NISM XB Short Notes – Part 9: Taxation of Equity Products (Chapter 11)
NISM Series X-B Investment Adviser Level 2 | Equity Taxation Notes | PassNISM.in
Part 9 of the NISM XB short notes series covers Chapter 11: Taxation of Equity Products. Equity taxation is directly relevant to every investment adviser who recommends stocks, equity mutual funds, ETFs, or derivatives to clients.
Sources of Income from Equity 1. Dividend Income
Dividends are distributions of profit by a company to its shareholders. Since the abolition of Dividend Distribution Tax (DDT), dividends received by investors are fully taxable in their hands at their applicable slab rate, regardless of the amount. This applies to dividends from both listed and unlisted companies, and from mutual funds.
2. Capital Gains
Capital gains arise on the sale of equity shares or equity mutual fund units. The tax treatment depends on the holding period:
- Short-Term Capital Gains (STCG): Arising from sale of listed equity shares or equity-oriented mutual fund units held for 12 months or less — taxed at a flat rate of 15% (plus surcharge and cess).
- Long-Term Capital Gains (LTCG): Arising from the sale of listed equity shares or equity-oriented mutual fund units held for more than 12 months — exempt up to Rs 1 lakh per year; gains exceeding Rs 1 lakh taxed at 10% without the benefit of indexation.
Featured Snippet Answer: LTCG on listed equity shares and equity mutual funds is taxed at 10% on gains exceeding Rs 1 lakh in a financial year, without indexation. STCG is taxed at 15%. Both are subject to surcharge and cess. Charges and Taxes on Equity Transactions
For the NISM XB exam, you must know the various charges applied when buying or selling equity:
| Charge | Description |
|---|---|
| Brokerage | Fee charged by the stockbroker for executing the trade. |
| Securities Transaction Tax (STT) | Tax levied on the purchase/sale of securities on stock exchanges (not applicable on debt instruments). |
| Stamp Duty | Levied for transferring shares from one person's demat to another. |
| Exchange Charges | Fee charged by BSE or NSE for facilitating the trade. |
| SEBI Turnover Charges | Rs 10 per crore of transaction value; charged on both buy and sell sides. |
| DP Charges | Depository Participant charges for debiting shares from demat account; charged on the date of debit (irrespective of quantity). |
| GST | Levied on brokerage, exchange transaction charges, and clearing charges. |
ADRs and GDRs — Indian Companies Listed Abroad American Depositary Receipt (ADR)
An ADR is a US dollar-denominated instrument that trades on US stock exchanges and represents equity ownership in a non-US company. Many Indian companies have listed ADRs on NYSE and NASDAQ. ADRs are denominated and pay dividends in US dollars.
Global Depositary Receipt (GDR)
GDRs give access to both the Euro market and the US market. The US portion must comply with SEC requirements and the European portion with EU directives. GDRs may be listed on international exchanges such as the London Stock Exchange (LSE), NYSE, American Stock Exchange (AMEX), NASDAQ, or Luxembourg Stock Exchange.
Key Terminology for Mutual Fund Taxation
| Term | Definition |
|---|---|
| Equity Oriented Fund | A mutual fund that invests >65% of its corpus in equity shares of domestic companies. |
| Fund of Funds (FoF) | A mutual fund that invests in other mutual fund schemes rather than directly in stocks or bonds. |
| ELSS (Equity Linked Savings Scheme) | A tax-saving mutual fund with a 3-year lock-in. Investments qualify for Section 80C deduction up to Rs 1.5 lakh. |
| SIP (Systematic Investment Plan) | A method of investing fixed amounts in a mutual fund at regular intervals (usually monthly). |
| SWP (Systematic Withdrawal Plan) | A method of withdrawing a fixed amount or fixed number of units from a mutual fund scheme at regular intervals. |
| STP (Systematic Transfer Plan) | A method of transferring a fixed amount from one mutual fund scheme to another scheme of the same fund house. |
Tax note on ELSS: Each SIP instalment in an ELSS is treated as a separate investment with its own 3-year lock-in period. Capital gains upon redemption are taxed as LTCG at 10% on gains above Rs 1 lakh.
Derivatives — Terminology for Taxation
| Instrument | Description |
|---|---|
| Futures | A standardised exchange-traded contract to buy or sell an underlying asset at a specified future date and price. |
| Options | A contract giving the right (but not obligation) to buy (Call) or sell (Put) an underlying asset at a specified price by a specified date. |
| Forward Contracts | A customised OTC contract between two parties for delivery at a future date at a pre-agreed price. |
| Swaps | Private OTC agreements to exchange cash flows according to a pre-arranged formula (e.g., interest rate swaps). |
| Currency Derivatives | Exchange-based futures and options contracts on currency pairs; used for hedging currency risk. |
| Interest Rate Derivatives | Financial derivative contracts whose value is derived from an interest rate benchmark. |
| Commodity Derivatives | Futures or options contracts on commodities (gold, oil, agricultural products) for a pre-determined future delivery. |
Nature of Derivative Income — F&O Taxation
This is an important and frequently tested topic in the NISM XB exam:
- Gains and losses from Futures and Options (F&O) trading are always taxed under the head Profits and Gains from Business or Profession (PGBP).
- F&O income is classified as non-speculative business income (not speculative), even though it might seem like speculation. This distinction is important for set-off of losses.
- F&O losses can be set off against any business income (other than speculative income) or other income heads (except salary).
Dividend Stripping
Dividend stripping is a tax avoidance strategy where an investor:
- Buys units of a mutual fund or shares just before the record date for dividend/income.
- Receives the dividend (which was tax-free earlier; now taxable).
- Sells after the record date at a lower price (since NAV falls after dividend payout) and claims a short-term capital loss.
The Income Tax Act has anti-avoidance provisions to curb dividend stripping — the capital loss arising from such transactions may be disallowed if the shares/units were bought within 3 months before the record date and sold within 3 months (for shares) or 9 months (for units) after the record date.
Bonus Stripping
Similar to dividend stripping: an investor buys mutual fund units before the record date for bonus units, receives bonus units, and then sells the original units at a loss. Anti-avoidance provisions apply here too — the loss may be disallowed if original units are sold within 9 months of the record date.
Quick Revision Checklist — Equity Taxation (NISM XB)
- ☑ Dividends: fully taxable in investor's hands at slab rate
- ☑ STCG on listed equity: 15%; LTCG: 10% on gains above Rs 1 lakh (no indexation)
- ☑ F&O = non-speculative PGBP income (not capital gains)
- ☑ 7 types of charges on equity trades
- ☑ ADR = US listed; GDR = globally listed; both represent Indian company equity
- ☑ ELSS: 3-year lock-in; Section 80C deduction; taxed as LTCG
- ☑ Dividend stripping & bonus stripping: anti-avoidance rules under IT Act
Internal Links
- NISM XB Part 10: Taxation of Other Products (ESOP, SGB, REIT, InVIT, AIF)
- NISM XB Part 8: Debt Products Taxation
- NISM XB Mock Test
Original educational content for NISM XB exam preparation at PassNISM.in. Refer to official NISM workbook for authoritative content.