A couple of years after I began working, I managed to notch up a respectable balance in my savings account. No longer financially dependent on my parents, , I decided it was time to start investing to grow my money. However, I quickly learned that even if your investments make 50 per cent returns, you don’t get to keep all of it. You have to pay taxes on your gains, and watching your money get deducted is never pleasant.
That’s when my chartered accountant, Abhay Asknani, gave me some valuable advice. He said, ‘Focusing only on increasing profits isn’t the best strategy. You need to have an active tax-management plan to ensure your returns are maximised and your taxes are minimised.’
Let’s dive into how to achieve that:
Understanding Tax Implications
First and foremost, it’s crucial to understand the tax implications of any asset you plan to invest in. In equity investments, the tax you pay on gains depends on how long you hold the asset. If you sell the asset within a year, the gains are considered Short Term Capital Gains (STCG) and are taxed at 15 per cent. If you hold the asset for more than a year, the gains fall under Long Term Capital Gains (LTCG) and are taxed at 10 per cent. However, you get an exemption on LTCG up to ₹1 lakh annually. So if your total LTCG is less than ₹1 lakh in a financial year, you don’t need to pay any tax on it. Whether you invest in equity or bonds, understanding these tax implications is essential.
Here are a few strategies to help you maximise returns while minimising taxes:
1. Invest In Tax-Exempt Assets: If your risk tolerance permits, consider investing in tax-saving options that offer higher returns. For instance, instead of tax-saving fixed deposits, you might invest in Equity-Linked Savings Schemes (ELSS) mutual funds. For lower-risk options, the Public Provident Fund (PPF) and Employees' Provident Fund (EPF) offer tax benefits under Section 80C. The National Pension System (NPS) also provides tax advantages under Section 80CCD. Beyond upfront tax savings, look for assets where gains are tax-exempt, like PPF and EPF, which are preferable to options where you must pay taxes on capital gains.
2. Avoid Frequent Churning: Reduce taxes by avoiding frequent buying and selling of stocks. Frequent trading can lead to higher STCG taxes. Instead, adopt a long-term strategy, holding stocks for over a year to benefit from the lower LTCG tax rates. By minimising transaction frequency, you reduce tax liability and allow your investments to grow over time, resulting in more tax-efficient returns.
3. Tax Loss Harvesting: Use tax loss harvesting to reduce your taxes by offsetting capital gains with capital losses. This involves selling investments that have decreased in value to offset gains from other investments. For example, if you have two stocks, A and B, where A has gained value and B has lost value, you can sell B to realise the loss, which can then offset the gains from selling A, reducing your overall tax liability. Note that capital losses can only offset capital gains within the same financial year, and any unused losses can be carried forward for up to eight years.
4. Maintain A Balanced Portfolio: A balanced portfolio helps in reducing taxes and increasing gains by allocating investments across various asset classes. Diversify your holdings into equities, bonds, and other instruments to take advantage of different tax treatments. For instance, dividends from equities might be tax-free, while interest income from bonds could be taxed differently. A balanced portfolio also helps manage risk and reduces the need for frequent trading, minimising capital gains taxes. Periodic rebalancing can lock in gains from high-performing assets and offset losses, contributing to a more tax-efficient strategy.
5. Consult A Tax Advisor: If all this seems overwhelming, consult a tax advisor. Mistakes in tax planning can be costlier than consulting fees. Tax laws and regulations can change, and their impact on your investments can be complex. A tax advisor can help tailor your investment strategy to your specific financial situation and goals.
By implementing these strategies, you can effectively manage your tax liability and maximise your investment returns.