NEW DELHI: Paying taxes is as important a part of your financial planning as saving tax.

Knowing how your investments are to be taxed can help you select the right investments to meet your financial goals.

EQUITY

To compute taxes, investors need to be clear on the concepts of short term capital gains (STCG) tax and long term capital gains (LTCG) tax.

STCG tax (currently 15%) is levied on equity investments if you sell the investment within a year from the date of investment. However, if you sell an equity asset post one-year, it comes under LTCG tax (currently nil).

For instance, if you buy shares worth Rs 15,000 and sell them for Rs 20,000 in two months, you would be liable to pay 15% of the gain -- Rs 750 (plus surcharge & education cess) to the taxman.

Investors need to note that equity here includes equity mutual funds (funds with over 65% equity exposure) and equity shares of which you take delivery in your demat account.

Profits arising out of intra-day trading in stocks or from futures and options (derivatives) segment are to be added to your income and taxed accordingly.

DEBT

Debt instruments have different tax treatment when it comes to computing taxes.

The gains from government instruments like bonds, fixed deposits and NSCs are to be simply added to your income and taxed as per your tax slab. Profits from debt funds and fixed maturity plans (FMPs) are also treated similarly when the holding period is less than a year.

But if the holding period exceeds one year, the tax on debt mutual funds and FMPs can be reduced by using the indexation benefit. This is what makes them more tax efficient than other government schemes.

Indexation helps you adjust the cost of your investment for inflation and you get the option to pay tax at the rate of 20% (with indexation) or 10% (without indexation), whichever is lower.

Adjusting investment value for inflation is done by using the formula:

Adjusted Cost = Actual cost of acquisition x (Cost inflation index for the sale year/Cost inflation index for the investment year)

Let us try and compute tax on the following assumed investment:

Cost of investment = Rs 100,000 in FY06

Redemption = Rs 108,000 in FY07

Gain = Rs 8,000

Tax without indexation @ 10% = Rs 800

Adjusted cost for inflation = 100,000 X (551/519) = Rs 106,165

Adjusted gain = Rs 1,835

Tax with indexation @ 20% = Rs 367

Hence we notice that by using indexation, we were able to reduce the tax liability significantly. The tax amount is further chargeable to surcharge and education cess.

The concept of indexation is a little complex and investors can consult their financial adviser to work out the exact tax liability.

REAL ESTATE

For this relatively high-risk, high-reward investment avenue, STCG tax liability arises if you sell the asset within three years, post which you pay LTCG tax.

In case of STCG, real estate profits are to be added to the taxable income, whereas the LTCG tax is calculated at 20 percent with indexation benefits.

As per section 54EC of the Income Tax Act 1961, investors can invest the taxable sale proceeds in government prescribed capital gain bonds within six months of sale to save on taxes.

GOLD

Gold continues to be one of the hot investment spots in the Indian arena. Investors can invest in physical form or through gold exchange traded funds (ETFs).

Holding physical gold is not a very tax efficient investment as it attracts wealth tax of 1% on amount of holding above Rs 15 lakh.

Profits from physical gold are also taxed as STCG or LTCG criteria, as discussed for real estate.

However, the units of gold ETFs do not fall under the wealth tax bracket and their tax treatment is similar to those of debt funds.