In simple words, any profit that arises from the sale of an asset is termed as a capital gain. The asset in the discussion here is a capital asset.
This profit is accounted under the “income” category, and thus, an individual/entity is liable to pay tax for the amount in the year in which the transfer of capital asset takes place. The tax paid is called the capital gains tax.
In this article
- What Is the Structure?
- How Can We Classify Capital Assets?
- What Are the Types of Capital Assets?
- What are the Standard Terms that an Investor Should Know?
- What are the Steps to Compute Capital Gain Tax?
- What are the Steps to Compute Long-Term Capital Gains
- What are the Expenses Allowed for Deduction?
- Important Points to Remember
What Is the Structure?
Capital gains tax can be both short-term and long-term in nature.
The tax applicable on the gains that are garnered after holding an asset for more than a year is termed as long-term capital gains tax and the tax applicable on the profits that are generated on holding an asset for less than twelve months, the tax is termed as short-term capital gains tax.
How Can We Classify Capital Assets?
Physical assets such as land, building, property, vehicles, jewelry, machinery, and intangible assets such as patents, trademarks, leasehold rights are few examples of capital assets.
It also includes any rights of management or control or any other legal right on a company.
Following are the items that don’t come under capital asset – stocks, consumables or raw material that is held to conduct operations of a company/business
- Goods such as clothes and furniture that are owned by individuals and is used for personal purpose
- Agricultural land used for activities related to agriculture and allied services. The said land must come in the rural area which is the area outside the jurisdiction of a municipality or cantonment board and has a population of 10,000 or more.
- Bearer bonds or gold bonds that were issued a few decades back between 1970-2000
- Gold deposit certificates that are used under the Gold Monetisation Scheme, 2015
Also, it is crucial to note that capital gains are not applicable in the case of inherited property, as there is no sale in such transaction, and only ownership is transferred to the legal heir.
The Income Tax Act has exempted assets received as gifts by way of inheritance. However, if the beneficiary who inherited the assets decides to sell the asset, he/she will be liable to pay capital gains tax.
What Are the Types of Capital Assets?
There are two types of capital assets
1.Short-Term Capital Asset
An asset that is held for 36 months or less is considered a short capital asset.
The criteria are however revised for some of the instrument such as immovable properties (including land, building and house property) to 24 months since fiscal 2018.
2. Long-Term Capital Asset
An asset that is held for more than 36 months is considered as a long-term capital asset.
Please note some of the assets are considered as short-term assets when it is held for less than 12 months and are considered as long-term if held for more than 12 months. These assets are –
- Equity or preference shares of a company that is listed on any recognized exchange in India
- Instruments such as debentures, bonds, govt securities, etc. that are listed on any recognized exchange in India
- United of mutual funds (both quoted and unquoted)
- Zero coupon bonds (both quoted and unquoted)
In the case where an asset is acquired by way of gift, will or inheritance, the period for which the previous owner held the said asset is also included in determining if the asset is a short-term capital asset or long-term capital asset.
For rights and bonus share, the period of holding is counted from the date of allotment of the shares.
What are the Standard Terms that an Investor Should Know?
1.Full Value Consideration
This is the consideration that is received or is to be received by the seller as a result of the transfer of assets.
Capital gains tax is applicable in the year of transfer of assets, even if the buyer/seller does not transfer/receive the consideration value.
2. Acquisition Cost
The value at which the capital asset was acquired by the buyer
3. Improvement Expenses
The cost incurred while making an addition or alteration of the asset by the seller.
What are the Steps to Compute Capital Gain Tax?
1.Take the full value of consideration
2.Make deductions based on the following:
- Expenditure incurred in relation with such transfer
- Acquisition cost
- Improvement cost
3.The remainder is the short-term capital gains on which you are supposed to pay tax
Mathematically, it is shown as –
Short term capital gain = Full value consideration minus expenses incurred towards transfer, acquisition, maintenance, and improvement.
What are the Steps to Compute Long-Term Capital Gains
1. Take the full value of consideration
2. Make deductions based on the following:
- Expenditure incurred towards the transfer
- Cost of acquisition and cost of the improvement (both indexed)
Make further deductions as per the rule states under section 54, 54EC, 54F, and 54B.
Mathematically it can be shown as;
Long-term capital gain= Full value consideration minus expenses incurred towards transfer minus the indexed cost of acquisition and improvement, acquisition, maintenance, and improvement – minus expenses that can be deducted from full value for consideration.
What are the Expenses Allowed for Deduction?
1.Sale of House Property
- Brokerage or commission paid for scouting buyer
- Cost of stamp paper
- Travel related expenses that might have been incurred concerning the transfer transaction
- Expenditure regarding the process concerning transfer, including obtaining succession certificate, legal fees, executor fees, and the likes.
- Broker’s commission related to the transaction
P.S – STT or securities transaction tax is not allowed as a deductible expense
3. Sale of Jewelry
- Cost of a broker, if used, to scout a buyer
What is the indexed cost of acquisition and improvement
Cost of acquisition is indexed by using the Cost Inflation Index (CII). The method is done primarily to adjust the cost concerning inflation during the holding period of the asset.
The move allows for inflating the cost base, thereby reducing the gains in the hands of the investor/individual.
Indexing the cost of acquisition = Cost of acquisition / CII for the year in which seller first held the asset x CII for the year in which the asset is transferred.
An Example of Capital Gain
Mr. A bought a house in 2010 for Rs. 1 crore and sold the sale in 2019 for Rs. 2 crore.
Since this property was held for more than three years, the capital gains would be long-term in nature. Using the indexation formula, the consideration received is computed at Rs. 1.63 crore (hypothetical number).
Thus, the gain is Rs. 63 lakhs.
The long-term capital gains tax is 20%. Therefore, the seller has to pay Rs 12.6 lakhs as tax.
The amount of tax can be further reduced by taking benefit of exemptions that are provided by the Income Tax Act on capital gains where profit is reinvested to buy another asset.
Important Points to Remember
Different assets have different holding periods to be called short term and long term.
Following table defines the period of holding for different asset classes.
|Asset||Period of holding||Category|
|Immovable property||< 24 months||Short Term|
|>24 months||Long Term|
|Listed equity shares||<12 months||Short Term|
|>12 Months||Long Term|
|Unlisted shares||<24 months||Short Term|
|>24 months||Long Term|
|Equity Mutual funds||<12 months||Short Term|
|>12 months||Long Term|
|Debt mutual funds||<36 months||Short Term|
|>36 months||Long Term|
|Other assets||<36 months||Short Term|
|>36 months||Long Term|
Disclaimer: The views expressed in this post are that of the author and not those of Groww