Capital gains are referred to the profit made on the sale of an asset when it is sold at a price higher than its purchasing cost. Capital assets include products and schemes like stocks, mutual funds, bonds, real estate etc. The term capital gain means the increased value at which the asset is sold. Similarly, the capital loss is the decrease in the value of the asset from its original cost.
The types of Capital Gains
There are two types of capital gains:
- Long-term Capital Gains: If the asset acquired by an individual stay in his/her possession for more than 36 months and is then sold, the profit earned on it is called long-term capital gain.
- Short-term Capital Gains: If the asset owned by an individual is sold before the completion of 36 months since the time it was acquired, then the capital made on it is called short-term capital gains.
Tax on Capital Gains
The calculation of tax on capital gains is influenced by the type of gain such as:
- Tax on Short-term Capital Gains : In the case of short-term capital gains the profit is added to the total income of the individual and is taxed under Income Tax Act based on the tax slab of the individual.
- Tax on Long-term Capital Gains : In the case of long-term capital gains inflation plays a major role in determining the value of capital gains. This is because the assets are held for long period of time and there are differences in the inflation rates. It is usually charged at 20.6%, which includes education cess.
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Capital Gain Shares
If the capital gains are invested in shares and stocks then the rate of tax excised on long-term capital gains and short-term capital gains as per the year 2017-18 are as follows:
- Capital gains invested in shares for less than 12 months is considered as short-term capital gains and it is taxed at 15 percent.
- There is no tax levied on the long-term capital gain invested in shares and mutual funds. However, the investment in debt mutual funds for both short-term and long-term capital gains are taxable.
- The short-term capital gain is added to the income of the individual and taxed according to his/her income tax slab, the long-term capital gains are taxed at 20 percent with indexation and at 10% without indexation.
The process of adjusting prices according to the standard index to calculate profits made from the sale of the asset while taking into account the current inflation rate is called indexation. Computing profits made of on an asset based on its original price does not give accurate results because inflation does not remain flat instead it keeps fluctuating with time. In indexation, inflation is also considered which is why it provides a more reliable figure in the case of long-term capital gains.
Cost Inflation Index (CII) and Capital Gains Calculator
Cost Inflation Index is an index concerning inflation which is declared every year by the government. It is very helpful in calculating the long-term capital gains on the long-term capital assets.
Capital gain calculator is a tool which is used to calculate capital gains online. To calculate capital gains the following details must be filled in:
- Sale price and the purchase price of the asset.
- Details of purchase date and sale date.
- Investment details of capital gains like investment in bonds, house property etc.
- Type of investment.
- Type of capital gain, either short-term or long-term.
- Cost Inflation Index (CII) of the year of purchase and sale.
- The period between the purchase and sale of the asset.
- The differences in an amount of the purchasing cost and selling price.
- Indexed purchase value.
- Indexed long-term capital gain and long-term capital gains without indexation.
Computation of Capital Gains
Capital Gains can be calculated by the following method:
Short-term capital gain = Total value of consideration – (Cost of Acquisition + Cost of
Improvement + Cost of Transfer)
Long-term capital gain = Total value of consideration – (Indexed Cost of Acquisition
+ Indexed Cost of Improvement + Cost of Transfer)
Cost Inflation Index (CII)
Indexed cost of acquisition = Cost of Acquisition x (CII of the year of transfer/CII of the year of acquisition)
Indexed cost of improvement = Cost of Acquisition x (CII of the year of transfer/CII of the year of acquisition)
The CII is issued every year by Income Tax department. The CII for the year 2016-17 is 1125.
Let’s take an example to calculate long-term capital gains using indexation:
If Mrs. Roy sold her house in October 2015 for 50 Lakhs INR, which she bought for 20 Lakhs INR in June 2010, then
(Cost Inflation Index) CII = (CII for year 2015-16/CII for the year 2010-1011) = (1081/711) = 15.2
Purchase index cost = CII X Purchase Price = 1.52 X 20,00,000 = 30,40,787.6
Long-term Capital Gain = Sale Price – Indexed Cost = 50,00,000 – 30,40,000 = 19,59212 INR
Tax on Long-term Capital Gain = 20% of 19,60,000 = 3,91842.4 INR
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Tax Exemptions on Capital Gains
- According to Section 54, the tax on the capital gains can be exempted if the capital is invested in buying another house property. This property can be bought either a year prior or within two years of the sale of the original property. The exemption can also be availed if the house is under construction and the construction will be completed within 3 years.
- The tax on the entire capital profit can be exempted if the capital gain is invested in bonds provided by government such as National Highway Authority of India (NHAI) or Rural Electricity Corporation (REC), under Section 54 EC. A maximum amount of Rupees 50 Lakhs and Rupees 45 Lakhs can be invested in these bonds, respectively.
- Capital gains can also be invested in Capital Gains Account Scheme to claim exemption from the tax. The money invested in this scheme is locked away for a certain period as determined by the bank.
- Agriculture land is not considered as a capital asset and thus no tax is levied on its sale.
- If the entire capital profit is invested in setting up a small-scale industry, tax exemption can be obtained from it. However, the machinery and tools for manufacturing should be purchased within 6 months from the time the asset was sold.
To claim this deduction, you need to compute the interest separately from the principal repayment, on the loan that you took from a bank or financial institution. You can get an exemption for the complete annual interest amount irrespective of whether the payments are made to the lender.