Effective tax planning includes choosing the right investment option in order to maximize wealth and to generate higher returns in the long run. Individuals can, directly and indirectly, invest in the share market.
A direct investment means investing in stocks and equity savings scheme. Indirect investment means investing in the mutual fund, insurance, and National Pension Scheme [NPS]. There are various tax benefits available on an investment in equity. Some of the primary ones are discussed below:
Tax-free dividends
A large number of companies distribute their income amongst shareholders in the form of a dividend. The dividend is an income for the investor and the same is completely tax-free under the Income Tax Act. Any amount received in the form of the dividend is not taxable.
Long-term capital gains
When the shares are sold in the share market, investors either make a gain on the sale or suffer a loss. If the shares are sold at a price higher than the purchase price, it will be a gain and in case they are sold at a lower price, there will be a loss. Shares that are held for more than one year are known as long-term and the gain on the sale of such shares is exempt from taxation. In case of a short-term gain, it will remain taxable at 15%, regardless of the income tax slab the investor falls in. This implies that long-term investors can significantly benefit from taxation in case of capital gains.
Set off and carry forward of capital gains
The purchase and sale of shares are carried out through a demat account. The biggest tax benefit with regard to investing in equities is the option to set off capital gains. Short-Term Capital Gains [STCG] and Short-Term Capital Loss [STCL] can be adjusted against each other. Similarly, Long-Term Capital Loss [LTCL] and Long-Term Capital Gains [LTCG] can also be adjusted against each other. The capital loss can even be carried forward for up to eight financial years.
Equity-Linked Savings Scheme [ELSS]
Investment through ELSS has a number of benefits. It is liable for a deduction to the tune of INR 1.5 Lakh under Section 80C of the Income Tax Act. It has a lock-in period of three years and the dividend, as well as long-term capital gains, remain tax-free. If individuals are investing for the sole purpose of tax saving, this is an ideal choice.
Rajiv Gandhi Equity Savings Scheme
The scheme can earn tax benefits amounting to INR 50,000 and has a lock-in period of three years. Further, it is available to only those investors who have an income of less than INR 12 Lakh a year. It is considered as a preferred option of investment for the purpose of a deduction under the Income Tax Act.
Every investor should choose an investment strategy based on their long-term goals. In addition to making the most out of tax benefits, wealth maximization should be the goal. With a number of investment avenues available in the share market, it is possible to reduce the tax liability and maximize wealth at the same time.