TAX HARVESTING

None of us enjoys paying taxes. Yet we need to pay tax on our income, GST on things we purchase, and since 2018 on the gains we make from our investments in Equity stocks or Equity Mutual Funds.

Investors who have an investment in an equity portfolio will have higher incremental gains. Therefore, if you want to pay low or no taxes, you need to ensure these gains don’t build up far beyond the tax-free limit, and that’s what Tax Harvesting is all about.

Tax Harvesting is the strategy of selling a part of your Equity stocks or Equity oriented mutual fund units to book long-term capital gains and reinvesting the proceeds in the same or different mutual fund scheme.

Under current tax laws, gains of up to ₹1.25 lakh on LTCG from equity investments are exempt from tax. Any gains above ₹1.25 lakh are taxed at 12.5% without indexation. Therefore, you can utilize this ₹1.25 lakh exemption strategically through tax harvesting to further reduce your tax liability.

After realizing the gains, you can repurchase the same or similar investments. Since, you are moving from equity to equity, there is no risk of volatility. This resets your cost base to the new purchase price. This strategy ensures that future gains will start from a higher base, which can help in avoiding taxes in subsequent years as well. You can follow this strategy every year to maximize the ₹1.25 lakh tax exemption.

Your net worth is capital plus profit. Please understand that your net worth will remain same. You must try to increase your capital and decrease your profits to reduce your future tax liability. Actually, your profits may look decreased but part of your capital is profit. The important figure is NET WORTH.  For example, if you have invested ₹5 lakh in equity shares or equity mutual fund and after one year, it becomes ₹6.25 lakh then your Net Worth is ₹6.25 lakh. If you sell this entire portfolio or scheme and realized LTCG of ₹1.25 lakh, then you don't have to pay 12.5% income tax while filling return. Now, when you re-invest this amount of ₹6.25 lakh again, your Net Worth will remain the same. The capital is ₹6.25 lakh and profit now is zero but ₹1.25 lakh of profit is already invested as capital.  The important thing to remember is that you need to reinvest this capital soon to avoid significant loss, if the market goes up before you re-invest. 

I hope this is well understood now. Next, I shall try to explain how to double or triple this amount of tax harvesting. 

Long-Term Capital Gains (LTCG): Gains on equity shares or equity mutual funds held for more than 12 months are classified as LTCG. LTCG above ₹1.25 lakh is taxed at 12.5% without indexation.

This is true for a single mutual fund account. Instead of one account, the investors can have more than one account. Open mutual fund account for every member of the family who is more than 18 years old. For example, if you have two more members in the family i.e. your wife and one child, then you can open 3 mutual fund accounts and your free income tax limit will be 1.25 lakh x 3 i.e. ₹ 3.75 lakh. Mind you, this is profit and does not include capital. If your mutual fund account is 3 to 4 years old then you capital would be as good as your profit. So, in every financial year you can take out approximately ₹7-8 lakh. If you have any requirement of capital, then use this amount otherwise reinvest ASAP in equity market to avoid the loss if market runs up before you invest.

Also, if the income of your wife and child is less than yours then even if they book the profits, either they will be paying less tax than you or no tax.

Important Notes:

Ensure that the investments you are harvesting have been held for more than 12 months to qualify for LTCG.

The tax harvesting strategy only works on equity shares and equity-oriented mutual funds; it doesn't apply to debt funds or other asset classes.

Regards, 

Col Sanjay Datt

Associate Business Partner, 

Investor First

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