What is Capital Gains Tax?

Profit earned on the sale of Capital Assets is Capital Gain. The profit earned is treated as income and is liable for the tax. The tax pertaining to this Capital Gain is Capital Gains Tax. This has to be paid the same year when the transaction of sale happens.

The capital gains tax can either be long-term or short-term depending on the period for which the asset was held before selling. Capital assets received out of inheritance are not liable to capital gains since there is no consideration involved, i.e., the asset is not sold but only there is a transfer of title. Capital assets obtained as a gift or out of an inheritance or through a will are exempted by the Income Tax Act. However, if the capital assets so obtained are sold by the person who receives the title then Capital Gain is applicable.

What are Capital Assets?

The following assets are considered as Capital Assets:

  • House Property
  • Patents
  • Land
  • Building
  • Trademarks
  • Vehicles
  • Jewellery
  • Leasehold Right

The right to manage or control a Company or any other legal right in respect of the Company is also included under Capital Asset category.

The following assets are not considered as Capital Assets:

  • Any goods held for personal use like furniture, clothes, etc.
  • National defence gold bonds of 1980, 61/2% gold bonds of 1977 or 7% gold bonds 1980 issued by the Central Government.
  • Any raw material, stock, and consumables held for running a business
  • Lands in the rural area used solely for agricultural purposes
  • Gold deposit bonds received under the gold deposit scheme of 1999 or certificates of deposit under the Gold Monetisation Scheme 2015.

The Basis for Rural Area Categorisation(from Assessment Year 2014-2015)

Any area which has a population of 10,000 or more and does not come under the jurisdiction of cantonment board or municipality comes under the rural area category. Also, there is a distance stipulation (aerially measured) is given below. The population aspect is as per the last census.

Distance Population

For the distance of 2 Kms from the local cantonment board/municipality limits

If the Cantonment board/municipality population is 10,000 and up to 1 lakh

For the distance of 6 Kms from the cantonment board/municipality limits

If the Cantonment board/municipality population is above 1 lakh and up to 10 lakhs

For the distance of 8 Kms from the cantonment/municipality limits

If the Cantonment board/Municipality population is more than 10 lakhs

Classification of Assets Based on the Period of Holding

The assets are classified into Short-Term and Long-Term assets based on the period of holding.

Capital Asset Classified as Short-Term

If the holding of the asset is for 3 years or less, it is classified as a short-term asset. This stipulation of 3 years holding to be classified as short-term was reduced to 2 years from the Financial Year 2017-2018.

For example, for a property that is held up to 2 years and then sold, the profit made out of the transaction will be considered as a capital gain of long-term, if the transaction happened after March 31, 2017.

Capital Asset Classified as Long-Term

If the holding of the asset is for more than 3 years, it will be classified as a long-term asset. The period of holding reduced to 2 years for a short-term asset does not apply for movable properties like debt-oriented mutual funds, jewellery, etc. They will still be considered as a long-term capital asset if the period of holding is over 3 years as before.

Some of the assets will be classified under short-term capital asset if the period of holding is one year and less. If the transfer of title occurs after 10th July, this stipulation of 1 year or less holding will be applicable. In this case, the date of purchase is not considered. The details of such assets are furnished below:

  • Securities like bonds, government securities, and debentures listed on an Indian Stock Exchange that is recognised.
  • Preference shares or equity in a Company listed on an Indian Stock Exchange that is recognised
  • Quoted and Unquoted units of UTI
  • Quoted and Unquoted Zero Bonds
  • Quoted and Unquoted units of equity-linked mutual funds

These assets if held for a period above 1 year will be considered as a long-term capital asset. The period of holding of the previous owner will also be considered if the assets are acquired by a person out of a will or by inheritance or by way of a gift for determining the classification of the assets as long-term or short-term assets. The period of holding is calculated from the allotment date in case of rights shares and bonus shares.

A table defining the classification of different assets as a short-term asset and long-term assets as per the period of holding is given below:

Type of Asset Holding Period Short-Term/Long-term

Equity shares that are listed

Less than 1 year

More than 1 year

Short-Term

Long-Term

Shares that are not listed

Less than 2 years

More than 2 years

Short-Term

Long-Term

Immovable property

Less than 2 years

More than 2 years

Short-Term

Long-Term

Equity-linked mutual funds

Less than 1 year

More than 1 year

Short-Term

Long-Term

Debt mutual funds

Less than 3 years

More than 3 years

Short-Term

Long-Term

Other assets

Less than 3 years

More than 3 years

Short-Term

Long-Term

Taxes Implied on Capital Gains: Short-Term and Long-Term

The taxes implied on Capital Gains of Short-Term and Long-Term is detailed in the table given below:

Type of Tax Terms and Conditions Applicable Tax

Capital Gains Tax - Long-Term

Other than the sale of equity-linked funds/equity shares

20%

Capital Gains Tax - Long-Term

Sale of equity-linked funds/equity shares

10% above 1 Lakh

Capital Gains Tax - Short-Term

In the case when transaction tax for securities is not applicable

The tax is applied as per the slab applicable for the taxpayer on including the short-term capital gains as income in the IT Returns.

Capital Gains Tax - Short-Term

In the case when transaction tax for securities is applicable

15%

Tax Implied on Debt Mutual Funds and Equity

Gains on sale of equity funds and debt funds are differently treated. An equity fund is a fund that invests a major part of its portfolio in equities.

Type of funds

Effective from July 11, 2014

On or before July 10, 2014

 

Capital Gains -Short-Term

Capital Gains -Long-Term

Capital Gains -Short-Term

Capital Gains -Long-Term

Equity Funds

15%

Nil

15%

Nil

Debt Funds

As per the individual's tax slab rate

20% with indexation

As per the individual's tax slab rate

Without indexation, it is 10% and with indexation, it is 20% and the lower of the two will be considered.

Modified Tax Rules for Debt Mutual Funds

The investment made in Debt mutual funds should remain for a period of 3 years for it to be classified as a long-term asset. The capital gains of the Debt Mutual Funds encashed within 3 years are included for the income for the year and the tax calculated as per the applicable income tax slab rate.

How to Calculate Your Capital Gains: Short-Term and Long-Term?

The capital gains calculation is based on the period of holding of the asset. Capital gains for assets held for a short period and capital gains for assets held for a long period.

The following are the components that are considered for calculation of Capital Gains Tax:

  • Value of consideration: The proceeds that result in the sale of a capital asset are the sale consideration received for the asset. The gain that results out of such a transaction is the capital gain and capital gains tax is applicable in the financial year when the sale occurred, even if you do not receive any consideration.
  • Acquisition cost: It is the purchase value of the asset
  • Improvement cost: If any renovations or additions are made for the capital asset before selling, the cost incurred for such renovations or additions is also considered. Such improvements made before 1st April 2001 is not considered.

If the taxpayer has acquired the property by any other way other than purchase, the cost incurred by the earlier owner for improvements made on the capital assets will be included.

Calculation of Short-Term Capital Gains

The following are the steps to calculate short-term capital gains:

  • Begin with the sale consideration in full
  • The following have to be deducted from the sale consideration:
    • Expenses incurred on transfer of the asset to the buyer
    • Acquisition cost
    • Expenditure incurred for improvements made on the asset
    • The amount thus arrived is the Short-Term Capital Gain

In a nutshell, Short-Term Capital Gain = Sale consideration minus expenditure incurred on transfer of the asset to the buyer minus acquisition cost minus improvement cost.

Calculation of Long-Term Capital Gains

The following are the steps to calculate long-term capital gains:

  • Begin with the sale consideration
  • The following must be deducted from the sale consideration:
    • Expenses incurred on the transfer of the asset to the buyer
    • Indexed Acquisition cost
    • Indexed Improvement cost
  • Sections 54, 54EC, 54F and 54B provide some exemptions. Such exemptions must be deducted from the value arrived after making deductions as mentioned in the second step.

In a nutshell, Long-term capital gain = Sale consideration

Minus expenses incurred for the transfer of the asset to the buyer

Minus Indexed Acquisition cost

Minus Indexed Improvement cost

Minus expenses permitted to be deducted from the sale consideration (the expenses that are directly connected to the transfer or sale of the capital asset are permitted to be deducted from the sale consideration. Such expenses are compulsorily required for the transfer of the asset)

Union Budget 2018 permitted exemption up to 1 Lakh per year on the capital gains that occurred out of the sale of units of equity-linked fund/equity shares after 31st March 2018.

There will a levy of tax at 10% on LTCG on units of equity-linked funds/shares above 1 Lakh in a financial year without the advantage of indexation.

Deductions Allowed When a House Property is Sold

When a house property is sold the following expenses can be deducted:

  • Commission paid to the broker for finding a purchaser
  • Stamp paper cost
  • Expenses incurred for travel in respect of the transfer: These expenses could arise after the transfer process is complete.
  • For transfer procedures in respect of inherited property, i.e., expenses connected with the obtention of succession certificate, inheritance and will, and the executor's cost are permitted in some cases.

Deductions Allowed When Shares are Sold

When the shares are sold the deduction of the following expenses are allowed:

  • Commission paid for the sale of shares
  • The securities transaction tax or STT are not permitted for deduction

Deductions Allowed for Sale of Jewellery

On the sale of jewellery, the brokerage paid to find a purchaser is allowed for deduction. It should be noted that the expenses allowed for deduction while calculating capital gains will not be allowed once again for deduction in the IT Return under any other head.

Indexed Improvement Cost/Acquisition Cost

To make adjustments for the price appreciations related to inflation, the cost inflation index, i.e., CII is applied for indexing the acquisition cost and improvement cost. Indexing enables an increase in the cost base thus lowering the capital gains.

The calculation for indexed acquisition cost is:

Acquisition Cost/Cost Inflation Index (CII) for the financial year when the seller first held the asset or 2001-02 whichever is later x Cost Inflation Index for the year when the transfer of asset was done.

The calculation for indexed improvement cost is: 

Improvement Cost*Cost Inflation Index of the year when the transfer of asset was done/Cost inflation index of the year when the improvement was done.

How to Save through Tax Exemptions on Capital Gains?

The Income Tax Rules in India provide provisions for tax exemptions on Capital Gains in the following cases:

Under Section 54, the exemption can be claimed on capital gains tax by investing the sale proceeds of the house property in another house property

Under Section 54 you can claim an exemption on capital gain tax by purchasing or constructing a new residential property in India with the sale proceeds of residential property in India.

The rules for such exemption are as follows:

  • Both Individuals and HUF are eligible for such exemption
  • The purchase of a new residential property will enable set off of the capital gains from the sale of a residential property.
  • Both the new residential property and the residential property sold should be in India
  • The investment in the new property can be made one year before the sale of the old property or within 2 years from the date of sale of the old property. If the investment is made for the construction of a new house, the construction should be completed before 3 years from the sale of the earlier property.
  • Once the investment is made in a new house, the house cannot be sold within 3 years. If sold within 3 years you will not be eligible for the exemption and the capital gains on the property sold will be taxable. The 3 years is considered from the date of purchase of the property or completion of construction.
  • The entire sale proceeds need not be invested. Investment only to the extent of capital gains can be made. If the purchase price of the new house is more than the capital gains, then the exemption will be only to the extent of the capital gains that arise out of the sale.
  • Prior to Budget 2019, the exemption was allowed for capital gains only for 1 residential property. As per Budget 2019 exemption will be allowed once a lifetime for the taxpayer on capital gains of 2 properties provided the capital gain does not exceed 2 Crores.
Under Section 54F, the exemption can be claimed by investing the sale proceeds of any other asset sold apart from the residential property in a new residential property

The rules for exemption under Section 54F are:

  • Both HUF and Individuals are eligible for this exemption
  • The entire sale proceeds have to be invested in either purchase or construction of a residential property.
  • If a new residential property is purchased, the purchase can happen one year before the old property is sold or within 2 years from the date of sale of the earlier property.
  • If the proceeds are utilised for construction of a new residential house, the construction should be completed within 3 years from the date of sale of the earlier property.
  • If only a part of the sale proceeds is invested in the new residential property then, the exemption will be proportionate to the investment made. Exempted amount = Capital gain *invested amount/net sale consideration.
Under Section 54EC, the exemption can be claimed by investing the sale proceeds of a long-term capital asset in 54EC Capital Gain Bonds

This section is advantageous to those who are liable for long-term capital gains tax but are unable to claim an exemption under Section 54 by investing the sale proceeds in a new residential property. They can claim an exemption by investing the proceeds in 54EC capital gain bonds.

The rules for exemption under Section 54EC are:

  • The sale proceeds have to be invested in the capital gain bonds within 6 months from the sale of the property. However, the investment should be made before the tax filing deadline to be able to claim the exemption.
  • The amount invested is exempted from tax, but the interest earned on the Capital Gain Bond is taxable.
  • The lock-in-period of the Capital Gain Bond is 3 years and it will be automatically redeemed after 3 years, Capital Gain Bond will not earn interest after 3 years.
  • A minimum of 20,000 has to be invested in the Capital Gains Bond. 10,000 is the face value of the bond. Investment in the Capital Gains Bond can be made up to the extent of 50 Lakhs.
  • The Capital Gains Bond cannot be encashed within 3 years. With effect from Financial Year 2018-19, the lock-in-period is enhanced to 5 years and so the bond cannot be redeemed within 5 years.
  • The Bonds are issued by REC and NHAI and the interest rate offered is 6%
  • The Bonds can either be held in physical form or D-mat form
  • No loans will be given against these Bonds

Investment in Capital Gains Account

Investing the sale proceeds in a new residential property involves a long procedure. A prospective seller has to be found, the required funds have to be arranged, and all the paperwork that is required for the transfer of the asset has to be completed. It would sometimes be difficult to complete the procedure within the tax filing deadline.

In such cases, the investment can be made in Capital Gains Account in any Public Sector Bank or any other Bank as per the Capital Gains Account Scheme which was introduced in the year 1988.

The following are the features of the Capital Gains Account:

  • A mention has to be made in the Income Tax Returns about the option made to invest in the Capital Gains Account Scheme.
  • The investment can either be made in a lump sum or in instalments before the tax filing deadline.
  • There are two types of accounts under this scheme. Capital Gains Savings Account which gives the flexibility to withdraw the amount whenever needed, but the amount so withdrawn should be utilised before 2 months from the date of withdrawal for the specific purpose to claim exemption. The other type of account is a Fixed Deposit which will be for a fixed period. It can be withdrawn only after the specific period.
  • The interest earned on the Capital Gains Account is taxable
  • No loans will be granted against the deposit in the Capital Gains Account

Capital Gains Can Be Set Off Against any Capital Loss Carried Forward from Previous Years

The Income Tax Act permits set off of Capital Gains against any capital loss carried forward from previous years, but there are certain conditions posed for this. They are:

  • Long-term capital gains can be set-off against long-term capital loss and short-term capital gains can be set-off against short-term capital loss.
  • The period for which the capital loss can be carried over is 8 years
  • There should have been a mention of this capital loss in the Income Tax Returns of the taxpayer

Claiming Tax Exemption on Sale of Agricultural Land

  • Agricultural land is not considered as a capital asset and hence the profit made out of the sale of agricultural land is not considered as a capital gain.
  • If the sale and purchase of lands are done as a real-estate business then the profit made out of such sales is considered as capital gains and is taxed under the business and profession head.
  • Capital gain that arises out of compensation received by compulsory acquisition of urban agricultural land is exempted from tax under Section 10(37) of the Income Tax Act.
  • If the capital gains do not arise out of any of the three cases mentioned above then, the exemption can be sought under Section 54B.

Section 54B - Exemption on Capital Gains Tax on Sale of Agricultural Land

Exemption on tax for any short-term or long-term capital gain can be claimed under section 5B.

  • An individual, parents of individual, and HUF are eligible for this exemption
  • An exemption can be claimed 2 years prior to the sale
  • An exemption is to the extent of the investment in the new property or the capital gains whichever is lower.
  • Investment in new agricultural land should be made within 2 years from the date of sale
  • The agricultural land so purchased should not be sold within 3 years from the date of sale
  • In case the agricultural land cannot be purchased before the tax filing deadline, the proceeds can be invested under the Capital Gain Account Scheme 1988 in any PSU banks or other banks.
  • If the agricultural land is not purchased, then the amount will be treated as capital gain in the year when the 2 year period from the date of sale lapses.

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