Important Keyword: income from trading, Income Tax.

Tax Loss Harvesting for Stock Traders

Investing in the stock market is often driven by the goal of generating profits. However, there are occasions when certain stocks may not perform as expected due to various factors such as the company’s financial health or external market conditions. As a result, investors may incur losses on their investments. Nonetheless, investors can employ a strategy known as tax loss harvesting to mitigate these losses.

Tax loss harvesting involves strategically selling shares that have experienced losses in order to offset any realized gains within the same financial year. By doing so, investors can effectively reduce their overall tax liability. This proactive approach allows investors to make the most of their investment portfolio by leveraging losses to optimize their tax situation.

What is Tax Loss Harvesting?

At the close of a financial year, some of the shares and mutual funds in your portfolio may show an unrealized loss. This means that if these assets were sold, the selling price would be lower than the purchase price, resulting in a loss. Conversely, some shares and mutual funds may have already been sold at a profit, resulting in realized gains.

Let’s consider an example to illustrate how this works:

1. Shares or mutual funds showing unrealized losses are sold before the end of the financial year, thereby realizing the loss.
2. This realized loss can then be used to offset other profits, thereby reducing the overall tax liability.
3. Essentially, this process involves harvesting unrealized losses to minimize taxes.
4. If the trader wishes to maintain their investment in the asset, they can repurchase it to keep their portfolio unchanged. Typically, traders are willing to incur transaction costs for these transactions rather than facing higher taxes.

In summary, tax loss harvesting involves strategically selling assets with unrealized losses to offset gains and reduce tax liability, while also considering the impact on the overall investment portfolio.

Example of Tax Loss Harvesting

Below is a snapshot of the P&L Statement of a trader as of 28.03.2022. The tab refers to short-term equity trades.

Before Tax Loss Harvesting

After Tax Loss Harvesting

The trader can sell 300 shares of Crest and 250 shares of Deepakfert to realize a loss of INR 1,27,500

By strategically realizing losses through Tax Loss Harvesting, traders can effectively reduce their tax liabilities. Additionally, if a trader wishes to maintain the composition of their investment portfolio, they have the option to repurchase specific shares. For instance, they might choose to acquire 300 shares of Crest and 250 shares of Deepakfert again. This approach not only allows traders to optimize their tax situation but also enables them to preserve the structure of their investment holdings.

Taxation on Trading Income

Before embarking on Tax Loss Harvesting, traders must be equipped to calculate their income tax liability on trading income and understand the applicable tax rates. This knowledge empowers traders to make informed decisions about whether to pursue this strategy. When it comes to taxation, traders have the flexibility to treat their income from trading in equity shares or mutual funds either as Capital Gains Income or as Non-Speculative Business Income, depending on the nature of their trading activities.

Let’s delve into the applicable tax rates:

A. Trading Income Considered as Capital Gains

B. Trading Income Considered as Non-Speculative Business Income – Income is taxable at slab rates as per the Income Tax Act.

For traders treating their trading income as Non-Speculative Business Income, taxation follows the slab rates outlined in the Income Tax Act. This means that the income tax liability is determined based on the trader’s total taxable income for the financial year.

Tax Loss Harvesting presents an opportunity for traders engaged in equity delivery and mutual fund trading. However, it’s important to note that this strategy isn’t applicable to other forms of trading such as equity intraday, equity F&O, commodity trading, and currency trading. In these cases, positions are typically squared off within the same trading day or on specific expiry dates, limiting the opportunity for tax loss harvesting.

Rules for Set-Off

The trader intending to engage in Tax Loss Harvesting should possess the ability to discern which losses can offset which profits, adhering to income tax regulations governing the set off and carry forward of losses. However, the decision to convert unrealized losses into realized losses must be made after careful analysis of the potential income streams against which these losses can be offset. If the loss cannot be set off against existing profits, opting for Tax Loss Harvesting may not be advisable.

For Equity Trading Income treated as Capital Gains:

• Long Term Capital Loss (LTCL) can only offset Long Term Capital Gains (LTCG).
• Short Term Capital Loss (STCL) can offset both Short Term Capital Gains (STCG) and Long Term Capital Gains (LTCG).
• LTCL and STCL cannot offset any other income.

For Equity Trading Income treated as Non-Speculative Business Income:

• Non-Speculative Business Loss can offset any income except Salary Income.
• Note: Traders with only Salary Income cannot offset Non-Speculative Business Loss against it. Hence, if Salary Income is the sole income, Tax Loss Harvesting may not be viable.

Read More: Expenses a Traders Can Claim in ITR

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Official Income Tax Return filing website: https://incometaxindia.gov.in/