Capital Gains Tax

Capital Gains Tax: Overview

A tax which is levied on the profit or gain which an investor has earned by selling his/her capital asset is referred to as the Capital Gains Tax. For the ease of computation purpose, capital assets have been classified in two broad categories which are Long-Term Capital Asset and Short Term Capital Asset.

Capital Asset

Any asset such as immovable property, vehicles, leasehold earning, jewellery, machinery or intellectual property such as patents and trademarks are termed as capital assets. Capital asset is broadly divided into two categories which are long term capital assets and short term capital assets. The two are differentiated on the basis of their period of ownership. Capital assets include any direct rights, which in of Indian companies, includes the rights of management or ownership control as well as other holding rights.

Capital Gain

Capital gain is the net profit which an investor makes after selling any of his capital assets at a price that exceeds its original purchase price. The transfer of such capital asset should have had been done in the previous financial year in order to be eligible for taxation during the current year. The entire value of this sale is taxable under the income head termed as ‘Capital Gain’. This whole process is backed by three fundamental elements:

  • A capital asset such as property, gold etc.
  • The transfer of such capital asset
  • A profit earned as a result of this transfer.

So in other words we can say that Capital gains occur only when someone sells their capital asset at an amount which is greater than what they actually paid while purchasing the asset. Capital assets broadly include various investment products such as shares and stocks, any immovable property such as a plot or a house or even mutual funds. However if  there is any loss at the time of selling the capital assets ,in the context of purchase price can result in capital loss, which would of course be tax exempt.

Capital gain is not pertinent for selling an asset which is inherited as no sale happens in such cases and there is an only ownership transfer. However, in case the asset is sold at a higher price than the price at which the asset was inherited, capital gains tax would be applicable to such a sale. The Indian Income Tax Act of 1961 has exempted such assets received in particular as gifts either by way of any inheritance or according to will.

Capital Gains doesn’t includes below mentioned assets held by any assessee.

  • Any stock held in trade.
  • Consumable raw materials which are kept for the specific purpose of any business or as per profession.
  • Any personal effects which are movable excluding jewellery, drawings or paintings, sculptures, archaeological collections or any such art work which is kept for their personal use.
  • Agricultural land which is not located within an 8 km radius of any municipality, town Municipal Corporation, any notified area board, any town committee / cantonment area board having a minimum residential population of 10,000 people.
  • National Defense Gold Bonds 6.5 % Gold Bonds or the Special Bearer/ Gold Deposit bonds under the government Gold Deposit Scheme.

Category of Capital Gain

The Capital gains is basically classified into 2 categories:

  1. Long-Term Capital gain: in case the asset is owned for more than 3 years continuously, it is considered as a long term capital asset. The gain or profit earned by selling such capital assets is called as long-term capital gains. In case of equities and mutual funds, long term capital gains apply if the units have been held for at least 1 year.

 Other capital assets that are classified as long term capital assets if period of holding exceeds 12 months include:

  • Equity shares that are listed in any stock exchange
  • The units of equity oriented mutual funds
  • Any listed debenture or government security
  • Units of UTI & Zero Coupon Bonds
Short-Term Capital gain: Any asset which is sold within less than 3 years of acquisition are known as short-term assets, hence the gain/profit by selling said asset is called to be short-term capital gain.

Calculation of Capital Gains

For the ease of calculation of capital gain tax it is done as per the nature of capital gain.
  1. Taxation on short-term capital gains- This is less complex than the long-term gains. The total tax liability is calculated by adding the overall gain to the total income of the tax payer. Subsequently, thereby the income tax calculation is applied as per the individual’s tax bracket.
  2. Taxation on long-term capital gains – Long term capital gains calculation is more complex in nature. This is primarily because the capital asset is held for a longer period of time and various other factors such as inflation come into the picture while calculating the same. This is broadly done on the basis of few other components such as
  • The process of amending various prices according to a standard index based system is termed as Indexation. This is done in order to factor in the rate of inflation while computing the profits earned after sale of capital assets. Indexation is a critical factor in the overall taxation system, since the prices of capital holdings tend to keep varying, computing the profits simply based on its original price cannot be a precise benchmark of profit. Apart from correct calculation, Indexation also brings inflation into picture and thus allows a correct and rational figure for long-term capital gains.
CII (Cost of Inflation Index)
  • CII is a fixed index which is regulated by the Indian government and declared in its annual budget every year. Cost Inflation Index is used for calculating the capital gains on the long-term assets. Currently the cost inflation index for the running financial year 2016-2017 is 1125.

The taxes are worked out based on below mentioned methodology:

1. Short-term capital gain tax = A- (B+C+D) whereas

A= Sale value of the asset
B= cost of acquisition
C= cost of improvement
D= the cost of expenditure incurred totally and solely in the connection with a transfer

2. Long-term capital gain = A-(B+C+D), whereas,
A=Full value of consideration received or accruing
B=indexed cost of acquisition*
C= indexed cost of improvement**
D= cost of expenditure incurred wholly and exclusively in connection with such a transfer
*Indexed cost of acquisition = A X (B / C), wherein
A= Cost of acquisition 
B=CII of the year of transfer
C= CII of the year of acquisition

**Indexed cost of improvement = A X (B / C), wherein,

A=cost of improvement 
B=CII of the year of transfer 
C= CII of year of year of improvement

Cost of transfer is the brokerage paid for managing the deal, cost of advertising plus legal expenses incurred etc.

Provisions of Capital Gain tax as per Income Tax act 1961

  • Currently the long-term capital gain on equity based mutual funds or on stocks in not taxable.
  • The short term gains are taxed at 15%.
  • In case of debt mutual funds, both short & long term capital gains are taxable.
  • In case of debt mutual funds, short-term capital gain is clubbed to the individual income and is taxable as per their income tax slab.
  • Long-term capital gains on debt funds are taxable at 20 % with indexation and 10 % without indexation.

Exemption in Capital Gains Tax

Below is a list of those cases which are exempted from any capital gain tax.
  1. Sale of an agricultural land located in the rural areas
  2. There is exemption from taxation if the sale proceeds of a residential property are further utilized to buy another residential property. This is however subject to the following conditions
  1. The purchase of property should be done either 1 year prior to selling the property or within two years of the sale.
  2. In case of under construction property, the same should be done within maximum three years from the transfer date of the earlier property.
  3. The newly acquired property cannot be further sold within 3 years of purchase or construction.
  4. The newly acquired property should be located in India.
  5. The person should not have more than one residential property apart from the one newly acquired as per the transfer date.
  6. No other property is purchased for another 2 year or constructed for the next 3 years.
  1. There are various other options such as Capital Gains Account Scheme. Any investment done in such scheme is exempted from tax payment under the capital gain head, provided the money is invested for a specified tenure as required by the bank.
  2. Other viable option is purchasing the Capital Gains Bonds. The overall investment done in this bond is exempted under Section 54EC of IT Act. However the exemption is exclusively applicable for long-term capital and ideally for those who have no plan to invest in another property in the recent future. Any resident Indian can invest in Capital gain bonds and the tax payer is permitted to invest within six months of selling the property. The bonds are valid after 3 years and can be redeemed after their scheduled maturity.
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