Capital gains refer to the gains you, as an investor, make when selling your capital assets. Because these gains are a part of your total taxable income, you are liable to pay tax on these.
The tax you pay on capital gains on selling short-term or long-term capital assets is known as capital gains tax.
As per the Income Tax Act of India, you are not required to pay any capital gains tax on the inherited property, as inheritance is not similar to selling. However, if you have plans to sell the property on a future date, your liability to pay tax on gains will arise as usual.
What are capital assets?
Capital assets refer to any property held by the assessee, whether it is connected to his business or profession. It includes various types of assets such as gold, ornaments, expensive stones, painting, shares, debentures, and stocks, and the list is huge.
However, there are certain exceptions to the definition of a capital asset. These are:
- Stock-in-trade or any kind of materials held for business purposes
- Specified gold bonds
- Special bearer bonds
- Specified agricultural land in India
- Any movable property held by the taxpayer for his personal use or dependents
Types of capital assets or capital gains
Capital gains can be broadly classified into long-term capital assets (that attract long-term capital gains tax) and short-term capital assets (attracting short-term capital gain taxes).
Long-term capital assets: Generally, when capital assets are held for more than 36 months, they are considered long-term capital assets.
However, in certain below-mentioned circumstances, the holding period of the asset must be more than 12 months and not 36 months to be considered long-term capital assets:
- Zero coupon bonds
- Equity-oriented fund units
- Listed preference and equity shares of a company
In the case of unlisted shares and immovable property (such as land or building or both), the holding period must be more than 24 months to be considered long-term capital assets.
Short-term capital assets: When capital assets are held for a period of fewer than 36 months, they will be considered short-term capital assets.
In cases of unlisted shares and immovable property, the period gets limited to 24 months instead of 36 months.
Similarly, section 112A specifies conditions where assets, if held for less than 12 months, are considered short-term capital assets.
How to calculate capital gains?
Calculating capital gains depends on the holding period and nature of the capital assets being held. To estimate long-term capital gains, the formula is as follows:
Long-term capital gains = Full consideration sale value (-) expenses incurred during the sale or transfer of assets (eg: brokerage, commission, etc. (-) Acquisition cost or indexed acquisition cost (if applicable) (-) indexed improvement cost (if applicable)
Similarly, the formula to calculate short-term capital gains is:
Short-term capital gains: Full consideration sale value (-) expenses incurred during the sale or transfer of assets (e.g.: brokerage, commission, etc. (-) acquisition cost (-) improvement cost (if any)
Capital gains on depreciable assets: Written down value at the commencement of the Previous Year (+) actual asset cost (-) full consideration value (-) expenses incurred during the transfer
How are capital gains taxes in India?
Long-term capital gains tax:
- Long-term capital gains are taxed at a 20% tax rate in India.
- LTCGs on the sale of listed equity shares, equity-oriented fund units, and business trust units (section 112A) shall be taxed at a rate of 10% above the value exceeding Rs 1,00,000.
- LTCGs on selling unlisted shares by NRIs or foreign companies will be taxed without any benefit of indexation.
- LTCGs arising from the selling of securities mentioned in section 112A will be taxed at 20% without indexation benefit or 10% without indexation benefit, whichever is lower.
Short-term capital gains tax:
- STCGs will be added to the taxpayer's total taxable income and will be taxed as per his income's slab rate.
- STCGs mentioned in section 112A will be taxed at a 15% rate.
Note: Now, w.e.f. 1-04-2016, the benefit of the reduced tax rate (i.e. 15%) for the income arising out of the transfer of units of business trust.
Example 1
Mr Ajay purchased 10,000 equity shares of LZ ltd in October 2021 for Rs 100 per share. He sold those shares in January 2022 for Rs 150 per share. The brokerage fees were Rs 1 per share. He paid STT. The shares were sold through the NSE.
His tax liability would be:
Sales consideration : 15,00,000 (10,000 x Rs 150)
Less: brokerage : 10,000 (10,000 x Rs 1)
Less: purchase value: 10,00,000 (10,000 x Rs 100)
Short-term capital gains= Rs 4,90,000
Tax on STCGs = 15% x 4,90,000
= Rs 73,500
Example 2
Mr Raja purchased land for Rs 1,00,000 in January 2005 and sold it for Rs 11,20,000 in June 2022. He paid a brokerage of Rs 20,000. What will be his tax liability?
It is clear that the gains he made fall under the category of "long-term capital gains" (LTCGs). Let's calculate his capital gains.
| Full consideration value on the sale of property | 11,10,000 |
| less: expenses borne on sale or transfer of property(eg: brokerage, commission, etc.) | 20,000 |
| Net sales consideration | 11,00,000 |
| less: Indexed acquisition cost of the property | 2,70,940 |
| less: indexed improvement cost of the property | nil |
| long-term capital gains on property | 8,29,060 |
Indexed cost of acquisition: cost of acquisition * CII of the year of transfer/ CII of the year of acquisition
= Rs 1,00,000 * 317 / 117
= Rs 2,70,940
CII for 2005-06 is 117, and for 2021-22 is 317.
Exemptions/Deductions under capital gains
Certain exemptions and/or deductions are allowed by the Income Tax authorities to reduce taxpayers' tax liability. A few of them are:
- Section 54: You can lessen the tax liability on transferring a property such as land. The procedure involves utilizing the gains to purchase or build a new house. However, you can utilize the exemption if your capital gains are at most two crore rupees. This is only eligible for long-term capital gains.
- Section 54B: This section elaborates that capital gains arising out of the transfer or sale of agricultural land may be used for acquiring another agricultural land.
- Section 54EC: The section only applies to long-term gains. It mentions that a taxpayer would be exempted from paying capital gains tax if he uses the gains due to selling land or building to buy specified bonds.
- Section 54F: The section only applies to long-term gains. It mentions that a taxpayer would be exempted from paying capital gains tax if he acquires/constructs another residential house property using the gains.
- Capital Gain Account Scheme: This scheme is ideal for taxpayers without plans to buy/construct another property/asset using the gains. In this, taxpayers can deposit their capital gains in the CGAS scheme for a specific period.
- Others: Several other sections in the Income tax act can help you reduce your tax liabilities, such as 54GB, 54GA, G5G, etc.
Final words
Capital gains are the profits or gains that arise when capital assets are transferred or sold. These gains are taxed at different tax rates.
Capital gains tax depends on different sections of the Act, the holding period of the asset, and the nature of the asset being held or transferred by the taxpayer.
As a taxpayer, you must also know different ways to reduce your tax liabilities. For detailed and customized tax planning, you must consult your financial advisor.