How much tax is required on earnings from the stock market, and what are the rules regarding it; learn everything here.

News Topical, Digital Desk : Income from investments in the stock market is also subject to income tax rules. Investors typically earn income from the stock market in two ways: dividends paid by companies and capital gains from the sale of shares. The tax rules for these two types of income are different. Therefore, it is important for investors to understand how income tax is calculated and what role rules like FIFO play in this process.

How much tax is levied on Dividend?

If an investor receives dividends from a company, they are added to their total income. According to the Income Tax Act, this income falls under the head "income from other sources" and is taxed according to the individual's applicable income tax slab. This means that investors with lower incomes will have a lower tax burden, while those with higher incomes may have to pay higher taxes.

According to experts, if an investor has taken out a loan to purchase shares, they may be eligible for some tax relief on the interest paid on that loan. However, this deduction is limited to a maximum of 20 percent of the total dividend income. There is no tax exemption on other expenses such as brokerage, commission, or service charges.

Understand with an example

For example, if an investor received a dividend of ₹1 lakh and paid ₹35,000 in interest on a loan taken to purchase shares, they can claim a maximum deduction of ₹20,000. Thus, their taxable dividend income would be ₹80,000.

How much tax is levied on shares 

The profit earned from selling shares is called capital gain. Depending on the holding period, it is divided into two parts: long-term capital gain (LTCG) and short-term capital gain (STCG).

If an investor holds listed shares for more than 12 months, the profit earned from selling them is considered long-term capital gains (LTCG). In such cases, gains up to ₹1.25 lakh are exempt from tax, while gains above that amount are taxed at a rate of 12.5 percent. This rule applies only if Securities Transaction Tax (STT) was paid at the time of purchase and sale of the shares.

Whereas, if the shares are sold after holding them for less than 12 months, then the profit earned from it is considered as short-term capital gain i.e. STCG, which is taxed at the rate of 20 percent, provided STT has been paid on that transaction.

Which stock should I sell first?

Additionally, investors in the stock market often purchase shares of the same company at different times. When they sell shares, it's important to determine which shares were sold first. The FIFO (first-in, first-out) rule applies. According to this rule, the shares purchased first in a demat account are considered the first to be sold.

According to experts, under Indian tax laws, the cost and holding period for shares and mutual fund units held in demat accounts are calculated using this FIFO method. This maintains transparency and uniformity in tax calculations and prevents investors from attempting to evade taxes by selecting different lots as per their convenience.

Many experts believe that it can be beneficial for investors to have two separate demat accounts. One account can be used for long-term investments and the other for trading. This makes tax management easier.

If all transactions are made from a single demat account, the FIFO rule can sometimes result in your lower-cost and longer-held holdings being considered sold first, leading to higher taxes beyond short-term capital gains. Using separate accounts makes it easier to maintain a clear distinction between long-term investments and short-term trading.

While having multiple demat accounts is perfectly legal and permitted by regulatory authorities, investors are required to declare transactions made in all their accounts in their income tax returns based on their PAN.

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