A Complete Understanding of Capital Gains

This page describes all essential information regarding long-term and short-term capital gain taxation. Capital gains are taxed at specific rates and exemptions are specified on them. The exemptions are prescribed under the Section 54, 54D, 54EC, 54F, 54G, 54GB etc. of Income Tax Act.

Section I: The basics

Defining capital gain

Any profit or gain earned by selling/transfer of “Capital Asset” is called capital gain and it is taxable in the year when the asset transfer completes. But no capital gain is applicable on a gifted or inherited property as these are specifically excluded from tax liability as defined in the Income Tax Act. If the inherited property gets sold by the heir than capital gain will be applicable on it.

Defining capital asset

Land or building or house property or goodwill of business or patents or trademarks or leasehold rights or drawings or paintings or jewelry are examples of capital assets. Also, rights in or in relation to an Indian Company and management rights, control rights are also counted as capital assets.

Things that are not considered as capital assets:

  • Clothes, furniture, and personal stuff.
  • Agricultural land in rural areas of India.
  • Special Bearer Bonds 1991
  • 6½% Gold Bonds, 1977
  • 7% Gold Bonds, 1980
  • Gold Deposit Bond issued under the Gold Deposit Scheme, 1999
  • National Defence Gold Bonds, 1980 issued by the Central Government
  • Any stocks or raw material or consumables held for Business or Professional purpose.

Agricultural land in rural areas of India:

Any area with a population of 10,000 or more that fall outside of a municipality or cantonment board jurisdiction is specified as a rural area from AY 2014-15. The rural areas must not fall within the distance specified below:

2kms from the local limit of municipality or cantonment board If the population of the municipality/cantonment board is more than 10,000 but not less than 1 lakh
6kms from the local limit of municipality or cantonment board If the population of the municipality/cantonment board is more than 1 lakh but less than 10 lakhs
8kms from the local limit of municipality or cantonment board If the population of the municipality/cantonment board is more than 10 lakhs

Defining long-term and short-term capital assets:

Long-term capital asset: a capital asset held for more than 36 months or 3 years.

Short-term capital asset: a capital asset held for 36 months or less.

Finding the specific holding period for capital assets are important as it determines the tax calculation for them. Some assets held for 12 months or less is considered as a short-term capital asset if the transfer date is on or after 10th July 2014 regardless of the purchase date.

Followings are such assets:

  • Units of Unit Trust of India,
  • Zero coupon bonds,
  • Units of equity oriented mutual fund,
  • Equity or preference shares in a company listed on a recognized stock exchange in India
  • Securities such as debentures, bonds or Govt securities etc that listed on a recognized stock exchange in India

Assets that are acquired by gift or will or succession or inheritance is determined short-term or long-term by counting the period held by the previous owner. In the case of Bonus Shares or Rights Shares, the period of holding is counted from the allotment date.

Tax on short-term and long-term capital gains

  • Long-term capital gains are taxed at a rate of 20% + surcharge + education cess and secondary and higher education cess.
  • Short-term capital gains get added to the income tax return and taxed as per taxpayer’s tax slab if securities transaction is not applicable.
  • Short-term capital gains taxed at a rate of 15% + surcharge + education cess and secondary and higher education cess, if securities transaction is applicable.

Tax on equity and debt mutual funds:

Capital gains earned from debt funds and equity funds are treated differently in terms of income tax liability.

Effective from 11th July 2014 Effective from on or before 10th July 2014
Short Term Gains Long Term Gains Short Term Gains Long Term Gains
Debt Funds Tax slab applicable to the taxpayers At a rate of 20% with Indexation Tax slab applicable to the taxpayers 10% without indexation or 20% with indexation, whichever is lower.
Equity Funds 15% Nil 15% Nil

Change in tax rules for debt mutual funds:

Debt funds held for more than 36 months are considered as a long-term capital asset and this means the investors must keep on investing into these funds for continuous three years. If the funds are redeemed or converted within three years than the capital gains will be added to taxpayer’s income tax liabilities and will be taxed as per their tax slab.

Section II: Capital Gain Calculation

Terms and Conditions:

  • Full value consideration

If consideration has been received or to be received in exchange by the seller after transferring the asset, then it will be considered as capital gain. However, the capital gain is anyways taxed liable even if no consideration has been received.

  • Cost of improvement

Any expenses made after 1st April 1981 to improve the capital asset is considered as a cost of the improvement.

  • Cost of acquisition

The value of the asset given by the seller for acquisition.

To calculate short-term capital gains:

  • Start with calculating full value of consideration by deducting the transfer expense, cost of acquisition and cost of improvement.
  • The resulted amount is your short-term capital gain.

To calculate long-term capital gains:

  • Start with calculating full value of consideration by deducting the transfer expense, indexed cost of acquisition and indexed cost of improvement
  • From this resulting number, exemptions provided under sections 54, 54EC, 54F, 54B etc. will be deducted.
  • The resulted amount is your long-term capital gain.

Expenses that can be deducted from full value for consideration

In the case of house property sale:

  • Stamp duty expense
  • Brokerage or commission expense
  • Traveling expenses regarding transfer which may be incurred after the complete transfer
  • For inherited property, expenditure incurred for will and inheritance, succession certificate obtaining cost, costs of the executor, may also be allowed in some cases.

In the case of shares sale:

  • Broker's commission incurred for shares sold
  • STT or Securities Transaction Tax is not deductible.

In the case of jewelry sale:

  • Broker's commission involved in securing a buyer can be deducted.

These deductions are not allowed to considered to be calculated under any other head of income tax return except capital gains. These deductions can be claimed only once.

Indexed cost of acquisition/improvement

Calculating the indexed cost of acquisition:

The cost of acquisition / Cost inflation index (CII) for the year in which the asset was first held by the seller or 1981-82, whichever is later X cost inflation index for the year in which the asset is transferred.

Calculating the indexed cost of improvement:

The cost of improvement / CII for the year in which the improvement took place X cost inflation index for the year in which the asset is transferred.

Section III: Exemption on capital gains

Section 54: Exemption on sale of house property on purchase of another house property

  • This exemption is available only when capital gains earned from a house property is invested into buying another house property.
  • The total amount of capital gain earned is only needed to invest to avail this exemption.
  • The new property can be bought either before one year or after two years of the sale.
  • To avail this exemption, the capital gain can be also used in property construction but that need to be completed within three years from the selling date.
  • Only one house property can be bought or constructed from the capital gains earned from another property sale to claim this exemption.
  • If the new property is sold within 3 years from the exemption claim then the exemption will be taken back.

Section 54F: Exemption on capital gains on sale of any asset other than a house property

  • This exemption can be claimed when a residential house property is brought with the capital gain earned from a long-term asset other than a house property.
  • The new property can be bought either before one year or after two years of the sale.
  • Only one house property can be bought or constructed from the capital gains earned from another property sale to claim this exemption.
  • If the new property is sold within 3 years from the exemption claim then the exemption will be taken back.
  • The entire new property purchase process will be exempted from taxes if all the above conditions met.
  • If a portion of sale proceed is invested then the exemption will be = capital gains/net consideration X cost of new house

Section 54EC: Exemption on sale of house property on reinvesting in capital gains account scheme

  • When capital gain earned from selling a house property is invested into specific bonds.
  • The investment can be done to purchasing bonds up to INR 50 lakhs issued by National Highway Authority of India (NHAI) or Rural Electrification Corporation (REC).
  • The invested money can be redeemed after 3 years but can not be sold before the lapse of 3 years from the property selling date.
  • The profit needs to be invested in the bonds within 6 months of selling date to claim this exemption.
  • To claim this deduction, investment needs to be done before the income tax filing deadline.

Investing in Capital Gains Account Scheme

  • If the capital gains have not been invested till the income tax filing deadline of that financial year than the amount can be deposited into a PSU bank as prescribed in the Capital Gains Account Scheme, 1988.
  • This deposit will be considered as short-term capital gains in the year of specified period lapses.
  • This deposit can be also used to claim exemption from tax liability.

 

Section IV: Tax saving by selling agricultural land

To save tax on selling agricultural land:

  • In some cases, such amount is totally exempt from tax or it is not taxed under the capital gain head.
  • The rural agricultural land in India is not considered as a capital asset and thus the earning generated from it are not taxed.
  • If agricultural lands are held as a stock-in-trade and they are buy-sale regularly then such earning will be taxed under the head of Business and Profession head in the income tax E-filing form.
  • Under Section 10(37) of the Income Tax Act, capital gains received for compulsory acquisition of urban agricultural land are not taxed.
  • If agricultural land is not sold under any of these above cases then exemption can be claimed under Section 54B.

Section 54B: Exemption on capital gains from transfer of land used for agricultural purpose

  • This exemption is available when an agricultural land is transferred by a taxpayer or his/her parents for 2 years prior to the sale which will generate a short-term or long-term capital gain.
  • Capital gain or the investment in the new asset within 2 years from the transfer, whichever is lower is exempted from tax.
  • The newly purchased land should not be sold within three years from the date of exemption claimed.
  • according to the Capital Gains Account Scheme, 1988, in case, no new land is purchased by the income tax filing date then one can deposit it into a public sector bank or IDBI Bank to claim exemptions.
  • if the deposited amount is not used for purchasing an agricultural land then is will be considered as the capital gain for the year in which the 2 years period from the date of sale of land is expired.

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