How to calculate capital gains tax for the portfolio?

Come financial year end and most of the investors get jittery about tax implications of their portfolio, especially with all the accounting it involves. Many investors do not know how to calculate the tax liability for their portfolio. Knowing tax capital gains tax liability not only helps in filling income tax return but it could also help in making sell decisions. In this post we will walk through the capital gains tax and its calculation.

What is Capital Gains Tax?
Capital Gains tax is the tax that an investor has to pay on the income earned from his investments in a given financial year. These include income from selling stocks, mutual funds, bonds etc.
There are two categories of capital gains:-

• Short Term Capital Gains - Gains earned from securities that were held for less than a year
• Long Term Capital Gains - Gains earned from securities that were held for a year or more.

Capital Gains Tax Structure
Following table summarizes the current capital gains tax structure:-

Direct Equity		Mutual Funds
		Equity		Non Equity
Short Term	Long Term	Short Term	Long Term	Short Term	Long Term
15.45% = 15% + 3%*	Nil	15.45% = 15% + 3%*	Nil	Applicable Income Tax Slab + 3%*	10.30% (Without Indexation) = 10% + 3%* 20.60% (With Indexation) = 20% + 3%*

* = Education Cess
Indexation helps in reducing the tax liability by taking into account the effect of inflation on the purchase price of a security.

Dividend Distribution Tax
Apart from Capital Gains tax there is tax implication on the dividend earned on held securities. Following table summarizes the dividend distribution tax:-

Direct Equity	Mutual Fund
	Equity	Debt Schemes	Money Market and Liquid Schemes
Nil	Nil	13.519% = 12.5% + 5%** + 3%*	27.0375% = 25% + 5%** + 3%*

* = Education Cess, ** = Surcharge  

Capital Gains Tax Computation
Capital Gains Tax Computation is three step process.

1. Determining the holding period for the security
First step in calculating the capital gains tax is to determine the duration for which the security was held before it was sold. This is simple if there was only one buy and one sell transaction in a security. In this case it would simply be the difference between sell and buy dates. But when there are multiple buy and sell transactions in the same security then the principle of First In First Out (FIFO) has to be applied.
Lets try to understand using the following diagram


In the diagram above, there were three buy transactions and two sell transactions. First sell transaction occurred on 15-Jan-13. Shares sold under this transaction would be adjusted against shares bought on 15-Feb-12. Since the holding period for these shares was 11 months therefore, it would be considered as short term capital gain. Second sell transaction of 100 shares happened on 15-Mar-13. Now first 50 shares out of the 100 would be adjusted against 50 shares bought on 15-Feb-12. Since holding period for these was 13 months, therefore, it would be considered as long term capital gain. Second 50 would be adjusted against 50 shares bought on 10-May-12. Since holding period for these was 10 months, therefore, they would be considered as short term capital gains.

2. Computing the Capital Gains
After computing holding periods for all the security transactions we would compute the capital gains earned for each of the transaction. Following table summarizes the capital gains earned in the example above.

Sell Transaction Date	Corresponding Buy Transaction Date	Holding Period	Capital Gain Type	Capital Gain
15-Jan-2013	15-Feb-12	11 Months	Short	50 * 350 – 50 * 200 = 7500
15-Mar-2013	15-Feb-12	13 Months	Long	50 * 400 – 50 * 200 = 10000
15-Jan-2013	10-May-2012	10 Months	Short	50 * 400 – 50 * 250 = 7500

 

3. Computing Tax Liability

Financial Year	Capital Gain Type	Capital Gain	Tax Liability
2012-13	Short	7500 + 7500 = 15000	15000 * 0.15 = 2250
2012-13	Long	10000	Nil

Same procedure can be applied for all the instruments held in the portfolio to determine the capital gain type and the actual capital gain tax for the overall portfolio.

I hope this would help the investors in clarifying the tax calculations for their portfolio.