The Hindu Business Line : Tax-loss harvesting

AT THIS time of the year, you may be investing in small savings schemes or eligible mutual funds to reduce your tax liability. If you are an active trader, there is another way to reduce your tax burden. It is called tax-loss harvesting.

Suppose you had bought 1,000 shares of a tech company at Rs 50 per share. If the current market price is Rs 30 per share, your short-term unrealised loss is Rs 20,000. Assume that you already have short-term trading profits of Rs 50,000. If you sell the tech stock, you can set-off the losses against your trading profits of Rs 50,000. This will reduce your tax burden.

Of course, selling a loss-making position requires discipline and emotional strength. A typical trader may be unwilling to take losses. She may instead wait and earn a profit from that position. This has two disadvantages. One is the opportunity lost in not being able to buy another stock with the money locked up in the loss-making position. The other is the opportunity lost in improving after-tax returns. Suppose you hold on to your loss-making position. You will have to pay taxes on your profits worth Rs 50,000. That will be Rs 5,000 (10 per cent on Rs 50,000). So, your after-tax profits will be Rs 25,000 (Rs 45,000 less Rs 20,000 loss).

If you sell the loss-making position, you will have to pay taxes on Rs 30,000 (Rs 50,000 profits less Rs 20,000 loss). Your after-tax profits will, hence, be Rs 27,000 (tax is paid only on Rs 30,000). That is why tax-loss harvesting is a popular form of enhancing after-tax portfolio returns among professional traders and money managers.

(The author is Head, Research, Navia Markets.)

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