Trading and investing –Tax implications

Trading and investing –Tax implications

power of compounding applies to expenses as well as profits.

. You buy a stock for Rs1. It doubles every year for eleven years (100 percent annual return!) and then you sell it for Rs2,048. That triggers capital gains tax on the Rs 2,048 profit. At a 20 percent tax rate, you’d owe the government Rs409. This leaves you Rs1,639. That is the same as getting a 96 percent return, tax-free, for eleven years. The tax knocks only 4 percentage points off the pretax compound return rate.

Suppose instead that you run the same Rs into Rs 2,048 through a lot of trading. You

realize profit each year, so you have to pay capital taxes each year. The first year, you

go from Rs1 to Rs2 and owe tax on the Rs1 profit. For simplicity, pretend that the short term

tax rate is also 20 percent (it’s generally higher). Then you pay the government 20

Paisa and end the first year with Rs1.80 rather than Rs2.00.

This means that you are not doubling your money but increasing it by a factor of 1.8—

after taxes. At the end of eleven years you will have not 2 ^11 but 1.8^11 . That comes to about Rs683. That’s less than half what the  buy-and-hold investor is left with after taxes.