Who wouldn’t want to earn profits or book gains? However, certain gains called capital gains attract capital gains tax under the Income Tax Act, 1961.

Capital gains is the profit or gain arising from the sale of capital assets. This is categorized as income under the head of capital gains and attracts tax in the year of asset transfer.

The capital gains in turn are classified as short term or long term, depending on the holding period of the asset.

What Is a Capital Asset?

Income Tax Act mentions the following as capital assets: Land, building, real estate property, vehicles, patents and trademarks, leasehold rights, plant & machinery, and jewellery.

Thus, a tangible or intangible asset with long durability or permanent nature, may be classified as capital asset. The rights held in an Indian company by way of management control, legal right, etc also comprises capital asset.

How to Avoid LTCG (Long Term Capital Gain) Tax?

Exclusion

  • Raw material, work in progress and consumables held for business purposes
  • Goods for personal use like clothing, furniture and fittings
  • Tract of agricultural land in rural India
  • Certain gold bonds issued by the Central Government

Classification of Capital Asset

1. Short-term capital assets are those where the holding period is less than 3 years. The following are the exceptions to this classification:

  • In case of the following, the holding period of less than a year applies:
  • Preference or equity shares listed on an Indian stock exchange
  • UTI units
  • Listed G-secs and debentures
  • Zero coupon bonds
  • Units of equity oriented mutual funds
  • In case of unlisted company shares, the holding period is 2 years
  • From FY17-18, in case of immovable property, the holding period is 2 years

2. Long-term capital assets are those where the holding period is over 3 years. The following are the exceptions:

  • In case of the following, the holding period of less than a year applies
  • Preference or equity shares listed on an Indian stock exchange
  • UTI units
  • Listed G-secs and debentures
  • Zero coupon bonds
  • Units of equity oriented mutual funds
  • In case of unlisted company shares, the holding period is 2 years
  • From FY17-18, in case of immovable property, the holding period is 2 years

IT provisions stipulate that in the event of asset acquisition by way of gift, will, succession or inheritance i.e without monetary consideration involved in the asset transfer, the holding period of the previous owner is also included to determine whether the asset is short term or a long-term capital asset.

In the case of bonus share or right shares, the period of holding is computed from the date of allotment.

Let’s Summarize the Above for More Clarity

Long term asset where the period of holding is more than 36 months:
debt mutual funds, other assets
Long term asset where the period of holding is more than 24 months:
Immovable property, unlisted shares
Long term asset where the period of holding is more than 12 months
listed equity shares, equity mutual funds, balanced mutual funds
Short term asset where the period of holding is less than 36 months
debt mutual funds, other assets
Short term asset where the period of holding is less than 24 months
Immovable property, unlisted shares
Short term asset where the period of holding is less than 12 months
listed equity shares, equity mutual funds, balanced mutual funds

Exclusions 

There are some assets like inherited property that are exempted from capital gain tax on transfer as there is no sale consideration involved.

The act also excludes assets received as gifts, inheritance or by way of a will from its ambit. However, if such assets are subsequently sold for a monetary consideration, it would be liable to capital gains tax.

What are Capital Gains Tax Rates?

Let’s look at the tax rates for each of these sections:

1.Long Term Capital Gain Tax (with indexation)

  • Immovable property: 20%
  • Movable property like jewelry: 20%

Exceptions

1.Long-term capital gains tax on sale of listed Equity shares: Capital gains exceeding Rs. 1 lakh taxed at 10% (without indexation)

2.Long-term capital gains tax on sale of listed Equity shares: Capital gains up to Rs.1 lakh is exempt

2. Short Term Capital Gains Tax (when securities transaction tax does not apply)

3. Short Term Capital Gain Tax (when securities transaction tax applies)

  • 15%. For example, short term capital gains tax on sale of listed equity shares is 15%

4. Tax on Equity and Debt Mutual Funds

Let’s look at the tax rate for each of these sections

Debt Mutual Funds

Short term gains:
The short-term capital gain on debt mutual fund is added to the income and taxed as per the assessee’s slab rates
Long term gain (with indexation) 20%
Long term gain (without indexation) 10%

Equity Funds

  • Short term gain: 15%
  • Long term gain: Nil

Note: An equity oriented mutual fund is that in which more than 65% of the portfolio is allocated towards investment in equities

What Is Indexation

The concept of indexation was mainly introduced due to the inflationary impact on the acquisition cost. Indexation permits one to compute the capital gains tax based on a higher purchase cost of the capital asset.

Rather than the historical cost, this reduces the capital gains and the tax liability.

Indexed cost of acquisition in case of long term capital gains =

Purchase cost * Cost Inflation Index (CII) of the year in which the asset ownership is transferred / Cost inflation index (CII) of the year in which asset was first under the possession of the seller or 2001-02 whichever is later.

Indexed cost of improvement =

Improvement costs * Cost inflation index of the year in which the asset ownership is transferred / Cost inflation index of the year in which improvement was undertaken

Cost inflation index applies only in case of long term capital assets.

It must be remembered that indexation benefit is not available to a short term capital asset. The underlying logic is simple.

In case of an asset held for a long time, it would be inaccurate to compute the capital gains by deducting the historical purchase price from the sale price, without considering inflation.

Computation Method of Capital Gains Tax

Let’s look at the computation method of STCG and LTCG

1.Short Term Capital Gains

Full monetary value of sale consideration less (expenses connected to the transfer) less (acquisition cost) less ( improvement costs)

Terminologies 

Full Value Consideration
It is the sale consideration received or expected to be received by the seller due to ownership transfer of the capital asset.It must be remembered that capital gains are chargeable to tax in the year of transfer, even if no consideration has been received as yet, but expected to be received.
Acquisition Cost
The cost borne by the seller to purchase the asset. In case the asset was acquired by the seller, other than by outright purchase, the acquisition cost and improvement costs of the previous owner would also be considered.
Improvement Cost
Expenditure of capital nature for making any alteration to the existing capital asset. The Income Tax Act excludes improvements made before April 1, 2001.
Transfer Cost
This covers expenses incurred like brokerage fee for arranging and closing the deal, marketing expenses etc . These are not of capital nature and are wholly related, incurred towards the asset transfer. These are necessary to effect the sale. It must be remembered that in case of sale of shares, the broker’s commission is an allowable expense. However, the securities transaction tax is not deductible. Securities Transaction Tax (STT) of 0.001% is levied by the fund when units of an equity fund or balanced fund are sold. There is no STT levied on the sale of units of a debt fund.

2.Long Term Capital Gains

Full monetary value of sale consideration less (expenses connected to the transfer) less (indexed acquisition cost) less ( indexed improvement costs) less (exemptions allowed under sections 54, 54EC, 54F, and 54B of the IT Act, 1961)

Section 54
Assessees can avail exemption on long term capital gains from sale of property by investing in upto two properties. The ceiling limit on capital gains is Rs.2 crore
Section 54EC
Assessees can avail exemption on long term capital gains from sale of property by investing in upto two properties. The ceiling limit on capital gains is Rs 2 crore.
Section 54F
Assessee can avail exemption on capital gains from sale of any long-term capital asset (other than property), if the entire sale proceeds is invested in a residential property. The new property must be purchased either a year before the sale or 2 years post the sale.
Section 54B
Assessee can avail exemption on short-term or long-term capital gains from transfer of agricultural land

Set off of Capital Losses

Capital losses are permitted to be set off only against capital gains. Short term capital loss may be set off against short term capital gain or long term capital gain.

Long term capital loss cannot be set off against any other income head (salary, income from business or profession, income from house property, other income), but only against long term capital gain.

Conclusion

In conclusion, it would do well to remember the capital gains provisions before investing in mutual funds based on type: equity, hybrid or debt.

The tax implications vary based on the fund type, holding period and the capital gains amount. The same rule holds for investing in shares and other traded securities as well.

Best is to consult a tax expert or be well versed in the latest tax rules to know the tax liability!

Happy Investing!

Disclaimer: The views expressed in this post are that of the author and not those of Groww