Short Term Capital Gain Tax vs. Long Term Capital Gain Tax

Understanding Capital Assets and Capital Gains

What is a Capital Asset?

Capital Assets: As per Section 2(14) of the Income Tax Act, 1961, capital assets include any form of property held by an individual, regardless of its association with their business or profession. This category includes different assets such as land and buildings (comprising residential, commercial, and agricultural properties), investments like shares, stocks, bonds, mutual funds, gold, intangible assets like goodwill, copyrights, patents, trademarks, and specific personal assets like jewelry exceeding ₹2 lakhs and artwork.

What are Capital Gains?

Capital Gains: The profit or gain resulting from the transfer of a capital asset falls under the purview of capital gains. This is subject to taxation under the "Capital Gains" section in the income tax return. Capital gains are classified into two categories:

• Short-term capital gains (STCG): These gains arise from the sale of assets held for less than 12 months, 24 months (or 36 months for dLong-term capital gains (LTCG): These result from tebt mutual funds before April 1, 2023), depending on the nature of the asset. The tax is levied at the individual's income slab rate.
  he sale of assets held for more than 12 months, 24 months (or 36 months for debt mutual funds before April 1, 2023). The tax rates vary depending on the type of asset.

Difference Between Short-Term and Long-Term Capital Assets and Gains

The major difference between short-term and long-term capital assets and gains depends on the holding period (the duration an asset is held before being sold) and the subsequent tax treatment:

Holding Period:

For short-term capital assets, the holding period in India is less than 24 months (36 months for debt mutual funds before April 1, 2023). In contrast, long-term capital assets are those held for more than 24 months (36 months for debt mutual funds before April 1, 2023) in India.

Tax Treatment:

Short-term capital gains (STCG) are subject to taxation at your income slab rate, akin to regular income. This has the potential to push you into a higher tax bracket, significantly impacting your investment returns.

Long-term capital gains (LTCG), on the other hand, enjoy more favorable tax rates, contingent on the type of asset.

How to Calculate Short-Term Capital Gain

Calculating short-term capital gains (STCG) involves a relatively simple formula, but understanding the nuances is crucial for accurate tax reporting. Here's a breakdown:
Formula:
STCG = Selling Price of Asset - Cost of Acquisition - Allowable Expenses
Where;

Selling Price of Asset: This is the amount you received when you sold the asset. Remember, it should include any brokerage charges or transaction fees paid at the time of sale.

Cost of Acquisition: This is the original price you paid for the asset when you bought it. Include any incidental expenses incurred at the time of purchase, like stamp duty or registration charges.

Allowable Expenses: These are additional expenses you may have incurred during the holding period of the asset, directly related to its sale. Examples include brokerage charges paid for selling the asset, advertising costs to attract buyers and transfer fees.

Important points to remember:

Holding Period: Remember, STCG applies only to assets held for less than 24 months (36 months for debt mutual funds before April 1, 2023). Assets held longer become long-term capital assets and are taxed differently.

Indexation (for Debt Funds and Physical Gold): For debt mutual funds and physical gold held for less than 36 months before April 1, 2023, you can use indexation to adjust the cost of acquisition for inflation. This reduces your taxable gain and potentially lowers your tax liability. However, indexation is not available for equity shares as of January 2024.

Securities Transaction Tax (STT): If the asset was traded on an identified stock exchange in India, the Securities Transaction Tax (STT) paid at the time of sale is not deductible from the cost of acquisition. It's considered a separate expense.

Short-term capital gains (STCG) are not taxed separately based on income brackets. Instead, they are simply added to your other income and taxed at your regular income slab rate. This means the applicable tax rate for your STCG will depend on your total taxable income for the year.

For example, if your total income before considering the STCG is Rs. 8 lakhs and you make an STCG of Rs. 2 lakhs, your total taxable income becomes Rs. 10 lakhs. As this falls within the Rs. 10 lakhs to Rs. 20 lakhs income slab, your STCG will be taxed at a rate of 30%.

Here are some additional points to keep in mind:

Surcharge and Cess: In addition to the income tax rate, you may also need to pay surcharges and cess on your STCG, depending on your income level. Consult the Income Tax Department website for details.

Exceptions: Some specific types of short-term capital gains may be subject to different tax rates or even exempt from tax altogether. These exemptions are usually related to specific investments or government schemes.

How to Calculate Long-Term Capital Gain

Calculating long-term capital gains (LTCG) in India involves some key steps and different approaches depending on the asset type. Here's a breakdown:

General Formula:

LTCG = Selling Price of Asset - Cost of Acquisition (adjusted for indexation, if applicable) - Allowable Expenses

Where;

Selling Price of Asset: Same as for STCG, including any transaction fees or charges.
Cost of Acquisition: Similar to STCG, but with potential adjustments:

Indexation: For debt mutual funds and physical gold held before April 1, 2023, you can increase the cost of acquisition for inflation using an indexation factor provided by the government. This reduces your taxable gain and potentially lowers your tax liability. Indexation is not available for equity shares as of January 2024.

Acquisition expenses: Include any related expenses incurred at purchase, like stamp duty or registration charges.

Allowable Expenses: Same as for STCG, covering expenses directly related to selling the asset (brokerage, advertising, transfer fees).

Important points:

Holding Period: Remember, LTCG applies only to assets held for more than 24 months (36 months for debt mutual funds before April 1, 2023).

Tax Rates: LTCG tax rates differ based on the asset type:
Equity shares/units of equity-oriented mutual funds: 10% without indexation (as of Jan 2024).
Debt instruments, gold, etc.: 20% with indexation (if applicable).

Residential property: 20% (with exemptions or deduction of cost of acquisition and improvement).

Surcharge and Cess: Depending on your total income (including LTCG), you may need to pay additional surcharges and cess on your LTCG.

Long-Term Capital Gains Tax Rates

Long-term capital gains (LTCG) are not directly taxed based on income thresholds. However, your total income, including LTCG, determines the applicable surcharge and cess rates in addition to the base LTCG rate based on the asset type. Here's a breakdown:

Base LTCG Rates:

Equity shares/units of equity-oriented mutual funds: 10% without indexation benefit (as of January 2024).
Debt instruments, gold, etc.: 20% with indexation benefit (if applicable).
Residential property: 20% with exemptions or deductions for cost of acquisition and improvement.
Surcharge and Cess: These are additional taxes levied on your total income (including LTCG). The applicable rates depend on your total income slab:

Capital Gains Tax Saving Hacks

• Holding Equity Investments for a longer period - if you hold your equity investments for a longer period of time, you can save tax on capital gains. The tax rate on long-term capital gains is lower. Moreover, you can also claim various deductions and exemptions under sections 54 to 54F on long-term capital gains.
• Tax loss Harvesting: Selling an old, unprofitable property at a loss and buying a new profitable asset can help you offset the capital gains from profitable trades.
• Opting for Dividend Re-investment Scheme: If an individual does not want to take the dividend payout, he/she can invest the dividend amount to purchase additional shares.
• Carefully Selecting Mutual Fund - To save maximum tax on capital gains, you need to choose mutual funds with longer durations, higher credit risks, and credit opportunities.
• Indexation for Long-term Debt Mutual Funds investment - Indexation is a method of calculating an asset’s cost after accounting for inflation to reduce the overall tax liability.