Capital Gains is the term used to define the profit that the investor makes by selling the capital asset for a price that is higher than its purchase price. It is the increase in the value of a capital asset (that can be in the form of an investment or real estate) that provides it a higher value than the purchase price.
To materialize the gain, the asset needs to be sold.
A capital gain can be short-term (one year or less) or long-term (more than one year) and has to be claimed on income taxes.
So, Capital Gain is the profit or gain that results from the sale of a ‘capital asset.’
Capital Gains do not arise when an asset is inherited as there is no sale, only a transfer. However, if the person who inherits the asset goes on to sell the asset; capital gains tax will be applicable. The Income Tax Act has exempted assets that are received as gifts either by way of an inheritance or will.
What is a Capital Asset?
Capital Asset is any property held by the assessee.
It includes land, house property, building, vehicles, leasehold rights, patents, trademarks, machinery, and jewelry.
It also includes having rights in or about an Indian company together with rights of management or control or any other legal right.
However, the following are not considered as Capital Assets:
- Stock in trade.
- Any consumables or raw material held for the purpose of business or profession.
- Personal effects such as clothes and furniture except for jewelry, paintings, sculptures, drawings, archeological collections, any artwork that is held for personal use.
- Agricultural land. Such agricultural land must not be located within 8kms from a municipality, Municipal Corporation, or a Cantonment Board with a minimum population of 10,000.
- 6.5 per cent Gold Bonds, Special Bearer Bonds, and National Defense Gold Bonds.
- Gold Deposit Bonds under Gold Deposit Scheme (1999).
What is Capital Gains Tax?
Capital Gains Tax is the tax levied on the profits made by selling the capital asset. For taxation purposes, the capital assets are classified into ‘Short-Term Capital Asset’ and ‘Long-Term Capital Asset.’
Short-Term Capital Asset – When an asset is held not more than 36 months or less it is known as a short-term capital asset. It includes shares and securities that are held for not more than 36 months.
Long-Term Capital Asset – When an asset is held for more than 36 months it is termed as a long-term capital asset. It includes shares and securities which are held for a period extending 36 months before the transfer.
For equity shares listed on a recognized stock exchange, listed debentures, Government Securities, units of equity oriented mutual funds, units of UTI, and for Zero Coupon Bonds, the period of holding will be considered as 12 months instead of the usual 36 months.
The transfer is recognized as giving up your right on an asset and includes sale, exchange, relinquishment, and compulsory acquisition under any law.
Note: Moving forward, from FY 2017-18, the criteria of 36 months has been slashed to 24 months in the case of immovable property such as land, house property, and building.
So, if a person sells his house property after holding it for 24 months, the income generated will be treated as long-term capital gain. However, the property should be sold after 31st March 2017. This change is not applicable to a movable property like jewelry, debt-oriented mutual funds, etc. They will be considered as a long-term capital asset when held for more than 36 months, as earlier.
Capital Gains Tax in India
As per the India Income Tax Act, the long-term capital gains on equity mutual funds and stocks are not taxed. However, the short-term gains are taxable at the rate of 15 percent.
For debt mutual funds, short-term as well as long-term capital gains are taxed.
The short-term capital gain that happens on debt mutual fund is added to the Income and is taxed as per the Income Tax Slab applicable for the individual.
The long-term capital gains that result in the sale of debt mutual funds are taxable at the rate of 20 percent with indexation and 10 percent without indexation.
The indexation adjusts the purchase value for inflation. It increases the purchase cost and lowers gain.
Capital Gains Computation
The Capital Gains can be computed as follows:
Short-Term Capital Gain = Full value consideration – (cost of improvement + cost of acquisition + cost of transfer)
Long-Term Capital Gain = Full value of consideration – (indexed cost of improvement + indexed cost of acquisition + cost of transfer)
Indexed cost of improvement = cost of improvement X cost inflation index of the year of transfer/cost inflation index of the year of improvement
Indexed cost of acquisition = Cost of acquisition X cost inflation index of the year of transfer/ cost inflation index of the year of acquisition
The cost of transfer is the brokerage paid for arranging the deal and includes legal expenses incurred, the cost of advertising, etc.
Let’s consider an example:
Mr. Chopra is a resident individual who sells a residential house on 10/5/2013 for Rs.25,00,000. He had purchased the house on 7/8/2011 for Rs.5,00,000 and had spent Rs.1,00,000 on improvement during June 2012.
As the asset was held for less than 36 months, it will be treated as a short-term capital asset and the
Short-Term Capital Gain = 25,00,000 – 5,00,000 – 1,00,000
If Mr. Chopra sells the house on 12.4.2015 for the same price, then the asset will be treated as a long-term capital asset and the long-term capital gain = 25,00,000 – (5,99,156 + 1,08,535) 707691 = 17,92,309
The indexed cost of acquisition will be 5,00,000 X 852/711 = 5,99,156
The indexed cost of improvement will be 1,00,000 X 852/785 = 1,08,535
Capital Gain Index
The cost inflation index is an important parameter when calculating the long-term capital gains. In long-term capital gains computation, we need to deduct the indexed cost of improvement and indexed cost of acquisition.
The indexation concept was introduced to account inflation.
So, the capital gain tax incorporates the effect of inflation on your purchase. Indexation is used to show higher purchase cost of the capital asset that is bought. It helps to lower the overall profit.
The acquisition price is indexed by using Cost Inflation Index (CII).
Capital Gains Tax Exemption
The sale of Agricultural land in India does not attract any capital gains because it is not considered as a capital asset.
There will be no tax if the entire sale proceeds of your capital asset are used to buy a house property. However, you must meet the following conditions for availing tax exemption under Section 54F:
- You will have to purchase a house in 1 year before or 2 years after the sale.
- The new house must be situated in India.
- You will not sell the house within three years of the purchase or construction.
- Under construction, properties must be completed within three years from the date of transfer of the original house.
- You do not purchase a new house apart from the new one within two years or construct a residential house within a period of 3 years.
- You must not own more than one residential house other than the new one on the date of transfer.
When you meet these conditions and invest the entire sale proceeds of buying a new house, then you do not have to pay any tax on the capital gain.
Further up, investing in Capital Gains Account Scheme does not attract any tax on the capital gains. However, you need to keep the money invested for the specified period, failing which it will be treated as capital gain. Also, investing in Capital Gains Bond, the tax will be exempted. It is applicable only in the case of the long-term capital asset. You are given a period of 6 months for investing in these bonds.
So, we see that Capital Gains is an important consideration that comes into picture when you go on to sell your capital asset which can be in the form of an investment or real estate.
However, as we have seen above, there are certain scenarios where Capital Gains Tax is exempted. Even by investing in Capital Gains Bonds, the tax will be exempted. We hope that the article has helped you in understanding about Capital Gains Tax.