The Long & Short of Capital Gains

Calculation of tax on capital gains is quite a complex issue. A working knowledge of the income tax rules is most certainly required. Rates differ as per the holding period and holding period differs depending upon the type of asset sold. So it is not really a surprise that most queries I receive from readers are to do with different aspects of capital gains. In any case, with the fiscal year having ended, many taxpayers would be busy finalizing their tax return. Therefore, this week, the column examines the capital gains tax structure encompassing the various rules and rates applicable to different assets

Basically, capital gains tax is applicable on capital assets such as property, gold, shares, units, bonds debentures etc. Depending upon your period of holding, these capital assets may be classified as long-term or short-term. Short-term assets are those that are held for three years or lesser. By corollary, assets that are held for over three years will be termed as long-term. Note the above rule carefully. A capital asset has to be held for over three years to be deemed long-term. For example, say you sell property exactly after three years of owning it, it would still be termed as a short-term asset. It has to be owned for over three years (even one day more) to be designated as long-term.

Now, in the case of shares, debentures, units of mutual funds and deep discount bonds, the period of holding to qualify as long-term assets is reduced to over 12 months instead of the abovementioned three years. The equity shares, units and bonds needn’t be listed or quoted. Only debentures have to be necessarily listed in order to qualify for the 12 month period.

Indexation

Starting with FY 81-82 as the base year, the RBI notifies the Cost Inflation Index (CII) every year. Indexed cost is arrived at by multiplying the cost with the ratio of CII for the year of sale and year of purchase respectively. Benefit of indexed cost is given to ensure that the taxpayer pays capital gain tax on the 'real' or actual gain and not on the increase in the capital value of the property due to inflation. So essentially, indexation adjusts the cost for inflation thereby reducing the amount of capital gains. For example, say a property that was purchased in April 1992 for Rs. 10 lakh is sold in January 2012 for Rs. 50 lakh. Now, in this case, the capital gain would normally have been Rs. 40 lakh (Rs. 50 lakh – Rs. 10 lakh). However, this would be unfair to the taxpayer since the value of the rupee in 1992 was not the same as it is today.

Hence the cost would be suitably inflated as per the indices for the specified year. The CII for 92-93 was 223 and that for 11-12 is 785. Therefore, the indexed cost in the above example would work out to Rs. 35.20 lakh (Rs. 10 lakh x 785 / 223). The resultant capital gain of Rs. 14.80 lakh is much lower than the non-indexed Rs. 40 lakh.

Tax Rates

Long-term capital gain tax rate is 20% after reducing indexed cost. However, only in the case of listed securities, units and zero coupon bonds, the taxpayer has the option of choosing to pay 10% after reducing the non-indexed cost from the sale price, if the same works out to be lower. For other assets such as property or gold or even unlisted shares (say of a private limited company), the 10% option isn’t available, long-term tax is payable only at 20% after indexation.

Short-term capital gains tax on listed shares and units is 15% (increased from the erstwhile rate of 10% by Finance Act 2008). On other assets, the short-term gains is simply added to the other income and taxed at slab rates applicable to the taxpayer.

Saving Capital Gains Tax

Tax on short-term capital gains cannot be specifically saved. In other words, short-term capital gain is necessarily taxable. On the other hand, depending upon the asset, long-term capital gain tax may be saved by making certain investments. For example, long-term gains from sale of a residential house may be saved by investing the capital gain amount in another residential property, either one year before or within two years of date of sale. Long-term gains on assets other than a residential house may be saved by investing the net sale consideration (and not the capital gain), in another residential property again one year before or within two years from date of sale. If only a part of the consideration is used to buy the new property, proportionate deduction will be available.

Lastly, tax on all long-term capital gain (whether from residential property or otherwise) may be saved by investing the capital gain amount in bonds under sec. 54EC. Currently NHAI and REC issue such bonds. The maximum amount investible is Rs. 50 lakh in any one financial year.

The following table captures the various rates applicable on different assets.

Capital asset

If transaction is covered by Securities Transaction Tax  (STT)

If transaction is not covered by Securities Transaction Tax  (STT)

Long- term

Short-term

Long-term

Short- term

Without indexation

With indexation

Listed Equity Shares

0%

15%

10%

20%

Slab Rates

Unlisted Equity shares 

NA

NA

NA

20%

Slab Rates

Listed Debentures

NA

NA

10%

NA

Slab Rates

Unlisted Debentures

NA

NA

20%

NA

Slab Rates

Equity oriented mutual funds

0%

15%

10%

20%

Slab Rates

Non equity oriented mutual funds

NA

NA

10%

20%

Slab Rates

Immovable Property

NA

NA

NA

20%

Slab Rates

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