What is Capital Gains and their taxability?
WHY INVEST IN MUTUAL FUNDS?
A capital gain is nothing but the profit made by the sale of capital assets. And what is a capital asset?
Capital assets are real estate assets in the form of pieces of land or houses, cars, investment properties, stocks, bonds, and even collectibles or art. When any of these items is sold at a higher price than the price at which it was acquired, the profit is considered a capital gain. If, however, a capital asset is sold at a lower price than the buying price, a capital loss is incurred.
The profit earned from capital gains is taxable income for the financial year in which the deal takes place. Capital gains tax is not applicable if the property happens to be inherited or gifted.
(Read more: Taxes on mutual funds)
Capital assets are classified into two categories to make tax calculations easy:
- Short-term capital assets: Capital assets, except for immovable properties and certain listed securities, owned by the assessee for less than 36 months are considered as short-term capital assets. In case of shares, debentures, and bonds, this period is less than 12 months. The profit earned from the sale of such assets is termed as short-term capital gains.
- Long-term capital assets: Capital assets, except for immovable properties and certain listed securities, owned by the assessee for more than 36 months are considered as long-term capital assets. The profit made from their sale is termed as long-term capital gains.
From assessment year (AY) 2018–19, there has been a change in the holding period of assets in terms of classification into short- or long-term assets. Real estate assets now need to be held for 24 months to be considered as long-term capital assets.
Meanwhile, some others are considered as long-term capital assets when held for more than 12 months:
- Units of UTI, quoted or otherwise
- Equity or preference shares of a listed company
- Units of equity-oriented mutual funds, quoted or otherwise
- Listed securities like debentures, bonds, government securities etc.
- Zero coupon bonds, quoted or otherwise
This rule is applicable if the date of transfer takes place any time after 10 July 2014 regardless of the date of purchase. In this case, a transfer refers to giving up of the rights on an asset by means of sale, exchange, and compulsory acquisition under any law and relinquishment.
However, for capital assets that are inherited, gifted, or acquired via a will or succession, the holding period of the previous owner is taken into account.
(Read more: Taxes on inherited mutual funds)
For any rights or bonus issues, the holding period is considered right from the date of allotment of such shares.
HOW ARE CAPITAL GAINS TAXED?
Capital gains are taxed on the basis of whether it pertains to a long-term or short-term asset.
- To calculate tax on short-term capital gains, the gain is simply added to the total income of the assessee and then income tax is calculated on the basis of the tax bracket in accordance with the income. In such cases, securities transaction tax (STT) is not applicable. If, however, STT does apply, the gains are taxed at a flat rate of 15% plus surcharge and education cess.
- To calculate tax on long-term capital gains, the role of inflation has to be considered as the holding duration is longer. In general, long-term capital gains are taxed at 20% plus surcharge and education cess. However, gains above Rs 1 lakh resulting from the sale of equity shares or units of equity-oriented funds attract 10% tax.
(Read more: Save tax with tax-exempt allowance)
TAXES ON DEBT AND EQUITY MUTUAL FUNDS
Taxes on debt and equity mutual funds are computed differently. Funds investing more than 65% of their respective portfolios in equities are termed as equity funds. Debt funds invest in fixed interest-generating securities like corporate bonds, government securities, treasury bills etc.
| Effective from 11 July 2014 | ||
| Mutual funds type | Short-term gains tax | Long-term gains tax |
|---|---|---|
| Debt funds | As per the income tax slab of the assessee | 20% (after indexation) |
| Equity funds | 15% (plus surcharge and cess) | Nil |
(Read more: Debt vs. equity funds)
CALCULATE TAXES ON CAPITAL GAINS
Before starting to calculate the capital gains, one has to understand the meaning of the terms used for those calculations.
- Full value consideration: This is the total amount—either in cash or kind—that the seller receives against his/her capital assets.
- Cost of acquisition: This is the price at which the capital assets were acquired by the seller.
- Cost of improvement: This is any expenses that the seller might have incurred for maintaining and improving the capital assets.
- Cost of transfer: This is any expenses incurred for the sale of the capital assets like brokerage, stamp papers etc.
- Indexed cost of acquisition/improvement: Cost inflation index (CII) is a government declared amount for each year. This value is applied while calculating the cost of acquisition and improvement to adjust the effects of inflation over the years. The value received after applying CII is called an indexed value.
SHORT-TERM CAPITAL GAINS TAX:
Full value consideration – (cost of acquisition + cost of improvement + cost of transfer) = Short-term capital gains
LONG-TERM CAPITAL GAINS TAX:
Full value of consideration received or accruing – (indexed cost of acquisition + indexed cost of improvement + cost of transfer) = Long-term capital gains
Indexed cost of acquisition = Cost of acquisition multiplied by the cost inflation index of the year of the transfer/cost inflation index of the year of acquisition.
Indexed cost of improvement = The cost of improvement, multiplied by the cost inflation index of the year of the transfer/cost inflation index of the year of improvement.
(Read more: ELSS investment affects asset allocation)
TAX EXEMPTIONS ON CAPITAL GAINS
Tax exemptions can be made on any capital gains earned from transactions of capital assets. The situations described below mention ways to avail such exemptions.
- Under Section 54 of the Income Tax Act, a person is eligible for exemption on the profit earned if the entire proceeds from the sale of capital assets are used to purchase another real estate property. The seller has to purchase a new house within two years from the date of sale or build a new house within three years from the date of sale.
- You can invest the entire capital profit in bonds issued by the National Highway Authority of India (NHAI) or the Rural Electrification Corporation (REC). Only then can you claim a tax rebate under Section 54 EC. The exemption limit is Rs 50 lakh.
- If you fail to buy a house within three years of selling your capital assets, there are still ways to save tax on the capital profit. You can invest your gains in the Capital Gains Accounts Scheme (CGAS) in any public sector bank within the stipulated timeframe and claim tax exemption on the entire amount.
- If you sell agricultural land lying outside the limits of a civic body, the capital gain amount would not be taxable.
- If you wish to set up a small- or medium-scale industry and sell your capital assets to finance it, the capital gains made would not be taxable. To avail the tax rebate, you must invest the entire proceeds from that sale in the industry and buy the required machines within six months from the date of sale of your capital assets.
(Read more: Investments to declare to get tax exemption)
