Taxation on Income Earned from Share Trading

Every businessman in the world knows the cost structure of doing his business at his fingertips. He uses this knowledge to negotiate prices from his suppliers as well as customers. Similarly, a trader or an investor needs to be aware of all the cost that will go in executing a trade.

While investing or trading can be a low-cost venture for an individual trader as far as the infrastructure cost is concerned, the operational cost is something to look out for. Operational costs or the cost of trading or investing can be divided in two parts. First is the fixed cost which constitute taxes and levies which remains the same across all brokering houses. The second is the brokerage cost which needs to be kept as low as possible. Low brokerage helps in bringing down the breakeven cost and is a key factor for frequent traders.

A trader, especially a scalper (one who exits from his trade in a few minutes on very small profit) or a day trader needs to know all the costs that are loaded over and above his entry price. He needs to get an idea of his breakeven level so that he knows the minimum exit price he should aim for in case his trade is not working.

It is advisable for all form of traders and investors to keep their cost structure low. The only variable that is in their hand for such individuals is the brokerage as every other cost is statutory. It is thus advisable to trade with a discount broker who ensures a lower cost operation and a lower break-even price.

Also Read: How returns from various asset classes are taxed?

Apart from brokerage, there are other levies and taxes which are collected on every transaction, irrespective of the fact that the trade is a profit or a loss or if the trade is a scalp trade or an investment.

Levies and Taxes

Stock market regulator Securities and Exchange Board of India (SEBI), the stock exchanges, state government and central government all impose some levy and taxes on each trade. A SEBI turnover fee, stamp duty, service tax, and securities transaction tax (STT) are all imposed on each trade be it in the cash segment or derivatives.

Stamp duty varies from state to state, but all other taxes and levies are common for all transactions. Apart from STT, all other taxes are a cost that every person who transacts in the equity market has to pay.

In case of STT its treatment for an individual is different while for a person who shows trading and investing as his business is different. If trading is shown as a business income then STT paid is allowed as a deduction under section 36 (xv).

Further, the STT paid in cash market and derivatives are different and are set by the central government.

Capital Gains Tax

Profits arising from trading or investing activity are taxed under the Capital Gains Tax. There are two heads under which this tax is classified – short-term capital gains tax and long-term capital gains tax.

If a trade is squared off in less than 12 months, the profit arising from such a transaction is called a short-term profit while in case of a loss it is called a short-term loss. The tax to be paid by the trader at the end of the year will be computed by deducting all short-term loss from short-term gains.

Suppose that a trader has through his trading made a short-term profit of Rs 75,000 while on some other short-term trades he incurred a loss of Rs 25,000. In such a case his tax liability will be computed on a profit of Rs 50,000 (Rs 75,000 – Rs 25,000). He will have to pay short-term capital gains tax on Rs 50,000 in that year as per the tax rate applicable in that particular year. Presently, short-term capital gains are taxed at 15 percent which in the above example works out to Rs 7,500.

In case a trader has taken a number of trades in a particular stock, then his profit or loss is calculated on the basis of first-in-first-out (FIFO) method.

Assume that a trader buys 500 shares of a company at a price of Rs 100, then again buys 500 additional shares at Rs 107. He then sells off 500 shares at Rs 105. For tax purposes, his profit will be calculated taking into account the first 500 at a price of Rs 100 which have been sold at Rs 105. Thus a profit of Rs 2,500 (Rs 5 * 500 shares) will be considered for taxation. The trader cannot, at his discretion say that he has incurred a loss on the trade where he bought 500 shares at Rs 107 and sold them at Rs 105. All shares bought first are considered to be first sold for computational purpose.

Another important point to note in short-term capital loss can be carried forward for a period of eight years. Any short-term capital loss from equity shares can be set off against short-term capital gains or long-term capital gains from any capital asset. The losses are allowed to be carried forward for a period of eight years only in the case where the trader has filed his income tax returns in time.

Say, a trader has made a short-term loss of Rs 50,000 in one year and the next he has a short-term gain of Rs 70,000. In this case, the trader will not be taxed for his losses in the first year, but in the second year, he will get the benefit of setting off his loss of Rs 50,000 from the profit of Rs 70,000. In other words, the trader will be asked to pay a short-term capital gains tax on a profit of only Rs 20,000 (Rs 70,000 – Rs 20,000).

The second type of capital gains tax called the long-term capital gains tax is applicable on investments sold after a holding period of more than 12 months. Presently in India, there is no long-term capital gains tax on listed shares.

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No taxes on holding for more than a year is one of the reason investors shy away from selling their shares in less than a year even if their price target is near.

Dividend Distribution Tax

Investors generally get the benefit of the dividend that a company announces, credited to their account. Traders occasionally get to see the dividend in their account as they are more concerned with price movement and rarely buy shares for a short-term period to gain dividends. In both the cases, the dividend that is credited is not taxable at the hand of trader or investor, presently. Companies who announce dividend generally pay taxes on it called the Dividend Distribution Tax, but it is upto the government to change it and allow taxation at the hand of the shareholders, as was the case in the past.

It is thus necessary for every trader and investor to know the tax structure applicable for all forms of asset classes.

 

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