How are Different Investment Instruments Taxed?

It’s that time of the year again – and no, it’s not Christmas.  

Tax season has become one of the most grueling and stress-inducing times of the year, and rightfully so. The lack of literacy around taxes, clubbed with the mystery of not knowing if you’ve paid your taxes right, makes it possibly one of the most difficult things to navigate around in the adult spectrum of life. 

With the financial year ending, and filing for your ITR returns being right around the corner, now is the best time to start optimising for your taxes. The best thing you can do now is to start learning bit by bit about taxes. And no, it’s not something you can ignore for too long.

Getting taxed on your investment returns is a whole different ball game – it comes with different taxation rules on different investment vehicles. Taxation of investments is  governed by the Income Tax Act, of 1961 (this classifies investments into different categories based on their nature and tax implications)

Confused? Let’s have a look

1. Equity Instruments

Equity investments allow investors to buy shares in listed companies. Investors earn returns through dividends and capital appreciation here. Over time, investing in equity instruments has become the most preferred way for investors to cash in the growth of a company and increase wealth. Here’s how they are taxed

• Short-term capital gains: If you sell your stocks within one year of buying them with profits, the gains are taxed at a flat rate of 15%.

Do keep in mind that a tax rate of 15% is applied regardless of the income tax slab that you might fall into. 

• Long-term capital gains: If you sell your stocks after one year of buying them, the gains you might have made are taxed at a flat rate of 10%. This is applicable only if the gains exceed Rs. 1 lakh. This means that gains under Rs 1 Lakh are not taxed if you have made them by selling your stock after a year of holding it.

Eg – Let’s say Ron held on to a few stocks for around 2 years and made a net profit of Rs 1.4 lakh post selling them. He will now have to pay a 10% tax on this gain, had he made a profit of under Rs 1 Lakh, he would be exempted from paying this tax. 

2. Mutual Funds 

Mutual funds don’t need an introduction. They’re known for reliable returns and long-term planning. They are classified into two categories – equity mutual funds and debt mutual funds. Taxation on mutual funds depends on a few factors like the type of fund it is, the duration you hold on to it, the gains you make post selling them, and the dividends you might have received from the fund house. 

Here’s how their taxation works 

1. Dividends – Any dividends made by investing in a mutual fund are added to your taxable income and taxed along with it, according to the tax slab you fall into. This was an amendment made in the 2020 Union Budget. 
2. Equity Mutual Funds – Equity mutual funds are investment funds that pool money from investors to buy stocks in publicly traded companies. Here’s how they are taxed. 

• Short-term capital gains tax (STCGS) is applicable on any profit you might have made out of selling your equity within a year. The STCG tax rate is 15% regardless of your income tax slab. 
• Long-term capital gains (LTCG) are gains that you make by selling your equity after a year of purchasing. If you make under Rs 1 lakh in profit, then you can be exempted from the LTCG tax. However, if you exceed RS 1 lakh, you will be taxed 10% on your gains. 

Do note that LTCG has an overall Rs 1 Lakh limit. Let’s take the above example of Ron here. If Ron made gains of Rs 50,000 on equity and Rs 40,000 on mutual funds, he would be exempt from paying LTCG tax. However, if he made Rs 55,000 on mutual funds, he would have to pay a LTCG of 10%, as his gains are now Rs 1,05,000. 

3. Debt Mutual Funds – Debt mutual funds pool money from investors to invest in fixed-income securities such as government and corporate bonds. Starting 1st April, the STCGs on Debt Mutual funds will be added to your taxable income and will be taxed at your income tax slab rate. The same applies to LTCGs. 

3. Futures and options (F&O) 

Investing in F&Os comes with an agreement to buy or sell an asset at a future date and price. F&Os help to speculate the future prices of underlying assets like stocks or currencies. Since investing this way is considered a form of derivative trading, taxes on these investments are categorised as business income.

If you’ve invested in F&Os, you need to file this under ITR-4, but be careful to check exactly which ITR section you’d fall under based on earned income. Since these investments are considered businesses, you can report business expenses as well.

4. Debt Instruments

Recently in an amendment to Finance Bill 2023, gains from debt mutual funds will now be taxed at your tax slab rates and will be considered short-term irrespective of the holding period. This means you will lose out on the indexation benefit these came with earlier.

5. FD Fixed Deposits (FD)

FDs  are a popular investment option in India and are known for their reliability and longevity. The interest earned on FDs is taxable as per your income tax slab. There are also tax saving FDs, like the SBI tax saving FD, that come with a tenure of more than 5 years.. Here, you can show the principal amount in section 80C and take a tax exemption of up to Rs 1.5  lakh in a financial year. Do know that withdrawals from tax-saving FDs are not exempted from tax. The interest earned on these FDs is taxable, and the tax liability will depend on the tax slab of the investor.

6. Government Schemes

The Indian government offers various investment schemes like Public Provident Fund (PPF), National Savings Certificate (NSC), and Sukanya Samriddhi Yojana (SSY). The interest earned on these schemes is exempt from tax (EEE).

7. Bonds

Investing in bonds is another way to invest in the debt market. The interest earned on bonds is taxable as per your income tax slab.

8. Physical Assets

1. Real Estate 

• Short-term capital gains –  If you sell your property within two years of buying it, the gains are taxed as per your income tax slab.
• Long-term capital gains – If you sell your property after two years of buying it, the gains are taxed at a flat rate of 20% after indexation.

2. Gold 

• Short-term capital gains – If you sell your gold within three years of buying it, the gains are taxed as per your income tax slab.
• Long-term capital gains –  If you sell your gold after three years of buying it, the gains are taxed at a flat rate of 20% after indexation.

9. Others

1. Gambling

Gambling is considered as “income from other sources” and is taxable as per your income tax slab. This includes income from the lottery, betting on horse races, card games, and other forms of gambling.

2. Chit Funds -The interest earned on chit funds is taxable as per your income tax slab.
3. Crypto -The gains “income from other sources” and you pay taxes as per your income tax slab.

10. Exempt Under Taxation (EEE)

As mentioned earlier, some investment schemes like PPF, NSC, and SSY offer tax exemptions under the Exempt-Exempt-Exempt (EEE) scheme. The interest earned on these schemes is exempt from tax at all three stages – investment, accumulation, and withdrawal.

Brace yourselves and pull up those socks!

With tax season right around the corner, you don’t want to be taken by shock when you see how much of your income will be cut in taxes. Learn more about ways to minimise taxes and pay your taxes in the right way. It’s also important to understand the tax implications of your investments before choosing certain investment vehicles.