Capital Gains - Types, Calculation and Exemption

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.

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.

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

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.

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.

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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.

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. 

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.

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:

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:

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

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.