Shares are held as investments and therefore regarded as capital assets for tax purposes. If shares are held for a period of more than 12 months, the shares qualify as long-term capital assets. The gains from sale of equity shares on a stock exchange are exempt from tax if the equity shares are long-term capital assets.
Therefore, even the losses incurred on sale of equity shares, which are long-term capital assets, on a stock exchange is exempt and is not to be considered in computing the taxable income. If you are therefore thinking of disposing of the shares, it is advisable to do so before the holding period of the shares crosses 12 months, so that you can claim the benefit of including the loss in the computation of your taxable income. Such losses would be regarded as short-term capital losses.
Though the short-term capital gains on sale of equity shares on the stock exchange is eligible for a concessional rate of taxation of 15%, short-term capital losses on sale of equity shares on the stock exchange do not suffer from any disadvantage compared with other short-term capital losses. However, in general, capital losses can be set off only against capital gains and therefore your short-term capital losses can only be adjusted against your other short-term capital gains or against any taxable long-term capital gains, and not against your salary or interest income.
The short-term capital gains against which you can adjust such losses would include not only short-term capital gains from sale of equity shares on a stock exchange, but gains from disposal of any other type of asset, including immovable property. Similarly, the short-term capital losses can be adjusted against long-term capital gains from sale of any type of asset, or against long-term capital gains from sale of equity shares in off-market trades, such as a buy-back by the company or a private sale through a spot transaction. Obviously, the question of set-off of such short-term capital losses against long-term capital gains on sale of equity shares on a stock exchange does not arise, since such long-term capital gains would in any case be exempt from tax.
There is no requirement that the short-term capital loss has to be first set off against short-term capital gains before being set off against long-term capital gains. The rate of long-term capital gains tax on sale of listed equity shares in off market trades is 10%, the rate of long-term capital gains tax on sale of other assets is 20%, the rate of short-term capital gains tax on sale of shares on a stock exchange is 15%, and the rate of short-term capital gains tax on sale of other assets is the applicable slab rate (generally 30% for income above Rs8 lakh).
So it makes sense to first set off any short-term capital losses against short-term capital gains on sale of other assets then against long-term capital gains on sale of other assets which are subject to tax at 20%, and then against short-term gains on sale of equity shares on a stock exchange, and finally against long-term capital gains on sale of listed equity shares which are subject to tax at 10%. This would maximize the tax benefit available on set-off of the short-term capital losses.
Do you have an option not to set off the capital loss but choose to carry it forward for setting off against future capital gains? There is no such option available, and if taxable capital gains are earned you necessarily have to set off the losses against such capital gains. Of course, in case you do not have any taxable capital gains, you can carry forward your capital losses for a period of up to eight years from the year in which the loss was incurred. To get this benefit, you need to ensure that you file your income-tax return for the year in which the loss was incurred within the time limit specified for filing that return.
If your holding period of the shares has already crossed 12 months, does it mean that you can no longer get the tax benefit of the loss that has been caused due to the drop in value of the shares? You need to remember that the benefit of set-off would be lost only if you sell the shares on the stock exchange. If you choose to do an off market sale with a purchaser at the prevalent market price, you can still claim the benefit of the loss in your tax computation. The only precaution that you need to take is to ensure that payment and delivery are simultaneous (which is a requirement for a spot transaction, which is permitted outside the stock exchanges), and that the transaction is carried out at the prevailing market price.