Capital Gains - Types, Calculation and Exemption

Introduction

In India, capital gains refer to the profits earned from the sale of assets. It was introduced in India in 1956, and it has undergone several revisions over the years. The tax is levied on both, short-term and long-term capital gains, with several rates and exemptions. This is dependent on the type of assets and the length of time it was held for. India’s capital gains tax system aims to encourage long-term investments while providing revenue for the government. Read on to know about the capital gains, its types, exemptions, and more.

Important Terminology

1. Capital Asset

A capital asset is an asset which is held by an individual or for long-term use in their business operations. Capital assets can include tangible assets such as real estate, buildings, and equipment, as well as intangible assets, such as patents, trademarks, and copyrights.

 

In general, capital assets are not held for sale in the normal course of business, but rather are held for the purpose of generating income or appreciation in value over time. When a capital asset is sold, the difference between the asset’s sale price and its original cost is called a capital gain or a capital loss. This depends on whether the assets are sold for more or less than its original cost. 

 

Capital assets are generally subject to different tax treatments than other types of assets, with gains or losses from the sale of capital assets being subject to capital gains tax rates, which are typically lower than ordinary income tax rates.

2. Capital Gains

Capital gains are the profits or gains which result from the sale or exchange of a capital asset. These gains can be realised on a variety of assets, comprising stocks, bonds, real estates, and several other types of property. They can also be realised through the sale of a business or other types of investments. 

 

Capital gains are subject to tax in several countries, including India. The tax rates on these gains depend on the holding period of the asset and the individual’s income level.

3. Full Value Consideration

Full value consideration refers to the total consideration paid for an asset, such as a property, stock, or other valuable assets. This consideration includes not only the amount paid in cash, but also any other type of payment, such as property, services, or other assets that were used to acquire the asset.

 

For example, if an individual buys a property for ₹50,00,000 and pays ₹5,00,000 in cash and trades in another property which is valued at ₹45,00,000, the full value consideration for the property would be ₹50,00,000.

 

Full value consideration is important for determining the tax implications of the transaction, as it helps to establish the fair market value of the asset at the time of the transaction. In addition, full value consideration is often used in legal agreements to ensure that all the parties understand to ensure that all the parties understand the total value of the transaction and the term of payment.

4. Cost of Acquisition

Cost of acquisition refers to the total cost which has been incurred by an individual or a corporation in order to acquire an asset, such as stocks, property, bonds, or other investments. This includes all the direct and indirect costs associated with the purchase of the asset, such as:

  • Purchase price or consideration paid to acquire the asset

  • Transaction fees, such as brokerage fees or legal fees

  • Taxes or duties paid on the purchase of the asset

  • Any other costs incurred to acquire the asst, such as transportation or storage costs

 

The cost of acquisition is an important factor in determining the capital gains or losses that result from the sale of the asset. It is subtracted from the sale price of the asset to determine the capital gains or loss, which is then used to compute the taxes owed on the sale of the asset.

5. Cost of Improvement

Cost of improvement refers to the total expenses incurred to enhance an existing asset, such as a property or equipment. This comprises the cost of labour, materials, and any other related expenses.

 

If the capital asset is the taxpayer’s asset and not their outright purchase, the acquisition and the improvement cost incurred by the previous owner would also be included. Also, the improvements which had been made prior to April 1, 2001, are never considered.

Types of Capital Assets

Here are the two types of capital assets:

1. Short-term Capital Asset (STCA)

An asset which is held for a span of less than 36 months is known as a short-term capital asset.

 

For immovable assets such as buildings, house property, and lands, the criteria is a span of 24 months or less (applicable from the financial year 2017-18). For example, if you sell off a property after having held it for a span of 24 months, any income earned will be considered as a long-term capital gain. This is valid if that asset is sold after March 31, 2017. 

 

The mitigated span of the above-mentioned 24 months isn’t applicable to movable assets such as debt-oriented mutual funds, jewellery, and more. 

 

Few assets are considered as STCA when they have been held for a span of 12 months or even less. This rule is valid if the transfer date is after July 10, 2014 (irrespective of the purchase date). Such assets are as follows:

  • Zero coupons bonds, whether it has been quoted or not

  • Units of mutual funds which is equity oriented, whether it has been quoted or not

  • Units of Unit Trust of India, whether it has been quoted or not

  • Securities such as government securities, bonds, debentures, and more, listed on an Indian stock exchange which is recognised

  • Preference or equity shares in a corporation which is listed on an authorised Indian stock exchange

2. Long-term Capital Assets (LTCA)

An asset which has been held for a span of more than 36 months is known as a long-term capital asset. Capital assets like buildings, house properties, and land will be considered as LTCA if you hold them for a span of more than 24 months (from FY 2017-18).

 

However, if the following assets are held for a span of more than 12 months, will be considered as LTCA:

  • Preference or equity shares in a corporation which is listed on an authorised Indian stock exchange

  • Securities such as government securities, bonds, debentures, and more, listed on an Indian stock exchange which is recognised

  • Units of Unit Trust of India, whether it has been quoted or not

  • Units of mutual funds which is equity oriented, whether it has been quoted or not

  • Zero coupons bonds, whether it has been quoted or not

Classification of Inherited Capital Asset

If you acquire an asset as a gift, succession, inheritance, or will, the span for which it was held by the earlier owner is also included while determining whether it is STCA or LTCA. Besides, for the right or bonus shares, the span of holding is considered from the date when these shares were allotted.

Type of Tax

Condition

Applicable Tax

Long-term capital gains tax 

On selling equity shares or equity oriented funds’ unit

10% more than ₹1,00,000

Long-term capital gains tax

Other than the sale of equity oriented funds’ units or equity shares

20%

Short-term capital gains tax

When there is no applicability of the Securities Transaction Tax (STT)

STCG adds up to your ITR and you are taxed as per the slab rates of income tax

Short-term capital gains 

When the Securities Transaction Tax is applicable

15%

Tax on Debt and Equity Mutual Funds

Gains which are made on selling the equity and the debt funds are generally treated in a different manner. Any fund which invests in equities (65%*total portfolio or more) is known as an equity fund.


Funds


Effective July 11, 2014


Effective July 10, 2014 or prior

STCG

LTCG

STCG

LTCG

Debt Funds

At the individuals’ slab rates of income tax

At 20% along with indexation

At the individuals’ slab rates of income tax

EIther 20% with indexation or 10% without indexation, whichever is lesser

Equity Funds

15%

10% more than ₹1,00,000 without indexation

15%

0

Taxation on Debt Mutual Funds

Capital Gains Tax

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The debt mutual funds must be held for 36 months or more in order to get qualified as Long-term Capital Gains. It implies that you must stay invested in such funds for a minimum period of three years. This should be done if you wish to receive the benefits of LTCG. If it is deducted within a span of three years, the capital gains shall get added to your income. This will then get taxed according to the slab rate of income tax.

Calculation of Capital Gains

Capital gains are computed in several different ways for assets which are held for a longer span of time and for those which are held for a shorter span of time.

1. Computation of STCG

Follow these steps to calculate the short-term capital gains:

  • Step 1: Begin with the full value of consideration.

  • Step 2: Subtract the below-mentioned factors:

    Acquisition cost

    Improvement cost

    Expenses which are incurred exclusively and wholly with respect to such transfers. 

  • Step 3: This amount is an STCG.

Here’s a tabular representation of the computation of STCG to make your understanding clearer:

STCG

  • Full value of consideration

 

1. (-) Expenditure incurred for such a transfer exclusively

2. (-) Acquisition cost 

 

3. (-) Improvement cost

 

 2. Computation of LTCG

Follow these steps to compute the LTCG:

  • Step 1: Begin with the full value of consideration.

  • Step 2: Subtract the following:

    Expenses which are incurred exclusively and wholly with respect to such transfers. 

    Indexed improvement costs.

    Indexed acquisition costs.

  • Step 3: From the result, reduce the exemptions which are offered u/s 54, 54F, 54B, and 54EC.

LTCG

  • Full value of consideration
  1. (-) Expenditure incurred for such a transfer exclusively
  2. (-) Indexed acquisition cost 
  3. (-) Indexed improvement cost
  4. (-) Expenditures which can be subtracted from the full consideration value*

 

*Note: Expenditures from the proceeds of sale of a capital asset, which directly relate to the transfer or sale of the capital asset are permitted to be subtracted. These expenses are important for the facilitation of the transfer.

 

Exception: The LTCG on the sale of equity shares or equity oriented funds’ units released after March 31, 2018 remain exempt up to ₹1,00,000 p.a. This is in accordance with the Budget of the year 2018. 

Deductible Expenses

1. Sale of House Property: 

Following expenses are deductible from the total selling price:

  • Expenses of the stamp papers

  • Commission or brokerage which is paid for securing a buyer

  • Travelling expenditures with respect to the transfer - these could be incurred post the transfer gets affected

2. Sale of Shares:

You could be allowed to subtract the following expenses:

  • The commission of the broker which is related to the shares which have been sold

  • STT isn’t permitted as a deductive expenditure

3. Sale of Jewellery:

If there is a case of sale of the jewellery of the broker and where the services of a broker were involved in getting a purchaser, the expenses of such services can be subtracted.

 

It must be noted that the expenses which are deducted from the selling price of the assets for computing the capital gains aren’t permitted as a deduction under any other income head. Also, you can claim it only once.

Indexed Improvement/Acquisition Cost

The acquisition and improvement cost is indexed by applying the cost inflation index. It is computed to adjust for inflation across the holding period of the asset. This lessens your capital gains and raises your cost base. 

Indexed acquisition cost is computed as follows:

Indexed acquisition cost 

(Acquisition cost * CII of the asset’s transfer year)/(CII of the financial year 2001-2002 or the year when the seller held the asset for the first time, whichever comes after)

The asset’s acquisition cost procured prior to April 1, 2001, must be the FMV or the actual cost on April 1, 2001, according to the taxpayer’s option.

Indexed improvement cost is computed as follows:

Indexed improvement cost

Improvement cost * CII of the year when the asset was/is transferred/CII of the year when the asset was/is improved

It must be noted that the improvements which are made prior to April 1, 2001, must not be taken into consideration.

Conclusion

In conclusion, capital gains play a significant role in the economy and the financial markets. Capital gains are an important source of income for the investors and they provide an incentive for the people to invest in companies, real estate, and other assets. Moreover, the capital gains generate tax revenue for the governments and contribute to the overall growth of the economy. 

 

However, the capital gains are subject to volatility and uncertainty, which can make investing in them risky. As such, it is important for investors to carefully evaluate their investment options and consider their risk tolerance before investing in assets that may generate capital gains. 

 

Overall, capital gains are an important aspect of the financial landscape, and they have a significant impact on the economy and the lives of individuals. Besides, understanding the role of capital gains and their risks and benefits is crucial for making informed investment decisions and building a strong financial future.

FAQs

How can you avoid taxes with capital gains?

You can invest for the long term, contribute to your retirement accounts, lower your tax bracket, donate stock for charitable purposes, and more.

What are the types of capital gains?

Capital gains can be classified into two types, namely, long-term capital gains (LTCG) and short-term capital gains (STCG). The classification is made based on the duration the assets are held.

What does a capital gain affect?

Capital gains are applicable to every type of investment such as investments and the purchases for your personal usage.

Which income is charged to tax under ‘Capital Gains’?

Any profit which arises from the transfer of capital assets during the year is generally taxed under ‘Capital Gains’.

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