Long-Term Capital Gains Tax (LTCG): What It Is & How It Works?

What is a Long-Term Capital Gain?

The Income Tax Act of 1961 defines "long-term capital gains" as profits earned from selling any asset held for over a year. These gains are taxed under the "Capital Gains" category. Any property owned by an individual, regardless of its use for business or personal purposes, qualifies as a capital asset for this purpose. Notably, securities held by foreign institutional investors under SEBI regulations are also considered capital assets.

What qualifies as Long-Term Capital Gains?

Section 2(29A) broadly classifies a capital asset held for more than 36 months as "long-term," but distinct time frames are assigned to specific asset categories. Unlisted shares and immovable property fall under this category after 24 months, while Zero-Coupon Bonds require 12 months for the same classification. In general, the duration for long-term holding spans from 1 to 3 years. Assets subject to Long-Term Capital Gains Tax (LTCG) include Listed Equity Shares, Equity-Oriented Mutual Funds, and Business Trust Units. Previously, LTCG on shares and securities subject to securities transaction tax (STT) were exempt under Section 10(38), but this exemption was rescinded in 2018. As of the financial year 2018-19, Section 112A imposes a 10% tax on LTCG for the mentioned assets when the sales exceed ₹1 lakh per year.

Taxation on Long-Term Capital Gains

Holding stocks, certain mutual funds, and business trust units for more than a year before selling (long-term capital gains) gets you a lower tax rate of 10% on profits exceeding Rs 1 lakh. Other investments tax gains at 20%, with additional charges.

Computation of LTCG

Section 48 of the Income Tax Act provides a comprehensive guide on calculating the tax on Long-Term Capital Gains (LTCG) arising from the sale of capital assets, offering clarity on confusing terms. The process involves several steps:

Determine the taxable income:

• Start with the sale price, referred to as the "value of consideration," representing the amount received for the asset.
• Deduct the following three amounts:
• Transfer expenses, covering costs directly associated with selling the asset, such as brokerage fees.
• Original cost denotes the price paid to acquire the asset (cost of acquisition).
• Improvement costs contain any expenses incurred for upgrades or renovations (cost of improvement).
• Important details to note:
• Securities transaction tax (STT) cannot be deducted from taxable income.
• The government may adjust the original and improvement costs for inflation using the "cost inflation index" (CII), resulting in the "indexed cost of acquisition" and "indexed cost of improvement."

Additionally, it's essential to understand key terms such as:

• Value of consideration: The money received for selling the asset is considered taxable even if received after the sale year.
• Cost of acquisition: The original purchase price of the asset.
• Cost of improvement: Any expenses invested in upgrading or remodeling the asset.
• Cost inflation index (CII): A government-calculated estimate of inflation based on 75% of the average rise in urban consumer prices.

Exemptions on LTCG Tax

The Income Tax Act provides various approaches for mitigating tax liability on long-term capital gains, including:

• Capital Gains Account Scheme (CGAS): Investing the gains in a CGAS can be an effective option to defer tax payments.
• Mutual Funds Investment: Certain mutual funds, when held for over a year, may yield tax-free returns, offering an alternative avenue for long-term capital gain investment.
• Property Sale and Reinvestment: Selling a property and reinvesting the gains in another property within 1-2 years can qualify for exemption. However, this option is not applicable if the original property was sold within three years of acquisition. It's crucial to adhere to the specified timeframes to avail of the tax benefits.

Capital Gain Account Scheme

An investor can benefit from tax exemptions through a capital gain account scheme, even without acquiring a residential property. Under this scheme by the Government of India, withdrawals from the account are permitted solely for the purpose of purchasing houses and plots.

In the event of withdrawals for purposes other than property acquisition, the funds must be utilized within three years from the date of withdrawal. Failure to do so will result in the entire profit amount being subject to long-term capital gain tax rates.

The long-term capital gains (LTCG) tax was introduced with the Union Budget of 2018, making every individual liable to pay LTCG after selling capital assets exceeding Rs. 1 Lakh.