Capital Gains Tax - What is Capital Gains Tax, Types, & Tax saving

What is Capital Gain tax in India?

Capital gain is the profit you get when you sell off a capital asset. You profit when you sell a capital asset at a higher price than the cost at which you acquired it. This profit is called Capital Gain, which is your income. This income is chargeable to tax, and the tax calculated on capital gains is called the tax on capital gains or capital gain tax.

To understand capital gains, you need to understand the concept of capital assets.

What are Capital Assets?

Capital assets are the property you own and can be transferred, like land, buildings, shares, patents, trademarks, jewelry, leasehold rights, machinery, vehicles, etc.
Here is a list of assets that do not fall under the category of capital assets:–

• The stock of consumables or raw materials held for use in business or profession.
• Personal belongings meant for personal use like clothes, furniture, etc.
• A piece of agricultural land is located in a rural area.
• Special bearer bonds, 6.5% gold bonds (1977), 7% gold bonds (1980), or national defense gold bonds (1980) which the Central Government has issued.
• Gold deposit bond (1999), issued under the gold deposit scheme or deposit certificate issued under Gold Monetisation Scheme, 2015, notified by the Central Government.

What are the different types of Capital Assets?

Capital assets are divided into two types based on the period after which they are sold off. The types of capital assets are as follows –

Short-term capital assets

Short-term capital assets are those held for less than or equal to 36 months. This means that if you sell off the asset within 36 months of buying it, it would be called a short-term capital asset. However, in some cases, the holding period is reduced to 24 months and 12 months. These cases include the following –

• If the asset is an immovable property like land, building, or house, then the holding period would be considered 24 months. This means that if you sell off an immovable property within 24 months of buying it, it would be called a short-term capital asset.
• Similarly, equity shares of a company listed on the Recognized stock exchange, securities listed on the Recognized stock exchange, UTI units, Equity oriented mutual fund units, and zero-coupon bonds have a holding period of 12 months. If these assets are sold off before 12 months of purchase, they would be called short-term capital assets.

Long-term capital assets

Long-term capital assets are those held for more than 36 months and then sold off. Immovable property sold after 24 months would be categorized as a long-term capital asset. In the case of equity shares, securities, mutual fund units, etc., however, the holding period of 12 months is applicable. If sold off after 12 months, they would be called long-term capital assets.

What are the different types of Capital Gain?

Now that you have understood what capital assets are and their types, it’s time to understand the types of capital gains. Capital gains are divided into short-term capital gains and long-term capital gains –

Short Term Capital Gain

Short-term capital gains (STCG) are the profits you earn when you sell off your capital assets within one year of holding them. Note that the holding period varies as per the capital asset.

• When the security transaction tax is applicable: Short-term capital gain tax is 15%
• When a security transaction tax is not applicable Short term capital gain tax will be calculated based on the income of the Taxpayers and will be automatically added to the ITR of the taxpayer and charged at normal slab rates.

Long-Term Capital Gain

Long-term capital gains (LTCG) are the profits you earn when you sell off your capital assets post one year. Note that the period of holding for different assets to be claimed as long-term asset varies according to the asset

• Long Term capital gain tax is applicable at 20% except on the sale of equity shares and the units of equity-oriented funds.
• Long Term capital gains are 10% over and above Rs 1 lakhs on the sales of Equity shares and units of equity-oriented funds.

How is Capital gain calculated?

Calculating capital gains depends on the type of capital gain you are earning. Short-term capital gains are calculated differently than long-term ones. However, before calculating the different types of capital gains, you should understand the concept of the full value of consideration, as it forms the basis of capital gains calculation

Full value Consideration

The full value of the consideration is, in simple terms, the money that you would receive when you transfer your capital asset. In technical terms, full value consideration is the consideration that the seller has received or would receive in exchange for transferring his capital asset.
Besides full value consideration, there are two other important terms:

• Cost of acquisition and
• Cost of improvement.

Cost of Acquisition: Cost of acquisition is the asset's cost price. It is the price at which you bought the capital asset.

Cost of Improvement: Cost of improvement is the money spent on the capital asset to improve it. The cost of the improvement is added to the cost of acquisition to compute capital gains. However, if the improvement cost is incurred before 1st April 2001, it would not be added to the acquisition cost.

How to calculate the different types of capital gains?

Short-term capital gains Calculations

Let’s understand it with an example. A house property was bought on 1st January 2021 for INR 50 lakhs. On 1st January 2022, INR 5 lakhs were spent on improving the house. On 1st November 2022, the house was sold for INR 65 lakhs.

Since the house was sold after 22 months of buying it, it would be categorized as a short-term capital asset. The gain from selling the house would be called a short-term capital gain, and it would be calculated as follows –

Long Term Capital Gain Calculations

In the calculation of long term capital gains, there are three different concepts that you should understand

• Indexed cost of acquisition,
• Indexed cost of improvement and
• Expenses deducted from the full value of consideration

Indexation of cost

Indexation of costs is done to factor the inflation over the years when you hold the capital asset. Since inflation decreases the value of money, indexation of the acquisition and improvement costs increases the amount of these costs, thereby lowering the capital gain earned. To calculate indexation, Cost Inflation Index (CII) accounts for the inflation incurred over the holding period. To calculate the indexed costs, the following formula is used –

The base year for CII has changed from 1981 to 2001. That is why, when calculating the indexed cost of acquisition, CII of 2001-02 is considered if the asset was purchased before the financial year 2001-02.

With the shift in the base year, the CII numbers have also changed. The CII for different years, as determined by the Central Government, are as follows –

Expenses allowed to be deducted from the full value of consideration

These are the expenses that were necessary to be incurred when selling the asset. Without these expenses, the asset would not have been purchased. These expenses, since mandatory, are allowed to be deducted from the full value of the consideration, which lowers the selling price / increases the cost of acquisition, and also decreases the capital gain. The expenses allowed to be deducted include the following –

Examples of Capital Gain

A house property was purchased on 1st January 2000 for INR 20 lakhs. On 1st January 2005, repairs were done on the house, which amounted to INR 5 lakhs. On 1st January 2023, the house was sold for INR 75 lakhs. A brokerage was paid to the broker, which was INR 1 lakh. What would be the capital gain amount?

Solution:

Since the asset has been held for more than 36 months, it is a long-term capital asset, and the gain is a long-term capital gain. The gain would be calculated as follows –

Capital Gain Tax in India

Now that you have understood the calculation of short-term and long-term capital gains, it’s time to understand capital gain tax in India.

Just like gains are short-term and long-term, capital gain tax in India is divided into short-term and long-term capital gain tax. Let’s see the capital gain tax rate for these respective taxes –

Short-term capital gains tax (STCG tax)

Short-term capital gains are taxed at your income tax slab rate if Securities Transaction Tax (STT) is not applicable on the gains. In such cases, the gains are added to your taxable income and then taxed at the slab rate under which your income qualifies. If, however, in the case of equity shares, STT is applicable, short-term capital gains are taxed at 15%.

Long-term capital gains tax (LTCG Tax)

Long-term capital gains are taxed at a flat rate of 20% Though STCG and LTCG are taxed at the above-mentioned rates, in the case of equity and debt-related investments, the tax rates and rules are different. Here is how equity and debt fund investments are taxed –

Surcharge on long term capital assets

The maximum rate of surcharge on the long-term capital gains of listed equity shares, units, etc., is 15%. The surcharge for other long-term capital assets is capped at 37%.

The 2022 budget proposed to bring down the surcharge rate for other long-term capital assets by 15% to bring parity in all such assets.

With the Interim Budget 2019 announced on 1 Feb 2019, the tax benefits on capital gains have been widened. Extending the benefits, the interim finance minister Mr. Piyush Goyal pronounced that the capital gains to the extent of Rs 2 Crore can now be invested in up to two residential house properties. This is to be done in lieu of the existing investment provision required in one residential house property. But this option can be availed only once in the investor's lifetime.

The amount invested in these two house properties shall not attract any long-term capital gains tax.

The long-term capital gain is presently required to be invested either in purchasing a residential house property in the next two years or constructing a house in the next 3 years, or investing in bonds u/s 54EC within 6 months to make the capital gains tax-free. But, from the financial year 2019-20 (the assessment year 2020-2021), the taxpayer would be made eligible to adopt this new system to invest in two residential houses once in a lifetime for an aggregate benefit of Rs 2 crore.

So, understand what capital gains are, when they are incurred, their types, and how they are taxed when you file your income tax return. To file your taxes or get the best tax planning done, Contact us Now!!

Exemption on Capital Gain

Because capital gains tax tends to erode a significant portion of earnings, it becomes critical for individuals to utilize tax-saving strategies to help them reduce their tax liability. To assist individuals in minimizing their capital gains tax liability, the government provides a list of exemptions under capital gains. These tax exemptions are known as capital gains exemptions.

Exemption Under Section 54: Sale of House Property on Purchase of Another House Property

The exemption on two house properties shall be available once in a lifetime to a taxpayer, provided the capital gains do not exceed Rs. 2 crores. The taxpayer is only required to invest the number of capital gains, not the complete sale proceeds. The exemption will be limited to the total capital gain on sale if the purchase price of the new property is higher than the number of capital gains.

The following conditions must be met to enjoy the benefit:

• The new property can be purchased either one year before or two years after the previous property has been sold.
• Gains can also be invested in property construction, but construction must be completed within three years of the sale date.
• In the 2014-15 Budget, it was made clear that only one house property could be purchased or built with capital gains to qualify for this exemption.
• Please remember that this exemption can be revoked if the new property is sold within three years of its purchase or completion of construction.

Exemption Under 54B: Transfer of Land Used for Agricultural Purposes

An exemption is available under Section 54B when you make short-term or long-term capital gains from the transfer of land used for agricultural purposes – by an individual, the individual's parents, or a Hindu Undivided Family (HUF) – for two years before the sale. The exempt amount is the lesser of the investment in a new asset or the capital gain. You must reinvest in new agricultural land within two years of the transfer date.

• The new agricultural land purchased to claim capital gains exemption should not be sold within three years of its purchase date.
• If you cannot purchase agricultural land before the due date for filing your income tax return, the number of capital gains must be deposited in any branch (except rural branches) of a public sector bank or IDBI Bank before the due date.
• Exemptions can be claimed for the amount deposited. If the amount deposited under the Capital Gains Account Scheme was not used to purchase agricultural land, it should be treated as capital gains of the year in which the period of two years from the date of sale of land elapsed.

Exemption Under Sections 54 E, 54EA, and 54EB – Profits from investments in certain securities

This capital gains exemption applies to capital gains derived from the transfer of long-term capital assets. Individuals can take advantage of such long-term capital gain exemptions if they reinvest in securities such as targeted debentures, UTI units, government securities, government bonds, etc.

The following conditions must be met–

• Individuals must reinvest in such new securities within six months of the transfer of capital assets.
• If the individual plans to sell the new securities before 3 years or 36 months, the previously offered exemption would be deducted from the total cost to determine the capital gains.

It is important to note that any loan availed against these securities before 3 years would be treated as a capital gain.

Exemption Under Section 54EC – Profits from the sale of a long-term capital asset are exempt from tax if reinvested in specific long-term assets.

Long-term capital gains on the sale of long-term assets would be qualified for long-term capital gain exemption. Individuals will be eligible for such exemptions if they reinvest their proceeds in assets of either the Rural Electrification Corporation or the NHAI.

Such capital exemptions are available if and only if the following conditions are met:

• Individuals reinvest the proceeds into specified assets within six months of the asset's sale.
• Capital gains should not exceed the amount invested. If only a portion of the gains were reinvested, the capital gain exemption would apply only to the reinvested amount.
• Specific assets must be held for a minimum of 36 months.

Exemption Under Section 54EE – Profits from a transfer of investments.

Capital gains derived from the transfer of long-term capital assets would be eligible for a capital gain exemption if –

• Individuals should reinvest their proceeds within six months of receiving them.
• If individuals sell their new securities before 36 months, the previously offered exemption is subtracted from the cost to calculate capital gains.
• If a loan is taken out against new securities before 36 months, the capital gains are taxed.
• In the current and following fiscal years, such investments should not exceed Rs. 50 lakh.

Exemption Under Section 54F: Capital gains on the sale of any asset other than a home.

Exemption under Section 54F is available when capital gains are realized from the sale of a long-term asset other than a home. To qualify for this exemption, you must invest the entire sale consideration, not just the capital gain, in purchasing a new residential house property. Purchase the new property either one year before or two years after the previous one. You can also use the profits to fund the construction of a home. The construction, however, must be completed within three years of the date of sale.

In Budget 2014-15, it was stated that only one house property could be purchased or built from the sale consideration to claim this exemption. This exemption can be revoked if the new property is sold within three years of purchase. If you meet the conditions mentioned and invest the sale proceeds in the new house, the entire capital gain will be tax-free.

However, if you invest a portion of the sale proceeds, the capital gains exemption will be calculated as follows: capital gains x cost of new house /net consideration = capital gains x cost of new house /net consideration.