MT: Indian Tax on stock/mutual funds

[RRK]

I want to open this discussion for stock sale gain/loss computation as applicable under Indian Tax code. Let us forget about DTAA, US taxation laws.

Background:
Person is Indian resident.
Have brokerage account in India.
Bought/Sold stocks traded in BSE/NSE.

Wash Sale Questions:
1. Is there a rule for "wash sale" ? ( In US if a stock is sold for loss, you should have not bought the same stock within 30 days of the sale or the loss is disallowed and the loss is added to the cost basis ).

In India, as I know there is no law for that.

2. If there is no law for Wash sale, can I sell the stock in my account for a loss and buy the same in my spouse account on the same day and claim loss from the first sale ?

I think the answer is Yes

3. Can I sell the stock in my account for a loss and buy the same stock in my another brokerage account on the same day and claim loss from the first sale ?

I think the answer is Yes

Lot identification questions:
4. If I buy a stock on different days of the year as below and sell some,

Buy REL 10 at Rs.100 on 1/1
Buy REL 10 at Rs.120 on 1/15
Buy REL 10 at Rs.130 on 2/1
Buy REL 10 at Rs.140 on 2/15
Buy REL 10 at Rs.150 on 3/1

Sell REL 20 at Rs.160 on 3/15

Can I choose the 20 to be the stocks I bought on 2/15 and 3/1. ( I am choosing the one with higher cost basis to minimize my ST capital gains ) ? Or should it be first in first out ?

I think the answer is Yes, you can choose the lot you wish.

5. I buy 100 shares of ITC at Rs.1000 and they offer a bonus of 100 shares ( In US, it is called stock split, and In US my cost basis will be 1000/200=Rs.5 per share).

In India, I have 100 shares with cost basis of Rs.10 and 100 shares with cost basis of Rs.0.

I sell only 100 shares at Rs.1200; I mark the shares I originally bought at Rs.10 a piece and compute short term tax on gain of Rs.200 and keep the 100 bonus shares for 12 months and sell to make it LTCG and pay zero tax.

Is this legally correct ?

I think the answer is Yes, it is legally correct.

I have given questions and my thoughts along with that. On the surface it will sound like a scam to those who are filing returns in US, but it is not.

Members who know Indian taxation and filing taxes regularly please share your thoughts.

[Bobus]

Allowability of Capital Loss and Dividend Stripping

Capital loss that amounts to dividend stripping is not allowed as a capital loss for Indian income tax purposes, per Section 94(7).

In the case of share, if purchase is made within 3 months prior to date of record for dividend and sale made within 3 months of date of record for dividend, then cap loss to the extent of tax free dividend received in the intervening period will not be allowed as a deduction.

In the case of unit of mutual fund, if purchase is made within 3 months prior to date of record for dividend and sale made within 9 months of date of record for dividend, then cap loss to the extent of tax free dividend received in the intervening period will not be allowed as a deduction.

Cost Flow Assumption

FIFO has to be used if specific identification method is not feasible i.e. where share numbers - for shares purchased in different lots - are not available.

Bonus Shares and Bonus Units of Mutual Funds

Bonus shares and Bonus units of mutual funds have a zero cost basis.

Bonus Units from Mutual Funds and Allowability of Cap Loss

Per Section 94(8), if a person buys units within 3 months of date of allotment of bonus units, and within a period of 9 months of date of allotment of bonus units sells some (but not all) of the units at a cap loss and holds on to the bonus units, then the cap loss will not be allowed.

[Bobus]

General Rules

http://www.rediff.com/money/2006/dec/19tax.htm

Extract

Loss under Capital Gains. Capital loss assessed under the head 'capital gains' cannot be set off against income under any other head. Capital loss can be set off against capital gains income only.

Further, long-term capital loss cannot be set off against short-term capital gains. Unadjusted capital loss can be carried forward up to eight years. Long-term capital loss cannot be set off against short-term capital gains even during this period.

[RRK]

Bobus,

Thanks, I am aware of the dividend impact on computing losses. This is why I avoided such situation in post#1. If some one can take care of the dividend part, I think #1 situations give several methods to reduce/post pone tax legally.

Let me add some more to the list.

1 ) Since LTCG tax on stocks and stock mutual funds are zero, I think LT capital loss from stock can't be claimed. Or GoI is only not taxing the gains but allow the losses for adjustment ? That would be great !

2) I know the losses can be adjusted only against similar type gains ( STCL against STCG and LTCL against LTCG), how does one adjust LTCL arising out of stocks and stock mutual fund sales ?

I think the answer is it can be adjusted against other LTCG arising out of bond funds sales (>1 year) and real estate sale gains ( >3 years). Need confirmation.

Tks,

[Bobus]

The info about restriction on exploitation of dividend stripping in #2 was posted as a caveat to what was posted in #1. So also was the info posted in #2 about cost flow assumptions, and bonus units from mutual funds.

1 ) Since LTCG tax on stocks and stock mutual funds are zero, I think LT capital loss from stock can't be claimed. Or GoI is only not taxing the gains but allow the losses for adjustment ? That would be great !

LTCL from Indian stocks / Indian equity mutual funds can be claimed as a deduction against LTCG from any capital asset, even though tax rate on LTCG on Indian stocks / Indian equity mutual funds is zilch.

2) I know the losses can be adjusted only against similar type gains ( STCL against STCG and LTCL against LTCG), how does one adjust LTCL arising out of stocks and stock mutual fund sales ?

STCL adjustment against STCG, and LTCL adjustment against LTCG are not the only permissible adjustments. In addition, STCL is allowed to be adjusted against LTCG. What is NOT allowed is adjustment of LTCL against STCG.

I think the answer is it can be adjusted against other LTCG arising out of bond funds sales (>1 year) and real estate sale gains ( >3 years). Need confirmation.

LTCL from Indian stocks / Indian equity mutual funds can be claimed as a deduction against LTCG from any capital asset, not merely LTCG arising from bonds or real estate.

[eserve_investor]

RRK:

As per my knowledge, Indian law is such that sales can be adjusted only on a FIRST-IN-FIRST-OUT basis. Atleast, this is the method that my auditor has religiously followed in the last couple of years.

I asked him about LOT identification a few years back, he said "NO". Based on my auditor's prior opinion on this, I would say (4) is an incorrect assumption on your part.

The rest looks okay to me. Actually, I just made some wash sale in today's down market and barely avoided paying surcharge. I just finished calculating the Advance Tax to be paid by today (3/15). That's why I am up and awake at 2:45 AM IST !

[quote]
RRK post:
Lot identification questions:
4. If I buy a stock on different days of the year as below and sell some,

Buy REL 10 at Rs.100 on 1/1
Buy REL 10 at Rs.120 on 1/15
Buy REL 10 at Rs.130 on 2/1
Buy REL 10 at Rs.140 on 2/15
Buy REL 10 at Rs.150 on 3/1

Sell REL 20 at Rs.160 on 3/15

Can I choose the 20 to be the stocks I bought on 2/15 and 3/1. ( I am choosing the one with higher cost basis to minimize my ST capital gains ) ? Or should it be first in first out ?

I think the answer is Yes, you can choose the lot you wish.
[/quote]

[Bobus]

eserve investor # 6:

Neither what you posted in #6 nor what RRK posted in #1 is correct regarding allowable cost flow assumptions, per Indian tax law, when it comes to sale of stock - specific identification method versus FIFO method.

Let me copy and paste in blue below what I posted earlier in #2, and then elaborate on it.

Cost Flow Assumption

FIFO has to be used if specific identification method is not feasible i.e. where share numbers - for shares purchased in different lots - are not available.

Elaboration

Please feel free to read CBDT circular by clicking on the link below, which supports the above position.

http://www.incometaxindia.gov.in/circulars/1995/Cir704.asp

Consider shares held in a demat account. Shares in demat form are not uniquely identifiable - they do not have scrip numbers. In such a case, specific identification is simply not feasible and FIFO is the only allowed method.

In contrast, specific identification is allowed (no compulsion to follow FIFO), if shares are held in paper form, where share certificates have distinctive/unique numbers.

Further, in the event someone has mutiple demat accounts, then FIFO needs to be applied only within each demat account, not across demat accounts.

I welcome corrections that are backed up with references to authoritative sources.

Full Text of Circular

Circular No: 704

Date of Issue: 28/4/1995

Section(s) Referred: 10(23D) , 2(42A)

Statute: Income-Tax Act

Subject : Transactions in securities--Determination of the 'date of transfer' and holding period for the purpose of capital gains--Instructions regarding.

Under the provisions of sub-section (42A) of section 2 of the Income-tax Act, 1961, the shares held in a company or any other security listed in a recognised stock exchange in India or units of the Unit Trust of India or units of a mutual fund specified under section 10(23D) shall be regarded as short-term capital assets if they are held by an assessee for not more than 12 months immediately preceding the date of its transfer. Clarifications have been sought as to which date should be regarded as the date of transfer and also about the date from which the holding period of the securities should be reckoned. Clarifications have also been sought as to how the holding periods will be computed for the purposes of capital gains when the securities, purchased in several lots at different points of time and which are taken delivery of in one lot, are subsequently sold in parts and no correlation of the dates of purchase and sale is available.

2. When the securities are transacted through stock exchanges, it is the established procedure that the brokers first enter into contracts for purchase/sale of securities and thereafter, follow it up with delivery of shares, accompanied by transfer deeds duly signed by the registered holders. The seller is entitled to receive the consideration agreed to as on the date of contract. The Board are of the opinion that it is the date of broker's note that should be treated as the date of transfer in cases of sale transactions of securities provided such transactions are followed up by delivery of shares and also the transfer deeds. Similarly, in respect of the purchasers of the securities, the holding period shall be reckoned from the date of the broker's note for purchase on behalf of the investors. In case the transactions take place directly between the parties and not through stock exchanges, the date of contract of sale as declared by the parties shall be treated as the date of transfer provided it is followed up by actual delivery of shares and the transfer deeds.

3. As regards the second issue, where securities are acquired in several lots at different points of time, the First-in-first-out (FIFO) method shall be adopted to reckon the period of the holding of the security, in cases where the dates of purchase and sale could not be correlated through specific numbers of the scrips. In other words, the assets acquired last will be taken to be remaining with the assessee while assets acquired first will be treated as sold. Indexation, wherever applicable, for long-term assets will be regulated on the basis of the holding period determined in this manner.
4. These instructions may be brought to the notice of all Assessing Officers in your region.
(Sd.) Pravin Kumar,
Under Secretary (ITA-II),
Central Board of Direct Taxes

[RRK]

Bobus,
Thanks for the research and reference.

I approached two CAs. One suggested FIFO and another said, I could do lot identification by my own choice. Both of them could not back it up with reference.

Hence I came here with that question. Now the circular you posted is dated in 1995. Is there a way to find out whether there is any amendment made after that date ?

eserve,
Thanks for your response.

When you answer my question, in the first part you said only FIFO is allowed, but in the second part, you answered I can pick any lot. They seem to be contradictory. Comments ?

[RRK]

In US you can do lot identification with demat account.
If FIFO is the only method allowed, how do I handle these events.

I own 50 shares of RIL, I sell 10 on a particular day in the morning and buy it back on the same day evening. ( Cover the short). These transaction is not settled through my demat account, no delivery happens in my account. The trades are squared off, I get the debit or credit in my account. So, I have to use the gain/loss as short term from just these two transaction.

Since my demat account is not touched, I think the cost basis of my shares in demat account doesn't matter here. ( eserve, let me know what you tax advisor thinks of this situation ? No FIFO here, right ? who is your brokerage and how does he settle transaction like this )

Situation-ii: In the same way the buy is done in the morning and sell is done in the evening, again the transaction is squared off by broker w/o involving demat account. ( Cover the long)

I would prefer FIFO in some situation. ( where it is advantageous). If the stock was bought a year back, it is good for me to use FIFO and avoid taxation of all gains. There FIFO by seniority will help.

[Bobus]

Now the circular you posted is dated in 1995. Is there a way to find out whether there is any amendment made after that date?

You may feel free to execute the following steps in sequence:

Visit http://law.incometaxindia.gov.in/

Place cursor on Tax Law and Rules, then on Acts, and click on IT Act.

Ask for Sectionwise listing of IT Act and then click on Section 2 which deals with definitions.

Check Section 2(42A) which defines ST cap asset, which is reproduced below:

[83(42A) 84[short-term capital asset means a capital asset held by an assessee for not more than 85[thirty-six] months immediately preceding the date of its transfer :]

Now click on footnote 83 that will ask you to see Circular 704 which was posted earlier, which suggests that the Circular has not been superceded.


When you answer my question, in the first part you said only FIFO is allowed, but in the second part, you answered I can pick any lot. They seem to be contradictory. Comments ?

I know the above is addressed to Member eserve investor. However, I am taking the liberty of responding. The second part of his post was a copy and paste of your earlier post.