Taxation of Equity Shares in India: What Investors Should Know

When an investor exits an Indian company by selling equity shares, the transaction attracts capital gains tax under the Income Tax Act, 1961. The law treats any right in relation to an Indian company as a capital asset. As a result, any surplus earned on the sale of equity shares is taxed as capital gains. 

Capital gains are classified as either short-term or long-term depending on the period for which the shares are held. This classification determines the applicable tax rate and exemptions. 

Short-Term and Long-Term Capital Assets 

With effect from July 23, 2024, a capital asset is considered long-term if it is held for more than 24 months. However, equity-related instruments follow specific holding period rules. Equity shares, debentures and bonds listed on a recognised stock exchange in India, units of equity-oriented mutual funds whether listed or unlisted, and units of debt-oriented mutual funds listed on a recognised stock exchange qualify as long-term capital assets if held for more than 12 months. If held for a shorter period, the gains are treated as short-term capital gains. 

Computation of Capital Gains on Equity Shares 

Short-term capital gain or loss is computed by deducting the cost of acquisition and transfer-related expenses from the full value of consideration. Long-term capital gain or loss is computed in the same manner. Indexation benefit on equity shares has been withdrawn for sales made on or after July 23, 2024. Securities Transaction Tax is not allowed as a deduction while computing capital gains, whether short-term or long-term. 

Tax Rates on Sale of Equity Shares 

Where Securities Transaction Tax is applicable, short-term capital gains under Section 111A are taxed at 20 percent plus applicable surcharge and cess for transactions from July 23, 2024. Prior to this date, the rate was 15 percent. Long-term capital gains under Sections 112 and 112A are taxed at 12.5 percent plus surcharge and cess from July 23, 2024, as compared to 10 percent earlier. Long-term capital gains on listed equity shares are exempt up to Rs. 1.25 lakh in a financial year under Section 112A. The surcharge on tax payable under Sections 111A, 112 and 112A is capped at 15 percent. 

Grandfathering of Shares Purchased Before January 31, 2018 

Earlier, long-term capital gains on listed equity shares were exempt under Section 10(38). This exemption was withdrawn from February 1, 2018. To ensure that appreciation in value up to January 31, 2018 was not taxed, a grandfathering mechanism was introduced. The cost of acquisition is determined by comparing the actual cost of acquisition with the lower of the fair market value as on January 31, 2018 or the actual sale price. The higher of these two amounts is taken as the cost of acquisition. For listed shares, the fair market value is the highest quoted price on the recognised stock exchange on January 31, 2018, or the immediately preceding trading day if there was no trading on that date. 

For example, if shares were purchased at Rs. 410 per share in September 2017, had a fair market value of Rs. 730 on January 31, 2018, and were sold at Rs. 760, the grandfathered cost would be Rs. 730 per share. The taxable long-term capital gain would therefore be Rs. 30 per share. 

Tax Impact of Common Corporate Actions 

During its lifetime, a company may issue bonus shares, rights shares, undertake stock splits, consolidate shares, or buy back its shares. Each of these actions has specific tax implications when the investor subsequently sells the shares. 

Bonus shares are issued to existing shareholders without any payment. If bonus shares are allotted before April 1, 2001, the fair market value as on April 1, 2001 is treated as the cost of acquisition. If allotted on or after April 1, 2001, the cost of acquisition is taken as zero. The period of holding is calculated from the date of allotment of the bonus shares. 

Rights shares are issued to existing shareholders in proportion to their holdings. If the right entitlement is sold, the cost of acquisition is taken as zero and the gain is treated as short-term capital gain. If the rights shares are subscribed and later sold, the cost of acquisition includes the amount paid, including any premium. 

A stock split does not result in any immediate tax liability. The number of shares increases, but the total investment value remains unchanged. The cost per share is adjusted accordingly, and capital gains tax applies only when the shares are sold, based on the revised cost and the original period of holding. 

Consolidation of shares similarly does not trigger tax at the time of consolidation. Capital gains tax applies only when the consolidated shares are sold, based on the notional cost derived from the original shares and the applicable holding period. 

For sales made after July 23, 2024, long-term capital gains on listed shares are taxed at 12.5 percent plus surcharge and cess, without indexation. Short-term capital gains are taxed at 20 percent plus surcharge and cess. 

Buyback of Shares 

The tax treatment of buybacks has changed significantly. For buybacks completed before September 30, 2024, investors are not taxed and the company pays tax under Section 115QA. For buybacks on or after October 1, 2024, the amount received by the shareholder is treated as dividend income and taxed under the head Income from Other Sources. No deductions are allowed against this income. 

The cost of acquisition of the shares is treated as a capital loss, either short-term or long-term, which can be set off against future capital gains and carried forward for up to eight assessment years. The company is required to deduct tax at source under Section 194, and for capital loss computation, the consideration is deemed to be nil under Section 46A. 

Closing Perspective 

Recent changes to capital gains taxation, particularly from July 2024 onwards, make it essential for equity investors to understand not just tax rates but also the impact of corporate actions and timing of exits. For promoters, founders and long-term shareholders, thoughtful tax planning is an integral part of preserving wealth. At Entrust, we believe that clarity, structure and foresight are key to building and sustaining wise wealth over time.