Do You Need to Pay Tax on Capital Loss from Selling Equity Shares/Equity Mutual Fund Units?

When you sell equity shares or equity mutual fund units and incur a capital loss, it’s crucial to understand how this loss is treated under the Income Tax Act. While you don't pay taxes on a capital loss, the key lies in how you manage this loss in your tax filings. In this blog, we will break down the nuances of capital losses, how to report them, and the opportunities for tax relief that they offer.

What is Capital Loss?

A capital loss arises when the sale price of an asset (like equity shares or equity mutual funds) is lower than its purchase price. In simple terms, it's the loss you incur when you sell an asset at a price below what you initially paid for it.

• Short-Term Capital Loss (STCL): When you sell equity shares or mutual fund units within one year of buying them, and the sale price is lower than the purchase price, you incur a short-term capital loss.

• Long-Term Capital Loss (LTCL): If the holding period exceeds one year for equity shares or equity mutual funds, the loss from the sale will be treated as a long-term capital loss.

Do You Pay Tax on Capital Loss?

The short answer is no, you don't pay tax on a capital loss. Capital loss doesn't attract tax liability, but it can have an impact on your overall tax calculations.

Capital Loss vs. Capital Gain

• Capital Gain is the profit made from the sale of an asset (equity shares, mutual funds, real estate, etc.) at a price higher than the purchase price.

• Capital Loss, on the other hand, occurs when the sale price is lower than the purchase price.

In case of capital gains, you are required to pay tax on the profit. However, capital losses can be used to offset your taxable gains.

How to Set Off Capital Loss?

Although you don't pay tax on capital losses, the Income Tax Act allows you to set off these losses against other capital gains, thereby reducing your overall tax liability. The ability to set off capital losses can be a significant tool in tax planning, and here's how it works:

1. Set Off of Short-Term Capital Loss (STCL)

• STCL from Equity Shares/Equity Mutual Funds:

  • If you incur a short-term capital loss on the sale of equity shares or equity mutual funds, you can set it off against short-term capital gains (STCG) from other sources.

  • For example, if you sell other stocks and incur a STCG of ₹1,00,000, and you have a STCL of ₹50,000 from a separate transaction, the loss will offset the gains, leaving you with only ₹50,000 taxable STCG.

  • If the STCL exceeds your STCG, the remaining loss can be carried forward.

2. Set Off of Long-Term Capital Loss (LTCL)

• LTCL from Equity Shares/Equity Mutual Funds:

  • Long-term capital loss can only be set off against long-term capital gains (LTCG).

  • For example, if you have an LTCL of ₹30,000 from the sale of mutual funds, you can set it off against long-term capital gains you earned from the sale of other securities, like real estate or other equity investments.

3. Carrying Forward Capital Losses

If your capital losses (whether STCL or LTCL) exceed the capital gains in a given financial year, you can carry forward the losses to subsequent years and set them off against future capital gains.

• Time Limit for Carry Forward: Capital losses can be carried forward for up to 8 consecutive assessment years. This means, if you can’t set off all your losses in the current year, you can carry them forward and set them off against future gains, thereby reducing your tax liability in the upcoming years.

• Important Condition: To carry forward the capital losses, you must report the loss in your Income Tax Return (ITR) for the year in which the loss occurred. If the loss is not declared, you lose the right to carry it forward.

Can You Set Off Capital Loss Against Other Income?

No, capital losses cannot be set off against income from other sources such as:

• Salary

• House property income

• Business income

For example, if you have a salary income of ₹5,00,000 and a short-term capital loss of ₹1,00,000, you cannot reduce your salary income by the capital loss. The capital loss can only offset capital gains, as discussed above.

Tax Benefits of Setting Off Capital Losses

While you may not be able to directly claim a deduction for your capital losses, the tax benefit arises from the ability to offset those losses against other capital gains. This can reduce your overall taxable capital gains, lowering your tax liability.

Additionally, if you carry forward the capital loss to future years, you may be able to set it off against capital gains in those years, potentially resulting in significant tax savings over time.

Steps to Report Capital Loss in Your ITR

When filing your Income Tax Return (ITR), you must report your capital losses accurately to avail of the set-off and carry-forward benefits.

Steps to File Capital Loss in ITR:

1. Declare the Sale Transactions: You need to declare the sale of equity shares and mutual funds under the Capital Gains section of ITR.

2. Enter the Details of the Sale: You must mention the sale price, purchase price, and the resulting capital loss for each transaction.

3. Set Off and Carry Forward Loss: If you have any other capital gains in the current year, apply the set-off rule. If your capital losses exceed your gains, opt for carrying forward the remaining loss.

4. File the Return: Submit the ITR with accurate details about the capital loss and your intent to carry it forward, if applicable.

Conclusion

You do not pay tax on a capital loss incurred from the sale of equity shares or equity mutual fund units. However, you can use that loss to offset capital gains and reduce your overall tax liability. Additionally, if you don't have gains to offset the loss in the current year, you can carry it forward to future years and set it off against future capital gains.

It’s important to report your capital loss correctly in your Income Tax Return, as failure to do so may result in the loss being disallowed for future carry-forward. If you’re unsure about how to handle capital losses in your tax filing, consulting a tax expert can help ensure you are using this provision effectively to maximize your tax benefits.