200. The price of IDFC Bank on 31-Jan-18 was 42

Step 1. For 500 shares purchased on 01-Sep-15

1. Original Purchase Price: 30

2. Price as on 31-Jan-2018: 42

3. Sales Price:47

4. Lower of 2 and 3: 42

5. Cost of acquisition as per Formula 1: Higher of 1 and 4: 42

6. Purchase Expenses (Brokerage and Taxes): 150

7. Selling Expenses (Brokerage and Taxes): 125 (200 * 500/800)

8. LTCG as per Formula 2: ((500*47-125) - (500*42+150)) : 2225

Step 2: For 300 shares purchased on 03-Feb-18. This will be considered as STCG

1. Original Purchase Price:40

2. Sales Price:47

3. Purchase Expenses (Brokerage and Taxes):120

7. Selling Expenses (Brokerage and Taxes): 75 (200*300/800)

8. STCG as per Formula 2: ((300*47-75) - (300*40+120):1905

Total LTC Gain / Loss: 2225

Total STC Gain / Loss: 1905

Hope this clarifies. In case you have any crazy situations, do let me know. Let us work on it together. 

Since this is a profit, but the amount is less than 100000, LTCG tax is not applicable. However STCG Tax at the rate of 15% is applicable.

Thieves who steal your wealth...

If you are person who earns regular income and has some hope of establishing a nest egg for your retirement, you should be careful of two thieves who can steal your wealth away from you.

The two thieves are taxes and inflation.

If you are a salaried employee, you might know the impact of taxes on your income. You may not feel the impact since tax is deducted by your employer before the money reaches your bank. If you are in the 30% tax bracket, over the year you will pay about 30% of your salary as tax, which is like working about 4 months in a year free for the government.

Taxes are one of the main reasons why there is a significant mismatch between salary perceptions between an employee and the company. Company has to pay the salary as per the contract whether it is paying you or to the government. Employees, on the other hand, get much lower pay than they were expecting.

No wonder. A salaried employee in the highest tax bracket is working without pay for almost 4 months in a year.

Also remember, Personal Income Taxes are not the only taxes that we pay. In addition to the Personal Income Taxes, we feed the additional appetite of the government for our money by way of what are known as 'Indirect Taxes'. Every time we purchase a good, we pay sales tax and every time you purchase a service, you end up paying Service Tax. 

If the purchase involves both a good and a service, for example buying a Television and Installation Services, we end up paying both the taxes. 

When it comes to direct taxes, like Personal Income Tax, government offers at least some way of minimizing the burden. Tax laws in most of the countries provide for either deductions from personal income or a few exemptions to the taxable income. We can lower our effective tax by creatively using the deductions and exemptions. 

(Some people say that Personal Income Tax on salary income is a form of double taxation. The company already pays taxes on its earnings. Charging Personal Income Tax on Salaried Employees is like taxing the same income twice, once from the Company and other from the employee)

Left unplanned, taxes can create havoc on your retirement planning. 

Now we come to 'Inflation'. This is a real silent thief. Insidious and unobtrusive are the adjectives that I am looking for to describe Inflation. This thief is totally unknown to most of us. Like rust eating iron, Inflation continuously and consistently eats into our wealth. It is omnipresent like air and is invisible and dangerous like electricity. 

What is inflation? It is defined as the 'Rate at which the general prices are rising and the purchasing power is falling'. Inflation leads to fall in purchasing power, which means that if you are spending 100 rupees today to buy one Kg of Onion (!), tomorrow (one year later) you will get less than a Kg of Onion for 100 rupees. 

Normally Inflation is measured in terms of Whole Sale Price Index, what is known as WPI Inflation. In addition to WPI Inflation, there are six other types of inflation that can hurt the common man. These are:

1. Consumer Price Inflation (CPI) also known as Retail Inflation
2. Food Price Inflation
3. Educational Cost Inflation
4. Medical Cost Inflation
5. Housing Inflation
6. Lifestyle Inflation

Most of the current savings mechanisms available to us do not protect us from Inflation. Many of us invest a lot (most) of our savings in Bank Fixed Deposits. This is the choice of investment for many seniors. When it comes to Bank FD, both these thieves lead a co-ordinated attack on the returns. Interest Income is taxed, so there goes down your return. What is left of the interest and the capital is impacted by inflation. 

Is there any weapon that we can use to attack both these villains? Is there an Investment 'Brahmastra' or an Investment 'Thunderbolt' that can help a common man defeat and destroy these nefarious personalities?

Yes. Fortunately for us, the answer is that such a weapon exists.

It is called Investment in Equities. In most of the countries Long Term Capital Gain is taxed at much lower rates than the return on any other investment mechanisms. In India Long Team Capital Gain is Zero. Over the past several years, Equities have provided significant 'Inflation Adjusted' positive returns to the investor. In Indian context, the value of Sensex in 1979 was 100 while today it is at 25000, a 2500% jump over the last 35 years, which means a return of 17% per year over the last 35 years. If you subtract an average inflation of about 10% over the same period, your effective return (also called the 'Real Return' ) is about 7%. 

By the same standard, the Real Return from an FD paying 10% Interest is negative 3.5 percent, which means that your wealth is depleting. 

Next question is, how do I invest in Equities. The best way to do that is using Systematic Purchase Plans. 

As I explain in this article, you can follow Systematic Equity Plan whereby a specified amount invested in a regular frequency to purchase shares of a few companies. Since the investment takes place through a mandate that you place with your bank, the investment becomes regular and mechanical. This removes the main equity investment killers out there which are Fear and Greed. 

Investing in stocks takes some expertise. If you think that you do not have the knowledge to choose good stocks to invest or to time the purchases, you can opt for investing in Mutual Funds. Mutual Funds are managed by experts who do the investing on your behalf. Here also you can do Systematic Investment through what is known as SIPs (Systematic Investment Plans). In SIP, a specific amount is invested in a product of a mutual fund company to buy the units of a specific fund over regular frequency. 

By following SIP or more demanding SEP route, you are making regular investments in equity. This means that you are using the Investment Brahmastra to slay the two thieves who want to steal your wealth Vis. Taxes and Inflation. 

Remember, In India only two incomes are totally exempt from Tax. Agricultural Income and Income from Capital Gains from investments in Equity. Why not capitalize on this situation?

(PS: In this article, I am only looking at the impact of Taxes on your Wealth. I am not looking into the philosophical argument whether Taxes are good or not. I have my own views on that)

(One could say that investment in Real Estate also provide similar returns. But one is forgetting the regular annual maintenance costs of maintaining your real estate and the annual property taxes that you pay government to maintain the property. Also purchasing and selling real estate involves a lot of transaction costs to the investor. This is the subject of another post)

To learn more about investing in general and investing in equity in particular, you can read my Book Review Series on Reviewing 50 Finance Books. In particular, I will recommend THIS and THIS