Updated: Mar 26
When we talk about tax on equity/ shares, we think the more we earn the more we pay. So is there a way out to save our tax?
Yes, there is! Tax harvesting is a technique to reduce the tax liability on investments. It registers the capital gain on yearly basis and thus your capital gain is calculated yearly and not compounded when you sell your equity which reduces your tax liability.
From 2018 onwards, govt. has levied a tax of 10% on LTCG with an exemption of 1,00,000. So how can we save tax after the amount crosses the exemption limit?
To better understand it, let’s suppose you have 100 shares of X Ltd. and their value is currently 1,00,000. The value of shares of X Ltd. rose and you have gained 1,00,000 as ‘Unrealized gain’. Next year, again there is a gain of 1,00,000 followed by the same trends for the next three years. Now your net capital is 5,00,000 and your gain is 5,00,000- 1,00,000= 4,00,000. So you need to pay tax on 4,00,000-1,00,000 (exemption) = 3,00,000 which will be 3,00,000*10%= 30,000. If you practice tax harvesting you can save all of this tax.
Now you must be wondering how to practice it?
So in the first year when you have the share at 1,00,000 and you earned a capital gain of 1,00,000, you should sell the assets and buy it again immediately. Each year repeat the process.
What will happen with it? Why should you lose the compounding of shares?
So if you do so, each time you earn LTCG of 1,00,000 which is exempted and you pay nothing in the form of tax.
But there are some things you need to take care of before you start this.
Choose the equity which is with you for more than a year and is profitable. Most importantly, you must have enough liquidity to buy back shares instantly at the same rate because when you place a selling order you receive the money after T+1 or T+2 days i.e. after one or two days. When you place a buy order you must have enough liquidity to buy them at the same time as selling. Make sure you do these transactions in market hours i.e. from 9:15 to 3:30. While you sell the shares, your shares of a company which you bought first will be sold first. This is called the First-in-first out method. So your purchase price will be calculated accordingly. So in order to save your tax, use help of the apps you are trading by keeping constant check on your capital gains, and wisely harvesting the tax to save your earnings from tax load.