Different Asset classes have different Tax implications – How Returns are taxed?

Stocks, Mutual Funds, Fixed Deposits, Bonds, Real estate, Gold etc., are various Asset Classes that are popular among the investor community. It’s very important for investors to have a proper asset allocation to achieve financial goals.

Different asset classes have different tax implications.  The returns (or) gains generated by these various asset classes are taxed differently.

For example- the interest income from Bank Fixed deposits is a taxable income, the dividend income from Stocks is tax-free, and the capital gains from sale of your property can be a taxable income and so on..

As an investor you should be aware of these tax implications so that you can create a tax-efficient investment portfolio.(However, your investment decisions should not be based only on tax-saving criteria).

In this post, let us understand the tax implications on various asset classes, how are the returns / gains from various asset classes like Stocks, Mutual Funds, Real Estate, Bonds, Gold etc., taxed?

Asset Classes & Financial Instruments – Tax Implications

Below are the details of tax implications on investments in various Asset Classes;

How are investments in Stocks Taxed?

• Stocks (Direct Equity /Shares)
  • If you hold your stock investments for more than 12 months, the gains are treated as Long Term Capital Gains and are completely tax-exempted. The LTCG on sale of Shares is taxable at 10% from FY 218-19.
  • As per Budget 2017-18, Exemption of Long Term Capital Gains Tax u/s. 10 (38) available only if acquisition of share is subject to STT (except cases like IPO, bonus issue, rights issue etc.,).
  • If you hold your stock investments for less than 12 months, the gains are treated as Short Term Capital Gains and are taxed at flat 15%.  (Applicable for Shares which are listed on stock exchanges and are sold on stock exchanges)
  • STT (Securities Transaction Tax) at the rate of 0.1% is charged on sale of Shares.
  • If you receive any Dividends from your stocks, they are tax-free in your hands. (Note that DDT of 15% is paid by the company before they pay dividends to the investor)
  • But, with effective from Financial Year 2016-17, 10% Dividend Distribution Tax (DDT) is levied in the hands of the investor / HUF / Partnership firm who receives dividend of Rs 10 Lakh or more in a financial year. This has now been extended to Private Trusts / Family trusts (Budget 2017-18).

Mutual Fund Taxation Rules

• Mutual Funds 
  • Equity Mutual Funds (Regular Equity funds, ELSS, Equity oriented Balanced Funds, Arbitrage Funds etc)
    • If you make a gain / profit on your investment in a Equity Mutual Fund scheme that you have held for over 1 year, it will be classified as Long Term Capital Gain.
    • If your holding in an Equity mutual fund scheme is less than 1 year i.e. if you withdraw your mutual fund units before 1 year, after making a profit, then the profit will be considered as Short Term Capital Gain.
    • The STCG (Short Term Capital Gains) tax rate on equity funds is 15%.
    • The LTCG (Long Term Capital Gains) tax rate on equity funds is NIL, now taxable @ 10% (w.e.f. FY 2018-19). (Related Article : ‘Budget 2018 LTCG Tax on Equity Mutual Funds & Important Implications‘)
  • Non-Equity Funds (Debt Funds, FMPs, MIPs, Gold Funds, Fund of Funds, Balanced – Debt oriented funds etc.,)
    • If you make a gain / profit on your investment in a Non-Equity Mutual Fund scheme that you have held for over 3 years, it will be classified as Long Term Capital Gain.
    • If you make a gain / profit on your Debt fund (or other than equity oriented schemes) that you have held for less than 36 months (3 years), it will be treated as Short Term Capital Gain.
    • The STCG tax rate on Non-Equity funds (or) Debt funds is as per the investor’s income tax slab rate.
    • The LTCG tax rate on non-equity funds is 20% (with Indexation benefit).
    • Capital Gains Tax Rates on NRI Mutual Fund Investments are as below;
    • The dividend received in the hands of unit holder for an equity mutual fund is completely tax free. The dividend is also tax free to the mutual fund house. However, w.e.f. FY 2018-19, the fund houses have to pay 10% Dividend Distribution Tax (DDT) on equity oriented mutual fund schemes. (Effective DDT rate is 11.648% inclusive of 12% surcharge & 4% cess.)
    • The dividend income received by a debt fund unit holder is also tax free. But, the mutual fund company has to pay a dividend distribution tax (DDT) before distributing this dividend income to its Unit-holders. DDT on Debt Mutual Funds is 29.12%.
  • A company or Mutual Fund AMC has to report the receipt of Rs 10 lakh or more from a person/an investor in a financial year for acquiring bonds, debentures, shares or mutual funds  to the Income Tax department,.
  • With effective from 1st April 2020, the dividend income received by investors from mutual funds (Equity or Debt funds) will be subject to TDS @ 10%. This TDS is applicable if such income is in excess of Rs 5,000 u/s 194K.
    • Also, such dividend income is a taxable income in the hands of investor as per his/her income tax slab rate.

How are Gold Investments Taxed in India?

• Gold
  • Gold ETFs or Gold Funds are treated as Non-Equity funds only .
  • The tax implications on gains of selling Physical Gold are same as in the case of Non-Equity mutual funds. (Indexation benefit is available for Long Term capital Gains)
  • Sovereign Gold Bonds
    • The interest payments on Gold Bonds shall be taxable as per your income tax slab rates.
    • Gold bonds are exempted from capital gains (LTCG) tax at the time of redemption.
    • However, kindly note that Long term capital gains arising to any person on transfer of SGB will continue to be taxable at 20% and eligible for indexation benefits. (there has been some confusion w.r.t holding period, as SGBs are listed securities, the bonds if held for more than 1 year, can qualify for LTCG, but there is no clarity on this matter.)
    • TDS is not applicable on the bonds. However, it is the responsibility of the bond holder to comply with the tax laws.

Tax Consequences on Real Estate Properties

• Real Estate
  • If Land or house property is held for 36 months or less 24 months  or less then that, such Asset is treated as Short Term Capital Asset. Short Term Capital Gains are included in your taxable income and taxed at applicable income tax slab rates.
  • If Land or house property is held for more than 36 months 24 months then that Asset is treated as Long Term Capital Asset. Long Term Capital Gains on sale of property are taxed at 20% (with indexation).
  • As per Budget 2017-18,  Holding period for Long term capital gain for all immovable properties has been reduced to 2 years from 3 years. Long Term Capital Gains on sale of property are taxed at 20% (with indexation). This is effective from FY 2017-18 or AY 2018-19.  (The base year for calculation of Indexation is going to be 2001 w.e.f FY 2017-18)
  • If you receive any rental income from the property then it has to be included in your income and taxed at income tax slab rate.
  • If you are claiming HRA (House Rent Allowance) of more than Rs 50,000 per month (or) paying rent which is more than Rs 50,000 then the tenant has to deduct TDS @ 5%. It has been proposed that the tax could be deducted at the time of credit of rent for the last month of the tax year or last month of tenancy, as applicable (Budget 2017-18).
  • The buyer of the property needs to pay TDS @ 1%, on sale of property which is valued at Rs 50 Lakh or more.
    • Effective 1 September 2019, the limit of Rs 50 lakhs would be towards consideration of the immovable property including all other charges incidental to the purchase of immovable property such as parking fee, society fee, club membership fee paid by the buyer (as per Budget 2019-20).
  • The Registrar of properties will have to report purchase & sale of all immovable properties exceeding Rs 30 Lakh to the Income Tax authorities.
  • The monetary limit for quoting PAN for sale or purchase of immovable property has been raised to Rs.10 lakh from Rs.5 lakh. Properties valued by Stamp Valuation authority at amount exceeding Rs.10 lakh also need PAN.
  • The Long Term capital Gains on sale of property can be saved by investing in specified investment avenues. (Read – ‘How to save capital gains on sale of property?‘)

How are investments in Bonds, NCDs, Fixed Deposits taxed in India?

• Fixed Income & Bonds
  • Tax Free Bonds
    • Interest received on TFBs is tax-free. TDS is not applicable.
    • Short-term capital gains from sale of tax-free bonds on exchanges are taxed at your income tax slab rate.
    • Long-term capital gains are taxed at 10% without indexation. The indexation benefit is not available for Bonds.
    • For STCG holding period is less than 12 months. For LTCG holding period should be more than 12 months.
  • Non-Convertible Debentures
    • TDS is not applicable on the listed debentures’ interest payouts (which are in Demat form). Else, TDS will be applicable if the interest exceeds the threshold limit of Rs.5,000/- in a financial year.
    • Interest earned on NCD bonds is taxable as per the tax slab of the investor.
    • If you sell NCDs on stock exchange before one year from the date of purchase, Short Term Capital Gains Tax is applicable. Tax rates depend on the tax slab you fall into.
    • If you sell NCDs on stock exchange before maturity but after one year, Long Term Capital Gains Tax (if any) at 10% without indexation is applicable.
  • Company Fixed Deposits
    • TDS is not applicable on interest earned upto Rs 5,000 pa.
    • You have to club the interest earned on these deposits as ‘income from other sources’ and file your annual Income Tax Returns.
  • Fixed Deposits / Recurring Deposits
    • The interest income earned on Fixed deposits/RDs is taxable.
    • Banks do not deduct TDS if the Interest income is less than Rs 10,000, which does not mean this is a tax-free income in your hands. You still need to add this as ‘income from other source’ when you file your Income Tax Returns. (Read : ‘Misconceptions on TDS‘)
      • The Budget 2018-19 has proposed to insert a new section 80 TTB so as to allow a tax deduction of up to Rs 50,000 in respect of interest income from deposits held by senior citizens. This amendment is effective from Financial Year 2018-19 / Assessment Year 2019-20.
      • Budget 2019-20 – Proposal to not to deduct TDS of up to Rs 40,000 on interest income from Bank / Post office deposits (the current FY 2018-19 TDS threshold limit u/s 194A is Rs 10,000).
    • If your interest income on a Fixed Deposit is more than Rs 10,000 then you need to show the entire interest income when you are filling your Tax returns.
    • If you fail to furnish the PAN number, your bank shall deduct tax at the rate of 20% instead of 10% generally applicable.
• Life Insurance – It is prudent to separate investment from insurance. Ideally, insurance is not suitable for wealth creation. However, some investment options like ULIPs can be treated as a separate class (personally I prefer MFs to ULIPs). The other traditional plans like endowment, money-back and whole-life insurance plans can be avoided. If you are young and planning for retirement, you can avoid buying Pension plans too.
  • ULIPs
    • The maturity proceeds from ULIP policy are tax-free.
    • Insurance policy proceeds received by the family members in the event of death of the policy holder is completely tax exempt under section 10 of the income tax act.
    • If you surrender the policy before maturity, the taxability would depend on whether you have paid 5 premiums on the policy or not. If you have paid so, taxability would be nil. Else, the surrender value will be added to your total income for the year and taxed accordingly.

If you are aware of the tax implications at various investment stages, you can pick tax-efficient investment options.  Tax efficiency is a measure of how much of an investment’s return is left over after taxes are paid. Tax efficiency is essential in order to maximize net returns on our investments. Below picture gives you an idea on the tax treatment of some of the popular financial instruments at various investment stages i.e., Contribution -> Accumulation -> Withdrawal;

(NPS withdrawals will fall under EEE category w.e.f April, 2019)

Asset Allocation is a very important investment strategy. You should invest in suitable financial products or Asset Classes based on your financial goals. If an investment option meets your requirements and is also a tax efficient one then it is well and good. Your investment strategy is to max out your after-tax returns.

(Image courtesy of Stuart Miles at FreeDigitalPhotos.net) 

(Post published on : 07-October-2016)