All investors invest their money across different types of assets such as stocks, bonds, mutual funds, real estate, cryptocurrency, etc. The aim of making investments is to get consistent returns over a span of time. Though certain investments are subject to tax exemption, did you know that the profit you make on selling these investments is subject to tax? Yes!
The amount or rate of tax you will have to pay primarily depends on two major factors, i.e. your annual income and the period for which you held the investments. This means that even if you and your friend made the same amount of revenue, you might have to pay different taxes.
In this blog, we'll go through the two types of gains in detail and see how they differ from each other on different grounds. But first, let's see what the capital assets are.
What are capital assets and gains?
These are assets that an individual owns in the form of property, buildings, mutual fund units, stocks, cryptocurrency, jewellery, etc. They may or may not be related to the individual's business/profession. But certain items aren't included in this category, such as raw materials, personal items, agricultural grounds in rural areas, etc.
When the above-mentioned investments/assets are sold for a higher value than the price of acquisition, the difference between the two amounts is termed "capital gains". And these gains are taxable under the Income Tax Act of 1961.
For example, Mr A bought an IPO of company B and sold it at a later date, on which he made a small gain in IPO. Whether this will be considered an STCG or LTCG will depend on the holding period of shares by Mr A. If the holding period of securities is less than 12 months, the capital gain IPO will be considered a Short Term Capital Gain (STCG) on which 10% (if it exceeds 1 lakh rupees) is charged under section 112A. Alternatively, if the securities are held for a period exceeding 12 months, it will be considered Long Term Capital Gain (LTCG), on which 15% tax will be charged under section 111A.
How are these gains categorised?
Based on the period you held your investments; capital profits can be categorised into 2:
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Short-term capital gains and
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Long-term capital gains
Now, let's see how these two differ from each other.
Difference between small gain and capital gain
Meaning
Short-term capital gains is the profits made when short-term capital assets such as stocks sold off, meaning that the holding period of such investments is less than one year or 12 months. At the same time, long-term capital gains depict the gains made when long-term capital assets are sold off, meaning that the holding period of such assets is more than one year. This point is applicable in cases when financial investments are sold.
In the case of immovable/immovable property
In the case of immovable property, capital gains are said to be long-term when such property is held for a period exceeding 24 months. However, it is said to be short-term when such property is held for less than 24 months.
When a movable property is sold, its gains are considered to be short-term when such property is held for less than 36 months. And it is said to be long-term when the period exceeds 36 months.
Tax-rate
On short-term capital gains that come under section 111, such as equity instruments, a 15% tax rate is applicable. STCGs not falling under section 111 are subject to tax as per the ordinary income of the individual. In the case of equity instruments, a 10% on profits beyond Rs. 1 lakh is considered as LTCG if the holding period exceeds 12 months. In the case of non-equity capital market instruments such as debt funds, a 20% tax rate with indexation will apply if the holding period is more than three years.
Profits
Individuals selling assets before the holding period of one year expect fewer profits as market volatility plays a crucial role. However, suppose the investments are invested for a longer time. In that case, the risk associated with the investment reduces, and the investor can expect a specific amount of profit in terms of returns.
Off-setting of losses again such gains
According to the Income Tax Act of 1961, losses
incurred during one year can be set off against the incomes of that particular year (subject to certain restrictions). Firstly, the intra-head adjustment will be made. This means that short-term losses of one year will be set off against short-term gains of that year, and the same is the case with long-term losses. And then, if losses are still left, the inter-head adjustment will be done.
Treatment in cases of inherited property
If you inherited your ancestor's property, the earnings would always be considered long-term but remember to check out tax exemptions given by the government. But let's say you got a property as a gift or honour. You may consider the transferer's period of holding that property. In this case, the period should not be considered long-term automatically.
Formulas
The formulas to compute both of these gains are:
STCG: Total value of consideration - Cost of acquisition - Cost of improvement - Cost of transfer
LTCG: Total value of consideration - Indexed cost of acquisition - Indexed Cost of improvement - Cost of transfer
Total value of consideration: It is the amount of consideration received at the time of selling the asset.
Cost of acquisition: It refers to the amount paid when purchasing an asset.
Cost of improvement: It is the cost incurred to improve the asset.
How to reduce taxes on such profits?
There are several techniques to reduce taxes. Let's have a look at a few of them.
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Have patience: Don't rush to sell your investments very early unless it is the last option left. If you hold your assets for more than a year, you'll have to pay lower taxes as compared to the amount you'd have to pay if you sold them before 12 months.
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Make use of exemptions: The government gives several exemptions to reduce the amount of taxes under different sections. You must go through sections like section 10(37), section 64, section 54F, section 54EC etc., to save taxes on long-term gains.
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Use capital losses to set off gains: This technique is often ignored by many and increases the investor's tax liability.
Final words
Making investments for longer periods can let you enjoy higher profits but also invites high tax rates. If you don't know how to manage your finances well there are chances that you'll end up paying more taxes than required. Hence, keeping exemptions and setting off losses against incomes in mind are crucial things to reducing taxes. You must take the help of an expert if you wish to save and manage your money well.
Frequently Asked Questions (FAQs):
Q. Are capital gains subject to tax in India?
Absolutely. Both STCG and LTCG being one among the categories of income earned are subject to tax in India.
Q. What if there are no capital gains to set off capital losses?
If there aren't any profits against which losses can be set off, these may be carried forward to the next financial year, up to 8 years.
Q. What isn't included in capital assets?
These assets are not included in capital assets: Personal items, stock-in-trade, raw materials, agricultural land in rural areas, gold, gold deposit and special bearer bonds.