Why tax loss carry forward is necessary for investors?

April 19, 2019 | Som Thapa

Capital gain and tax

When the investors make a profit in their investment through capital gain, they need to bear the tax liability for the profit which is known as capital gain tax. Capital gain is profit which is achieved when the value or price of the investment increases from the purchase price. For example, when an investor purchases shares of a company for a total cost of Rs. 100,000 and sells it for Rs. 150,000 [after brokerage expenses], then the difference between selling and purchasing amount i.e. Rs. 50,000 is the capital gain. This extra amount known as capital gain is liable for tax called a capital gain tax. In case of Nepal, the capital gain tax in shares is 7.5% for individual and 10% for the institution. Mutual funds are allowed tax-free in their capital gain as an incentive. So, basically the individual investor pays Rs.3,750 (7.5% of Rs.50,000) and the institutional investor pays Rs. 5,000(10% of Rs. 50,000) for the capital gain of Rs. 50,000 as shown in above example. So, the net gain will be Rs. 47,500 or Rs. 45,000 depending on the investors’ type (individual or institutional) which is the profit that will finally land in the hands of the investors.

Capital loss

However, when the investors bear the loss in their investments through a decrease in price or value of their shares, this loss is known as a capital loss. So, when the investor loses the Rs. 50,000 (by purchasing at Rs. 100,000 and selling at Rs. 50,000), this capital loss of Rs. 50,000 is to borne by the investor alone with no other third party (government) sharing in the loss. How is it fair that when you profit, someone comes in and shares in that profit while you have to bear the loss alone? This reminds me of the quote:

“Heads I win, tails you lose.”

Let me clarify this with the above example where an investor does 1 profitable trade of Rs. 50,000 gain and 1 losing trade of Rs. 50,000 in a period of one year. So, the gain of Rs. 50,000 which is taxed at 7.5% resulting in Rs. 3,750 capital gain tax. So, the net profit amount received by the investor is Rs. 47,500. On the other side, the investor bears a total loss of Rs. 50,000 alone. Hence, the investor is left with an overall loss of Rs. 3,750 in his investment at the end of the year even though he made equal profit and loss trades.

Let’s take another example. Suppose an investor has accumulated capital worth Rs. 10 lakh and he invests all his money and unfortunately loses all of it. His total loss of Rs. 10 lakh is borne by him alone. However, he is not disheartened by the loss and is determined to recover his loss. Next year, he collects another Rs. 10 lakh from his friends on loan and invests all his money again. This time, fortunately, he doubles his investment in a year thus recovering his previous year loss. He is immensely happy because he thinks he is in break-even position now. However, this is not the end of the story. When he tries to cash in the profit, Rs. 75,000 is deducted in the form of capital gain tax from his profit of Rs. 10 lakh leaving him with Rs. 9,25,000 profit this year. He is still short of Rs. 75,000 to break even in 2 years excluding the trading expenses and the interest to be paid on borrowed capital.

I don’t comprehend how this appears fair to the investor who has put his life savings into work taking an unlimited risk and still the system is acting against him instead of acting in favor of him. The government acts exactly like those friends and relatives who suddenly appear when you make a fortune in order to share in it and suddenly disappear when you lose it and when you need them the most.

Tax loss carry forward

The important question is how this problem can be solved in a way which will be fair to investors as well. The solution can be in the form of tax loss carry forward. Tax loss carry forward allows the investors to carry over the capital loss in the present year to future years in order to offset future profit and reduce future tax payments.

For example, if an investor has a total capital loss of Rs. 10 lakh this year, then he can carry that loss to future years i.e. he doesn’t have to pay tax on future profits until Rs. 10 lakh is recovered from future profits on investments. In this provision, the investor will not be taxed on the initial Rs. 10 lakh in profit. His taxable amount will be total profit in coming years less Rs. 10 lakh.

Tax loss carry forward provision will level the playing field for investors and motivate them to take risks when they feel that the risk is worth taking.