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Capital Gains Tax | Dividend Income Tax in India

HomeCapital Gains Tax | Dividend Income Tax in India

As a stock market investor, you need to be aware of the basic Income Tax provisions applicable to your investments. This is one area where you can seriously save some study time (unless you enjoy reading about taxation) as a very basic understanding of these provisions is enough to help you make sensible investing decisions. In India, income or profits from investing in stocks could be taxed under two broad categories:

A.      Capital Gains Tax        B.      Dividend Income Tax

Capital Gains Tax

Earnings from equity investments are categorized as short-term capital gains or long-term capital gains. In India, investments held for over one year are referred to as long-term investments, and the gains or losses made on them are called long-term capital gains or losses. On the other hand, investments held for less than one year are short-term investments, and gains and losses on them are called short-term capital gains or losses. 

For example if you bought 200 shares of Company “A” on 20th March, 2012 and sold them on 24th January, 2013, the period of your holding would be less than 1 year and hence any profit or loss on such a transaction would be treated as a short term capital gain/loss. On the other hand if you sold those shares after 20th March, 2012, i.e., after holding the shares for more than 1 year, profit or loss arising on such a transaction will be taxed as long term capital gain/loss.

How the tax treatment differs: On transactions involving purchase and sale of (dematerialised) shares, Short Term capital gain is taxable @15% while Long Term Capital Gain is tax exempted (yet another reason for holding shares for a longer term).

In the above example, assume that you bought the 200 shares of Company “A” @ Rs.50 per share and sold the same @ Rs.100 per share, netting a profit (i.e. gain) of Rs.10,000 (i.e. Rs.50 gain on 200 shares).

Now, if you sold these shares before 20th March, 2013, you will be liable to pay short term capital gain tax on the Rs.10,000 profit. Your tax liability accordingly will be Rs.1500 i.e. 15 % of Rs.10,000. However, if you had sold your shares after 20th March, 2013, the Rs.10,000 profit earned would be treated as long term capital gain and would be tax free.

What if I bought many shares of the same company at different times and sold at different times?

For computing capital gains chargeable to tax, the cost of acquisition and period of holding of any security is determined on the basis of First in First Out (“FIFO”) method. Accordingly, if you buy shares of one company at different times through the year, and sell some of it after one year, the shares bought first will be considered to have been sold first.

Example: 

Investor ‘A’ bought and sold Tata Motors shares as per the below schedule:

capital gain tax
 According to FIFO, the shares acquired at earlier time are considered to be disposed of first and accordingly out of the 600 shares sold on 8 November 2012, 500 shares bought @ Rs.177.95 on 21 October 2011 will qualify for (tax-exempt) long term capital gain. Profit on the remaining 100 share sale will be treated as short term capital gain and accordingly short term capital gain tax @ 15 % would be applicable on those 100 shares. As per FIFO, the 100 shares will be deemed to be the ones which were bought first in the entire holding, i.e. in the above example these 100 shares will come out of the lot (of 200 shares) purchased on 20 March 2011.

Accordingly, the short term capital gain on 100 shares will be Rs.1,250 (100 shares sold for 284.10 (minus) the price of 100 shares purchased @ Rs.271.60). 

Dividend Income Tax

Dividend income is good news for another reason – As per existing tax provisions, Income from dividends is tax free in the hands of the shareholders.

Instead, the Government of India levies a Dividend Distribution Tax (DDT) on companies @ 15% on the amount distributed as dividend to the shareholders of the company. Accordingly, a dividend-paying company first pays 30% income tax on its profits and then pays a 15% DDT on what it distributes to its shareholders out of its post-tax profits; which means that the effective rate of tax for the company on the amount paid out as dividend is much higher.

Example :

Company ‘A’ earns a net profit, of Rs.2,000. Company ‘A’ must pay income tax on this profit @30% i.e. Rs.600. Out of the post-tax profit of Rs.1,400 (Rs.2000 – Rs. 600), Company ‘A’ decides to distribute Rs.500 in dividends, and retain the remaining Rs.900 as reserves. Before distributing Rs.500 as dividend, Company ‘A’ must pay a dividend distribution tax @ 15% i.e.  Rs.75.

So how does the total transaction pan out:

Company ‘A’: Rs.2,000 (Profit) – Rs.600 (Income tax) – Rs.75 (DDT) – Rs.500 (Dividend) = Rs.825 transfer to Reserves.

Tax Authority: Rs.600 (Income tax) + Rs.75 (DDT) = Rs.675

Shareholders: Rs.500 – Rs.75 = Rs.425 on which no further tax is levied. 

Recommended for you:

–  High Dividend Paying Stocks in India


Note: For the purpose of this article DDT is calculated ignoring the surcharge and cess amount.

Disclaimer: Nothing in this article constitutes investment, legal, accounting or tax advice, or a representation that any investment or strategy is suitable or appropriate to your individual circumstances, or otherwise constitutes a personal recommendation to you. Sana Securities does not advise on the tax consequences of investments and you are advised to contact an independent tax advisor.

About the Author

Rajat Sharma pictureRajat Sharma is a well known stock market analyst and commentator. He has covered Indian markets for over a decade and is regarded for consistently identifying early stage investment opportunities. Attorney by qualification, Rajat has done extensive work for improving corporate governance and disclosure standards.