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The downside of stock trading isn’t just about losing money on a trade; it’s about losing money to taxes because you didn't know the rules. In India, your final profit depends heavily on how you structure your trades under the Income Tax Act, 1961.
This brings us to a critical concept known globally as the 'Wash Sale Rule.
Generally speaking, a 'wash sale' occurs when an investor sells security at a loss and quickly buys it back just to claim a tax benefit. While this is a specific term in US markets, the underlying principle, distinguishing between genuine Tax Loss Harvesting and artificial loss creation is something every smart trader needs to understand.
Key Takeaways
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A wash sale is when you sell a security at a loss and then rapidly buy the same or an identical one.
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India does not have a legislated wash-sale regulation like the United States, so there is no definite 30- or 61-day disallowance period.
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Genuine losses may typically be offset against capital gains provided the transactions have business substance and are properly documented.
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Tax authorities may nevertheless prohibit losses under anti-avoidance laws if the trades look contrived or tax-motivated.
What is a wash sale?
Before we look at Indian tax laws, let’s clarify what a 'wash sale' actually is. In the US, this is a strict rule: if you sell a stock at a loss and buy it back within 30 days, it is considered a 'wash sale,' and you cannot claim the tax benefit.
In India, however, the term is informal. You won’t find a 'Wash Sale Rule' in the Income Tax Act. Instead, Indian authorities focus on intent. They look at whether your loss was real and the transaction genuine, or if it was simply a setup to avoid paying taxes.
Wash sale examples
Let’s take a look at a couple of wash sale examples to better understand this concept.
Example 1
Assume that you buy a share of Company X for around ₹900. And one year later, you see that the share price has dropped to ₹700. You decide to book a loss (of ₹200) by selling the share for ₹700. However, a week after the sale transaction, you again decide to buy a share of Company X for around ₹650. In such a situation, the sale transaction that you made would then be termed as a wash sale, because you have effectively re‑established the same position after booking a loss.
Example 2
Assume that you buy a futures contract of Company X for around ₹900. For the purposes of this example, let’s also assume that the lot size of the futures contract is just 1 share. A week later, you find that the value of the futures contract has gone down to around ₹800. You decide to book a loss (of ₹100) by selling the futures contract and closing your open position. However, two weeks after the sale transaction, you again decide to buy the same futures contract of Infosys for around ₹700. In this situation, the ‘sale’ transaction that you made to close out your position would then be termed as a wash sale.
In both examples, the key point you can see is that you have realised a loss for tax purposes while ending up with almost the same investment position soon after.
What is the logic behind a wash sale?
Now that you’ve understood the concept with the help of these two wash sale examples, let’s delve deeper and try to understand why an investor would buy the same security again after booking a loss.
An investor might sell a loss-making stock or security to protect their investment capital from eroding further. After a few trading sessions, he might feel that the current stock price is quite attractive and hard to pass up, which might lead him to buy the same stock or security once again. In such a scenario, the wash sale transaction is triggered inadvertently.
That said, an investor may deliberately register losses at the end of the financial year to decrease the overall capital gains tax payable. This method is usually referred to as tax loss harvesting. In India, such loss booking is permitted as long as the transactions are legitimate and executed at arm's length rates on recognised exchanges or through proper channels.
Triggering a Wash Sale For Tax-loss Harvesting
When you earn a profit from the sale of a stock, it is termed as either a long-term capital gain or a short-term capital gain, depending on how long you hold the stock before selling it. According to the Income Tax Act, 1961, you can set off your long-term or short-term capital gains with long-term or short-term capital losses and only pay the difference as tax to the government.
As a result, investors may sell off loss-making shares immediately before or after selling lucrative holdings, with the goal of leveraging the realised losses to offset capital gains. By completing this easy procedure, they can minimise their tax liability.
Unlike the United States, India does not have a wash sale disallowance rule that automatically overlooks losses if you re-enter the same stock within a set number of days. If the tax department considers the transactions to be circular, pre-arranged, or lacking actual investment purpose, they may dispute the losses under anti-avoidance laws.
The wash sale rule
Technically, the wash sale rule is an Internal Revenue Service (IRS) regulation that applies only to the United States of America. According to the wash sale rule, an investor cannot use the loss arising out of a wash sale to set off his capital gains and reduce his tax liability.
However, the wash sale rule is non existent in India, meaning that Indian investors can use a wash sale for tax-loss harvesting purposes without any repercussions from the tax authorities.
This does not imply that such transactions are free of tax risks. Indian tax officials may depend on:
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General Anti-Avoidance Rules (GAAR) in Chapter X-A of the Income-tax Act, 1961.
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The doctrine against colourable or sham transactions established by Indian courts.
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Substance-over-form principles to see whether the transaction has real commercial substance beyond tax savings.
If a series of trades appears to be made solely to produce tax losses, with no genuine investment motive, the assessing officer may disallow the loss or recharacterize the transaction.
Here’s an example of how you can use the wash sale in India.
Assume that you hold a share of Company B. The share price has dropped from ₹100 (the price at which you bought) to around ₹60. You currently have an unrealised loss of around ₹40.
Simultaneously, you also hold a share of Company C. The share price of the C stock has risen from ₹2,000 (the price at which you bought) to around ₹2,100. You currently have an unrealized profit of around ₹100. You decide to sell this share for a ₹100 profit.
Now, the profit of ₹100 is the capital gain on which you’re required to pay tax. However, to reduce the tax impact, you also sell off the B share that you had for ₹60. You’ve effectively made a loss of ₹40 on this transaction.
But then, you don’t actually wish to let go of the Company B share. And so, you immediately buy it again at around ₹60. Such a move ultimately triggers a wash sale transaction.
By setting off the loss of ₹40 against the profit of ₹100, your net capital gain would be just ₹60, on which you would be required to pay tax, thereby reducing your tax liability.
Under Indian tax law, these transactions are normally authorised if they are made on a recognised stock exchange, at current market values, and as part of your routine investing activity. If you frequently purchase and sell to create false losses, you may face scrutiny under GAAR or anti-avoidance rules.
Reporting a Wash Sale Loss
In India, there is no specific wash sale rule or reporting procedure. Capital gains and losses from shares, mutual funds, and derivatives are recorded on your Income Tax Return (ITR) using the appropriate capital gains schedules.
Important factors for Indian taxpayers should know:
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Report each selling transaction, including the purchase price, sale consideration, and holding duration, to determine if the gain or loss is short- or long-term.
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Set off qualified capital losses against capital gains as allowed by the Income Tax Act.
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Short-term capital losses can be offset against both STCG and LTCG, but long-term capital losses can only be offset against LTCG.
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Carry forward unabsorbed capital losses for up to eight assessment years, provided the return is filed before the due date.
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Maintain appropriate paperwork (contract notes, demat statements, and bank statements) to demonstrate that your transactions are legitimate market trades.
Unlike the United States, India does not have an automatic mechanism that adds "disallowed wash sale losses" to the cost basis of repurchased stocks or transfers the holding period. In India, cost and holding period are established based on actual purchase and sale dates, subject to anti-avoidance measures.
Properly filed reporting assures tax compliance while preserving future tax benefits.
Also Read: What Is Long-Term Capital Gains Tax?
Conclusion
Since the wash sale rule is not present in India, you can make use of this kind of transaction to limit your tax burden. However, don’t forget to keep an eye on your overall returns, because you don’t want to suffer a net loss in the name of reducing your tax burden using a wash sale.
