Capital Gains Tax

In this article, we shall cover the Capital Gains Tax, what are the Long and Short Term Capital Gains Taxes, and how you can potentially save money on these taxes.

· 5 min read
Capital Gains Tax

If you have been in the stock market investment scene, you would have noticed that you were required to pay a ‘capital gains tax’ after you’ve bought and sold a particular stock. You may have been required to pay either Long Term Capital Gains (LTCG) tax or Short Term Capital Gains (STGC) tax, depending on the length of your investment.

In this article, we shall cover the Capital Gains Tax, what are the Long and Short Term Capital Gains Taxes, and how you can potentially save money on these taxes.

What is the capital gains tax?

‘Capital assets’ are those assets that are typically used in a business operation for revenue-generating purposes over a course of a certain timeline. Your home, commercial properties, bonds, art pieces, collectibles, and of course, stocks, are considered capital assets.
These capital assets can generate revenue either through the income it generates or through the rise in the value of the asset itself. The profit that you make from the latter is known as capital gains, and the tax that you’re supposed to pay on them is known as capital gains tax. Note that you are only required to pay this tax on the transfer and realized gains from this asset.

Capital gains are officially classified as ‘income’, and hence you are required to pay tax on that amount when the transfer of that asset occurs.

What are long-term and short-term capital gains taxes?

Your capital gains tax can be classified as short-term or long-term.

a. Short-term capital gains tax:-
Any asset that you have held for lesser than 36 months i.e. 3 years is called a short-term capital asset. For some immovable properties like land and homes, this criteria has been reduced to 24 months.

b. Long-term capital gains tax:-
Any asset that you have held for more than 36 months i.e. 3 years is called a long-term capital asset. Note that the reduced 24 month period is not applicable to movable properties like debt mutual funds, physical gold, etc. This means that these assets will also be classified as long-term capital assets once held for longer than 36 months.

As far as Indian transactions are concerned, this rule applies to transaction dates post the 10th of July, 2014, regardless of the purchase date.

There is a slight distinction to be noted regarding properties of inheritance according to the Income Tax Act. Taxes on capital gains are not applicable to such properties since technically there is no buying or selling of the capital asset, but only an ownership transaction. The tax on capital gains will only be applicable on the property if the inherited member proceeds to sell the asset eventually.

Which of my assets are considered ‘capital assets’?

If you are a common middle-class man, you’re likely to be holding any of the following capital assets:-

a. Common stock or preference shares of a publicly listed company from either the National Stock Exchange (NSE) or the Bombay Stock Exchange (BSE).

b. Quoted or unquoted UTI units

c. Debt related instruments like bonds and debentures from a publicly listed company from either the National Stock Exchange (NSE) or the Bombay Stock Exchange (BSE).

d. Government securities like Treasury Bills, Treasury Notes, Treasury Bonds, and Treasury Inflation-Protected Securities (TIPS)

e. Quoted or unquoted equity mutual funds units from an established mutual fund house

f. Quoted or unquoted zero-coupon bonds

Note that in the case of bonus shares or rights shares, the holding period begins from the allotment date.

How do I calculate my capital gains?

You can calculate your capital gains using a few factors. Your calculation for capital gains will vary depending on the amount of time you have been holding that particular asset, along with a few other factors. Some of these key factors that you should be aware of while calculating your capital gains are:-

  • Acquisition cost:- The acquisition cost is defined as the cost that the seller had to pay to acquire the given asset.
  • Cost of improvement:- The cost of improvement refers to those additional expenses made by the seller for boosting the quality of the asset. The cost of the improvement is typically explained using the expenses related to renovations made to a home before being sold. However, do note that according to Indian laws, only improvements made after 1 April 2001 can be considered for capital gains calculations.
  • Full value consideration:- The full value consideration is the final amount that the seller will receive at the end of the transfer of the asset. As per the practice of accrual accounting, these capital gains will be charged from the transaction year, even in the situation that the seller did not receive the final amount in that particular year.

An example of Long Term Capital Gains calculation
To illustrate the calculation of Long Term Capital Gains, let's look at the following procedure:-

  • Consider the full value of the asset.
  • Proceed to make the following deductions:
  1. The costs incurred due to the transfer of the asset.
  2. The cost spent on the acquisition of the asset.
  3. The cost spent on the improvement of the asset.
  • From the above-calculated number, subtract any exemptions that you may find provided under
    Section 54B:- capital gains exemption on the sale of agricultural land
    Section 54F:- capital gains exemption in case of asset transfers against the investment made in a residential house
    Section 54EC:- capital gains exemption if LTGCs are reinvested in specific instruments within a particular period of time
    Section 54:- capital gains exemption if LTGCs from a residential area being sold off is used in the construction of another residential area

Now, let’s make the following assumptions:-
Purchasing price of the house: ₹80 lakh
Financial Year of purchasing the house: 2011-2012
Financial Year of selling the house: 2019-2020
Selling amount of the house: ₹1.35 crores
From the above assumptions, we can calculate our inflation-adjusted cost to be around (289/184) x 80 = ₹1.25 crores
And therefore, we can calculate our long term Capital Gains to be around 1.35 crores – 1.25 crores = ₹10 lakhs
The long-term capital gains tax on ₹10 lakhs is 15%* ₹10 lakhs = ₹1.5 lakhs.

An example of Short Term Capital Gains calculation
To illustrate the calculation of Short Term Capital Gains, let's look at the following procedure:-

  • Consider the full value of the property.
  • Proceed to make the following deductions:-
  1. The costs incurred due to the transfer of the asset.
  2. The cost spent on the acquisition of the asset.
  3. The cost spent on the improvement of the asset.

To calculate the short-term capital gain, you must compute the full value consideration minus transfer expenses minus improvement costs and acquisition costs.

Now, let’s make the following assumptions
Purchasing price of the house: ₹90 lakhs
The selling price of the house: ₹65 lakhs
Amount spent for the improvement of the house: ₹5 lakhs
Therefore, we can calculate the gross short term Capital Gain as ₹90 lakhs - ₹65 lakhs + ₹5 lakhs = ₹20 lakh
Assuming there are no exemptions available on any of the Section 54 subdivisions, we can calculate the net short term Capital Gain as ₹20 lakhs
Therefore, the short-term capital gains tax on ₹20 lakhs is 30% of ₹20,00,000: ₹6 lakhs.

Summary

Capital gains tax is an important concept to understand for anyone who is involved in trading or investing stocks, equity or debt mutual funds, government securities or treasury bonds. These taxes can be classified as short term or long term depending on the holding duration, and you may get tax deductions on your capital asset transactions by cleverly using the deductions mentioned in Section 54 of the Income Tax Act.

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