Capital Gains Tax – Definition, Types, Exemptions & Tax Saving

The Indian taxation system is divided broadly into two types of taxes- Direct taxation and indirect taxation. Direct tax is further divided broadly into Income tax and wealth tax. Government charges tax on the income earned in Income tax. For that purpose, five heads of income are categorised. They are: 

1. Income from salaries

2. Income from house property

3. Profits and gains from business and profession

4. Income from capital gains and 

5. Income from other sources. 

In this article, we are going to learn about capital gain tax India in detail. 

What is Capital Gains tax in India?

Capital gains are profits or gains made from selling a capital asset. It will appear under the head ‘income from capital gains’ and the tax will be charged accordingly. This tax is charged in the year in which such capital asset gets transferred. Capital gains are further divided into short term capital gain (STCG) and long term capital gain (LTCG).

What is Capital Asset?

Capital Asset includes house property, land, building, vehicles, patents, trademarks, machinery, leasehold rights and many more. However, the following do not come under capital assets:

1. Rural Agriculture land in India.
2. Special Bearer bonds 
3. Gold bonds by the government.
4. Any raw material, stock held for business or profession.
5. Belongings of personal nature.

Though the following are personal movable assets, they are still considered capital assets:

1. Jewellery
2. Drawings, paintings, sculptures or any work of art
3. Archaeological collections

Conditions for charging capital gain tax

There are certain basic conditions for the charge of tax on capital gains. They are as follows:

1. There should be a capital asset.
2. There should be a transfer of such capital assets during the respective period.
3. There should be profits or gains on such a transfer. If any loss is incurred, tax is not charged.

Types of Capital Asset

There are two types of capital assets. They are short term capital assets and long term capital assets. They are explained as follows:

1. Short term capital asset (STCA)

Generally, a short term capital asset is an asset that has been held for not more than 3 years.

However, this duration is limited to 2 years in immovable properties such as land, building and house property from FY 2017-18. This 2 years duration does not apply to jewellery, debt-oriented mutual funds, etc.

2. Long term capital asset (LTCA)

Generally, a long term capital asset is an asset that has been held for a period of at least 3 years.

There are certain exceptions to the period of holding of 3 years. They are as follows:

1. This duration is reduced to 2 years from 3 years in immovable properties such as land, building and house property.

It means that if these capital assets are sold in less than 2 years, they are treated as short term assets, else long term assets. These 2 years do not apply to jewellery, debt-oriented mutual funds, etc.

2. With effect from 10/07/2014, for certain categories of capital assets, the period of holding is 12 months. It means that if these capital assets are sold in less than 12 months, they are treated as short term assets, else long term assets.

Such assets are:

a. Shares that are listed on a stock exchange recognised in India.

b. Securities that are listed on a stock exchange recognised in India.

c. Units of Unit Trust of India.

d. Units of an equity-oriented mutual fund.

e. Zero-coupon bonds.

Important Point- In case an asset is acquired by gift, will or inheritance, the period of holding of the previous holder is clubbed for determining the type of capital asset and gains on the same.

Also Read: Income tax Calculator - Calculate Your Taxes For FY 2021-22 Use Tax Calculator Online

Tax rates on short term capital gain and long term capital gain

From the following, you can easily know about capital gain tax along with the LTCG tax rate and STCG tax rate-

Long Term Capital Gain Tax Rate

• On the sale of Equity shares or units of equity-oriented funds- 10% over and above Rs 1 lakh. That means, up to Rs 1 lakhs, there is no tax on LTCG of such shares.
• Except on sale of equity shares or units of equity-oriented funds- 20%                         

Short Term Capital Gain tax rate

• When securities transaction tax is applicable- 15%
• When securities transaction tax is not applicable, such short-term capital gain is added to the income tax return, and tax is paid as per the basic income tax slab rates.

Tax treatment of equity and debt mutual funds

Tax treatment for debt and equity-oriented mutual funds is different. If any fund is invested heavily in 65 % equity, then it's called an equity-oriented fund. Else it's called a debt-oriented fund. Let us check their tax rates.

The holding period of debt mutual funds is 3 years. If they are held for more than 3 years they qualify as a long term capital asset. And when it is sold, it's called long term capital gain/ loss. On the contrary, if it's held for less than 3 years, it's a short term capital asset, and on its sale, it's classified as short term capital gain/ loss. In the case of short term capital gain, it adds to the income and is taxed as per slab rates.

Capital Gains calculation

Before understanding how to calculate capital gains tax, let us know about certain important terms:

1. The full value of consideration- It's the amount received by the seller as a result of the sale or transfer of capital assets. Tax is charged in the year in which such transfer takes place even if the amount is not received.
2. The cost of acquisition- This is the amount paid when the asset was purchased.
3. The cost of improvement- They are expenses incurred for making changes to capital assets. If such improvements are done before 01/04/2001, it's ignored.

Indexation: Cost of acquisition and cost of improvement are indexed in the long term as per the cost inflation index.

Indexed cost of acquisition: The Cost of acquisition multiplied by the cost inflation index of the year in which asset was transferred. This is divided by the year's cost inflation index in which asset was first held by the seller or 2001-02, whichever is later.

Indexed cost of the improvement: The Cost of improvement multiplied by the cost inflation index of the year in which asset was transferred. This is divided by the cost inflation index of the year in which improvement took place.

Calculation of short term capital gains

1. Full Value of Consideration
2. Less: 
   a. Expenses in connection with such transfer 
   b.Cost of acquisition 
   c. Cost of improvement

= Short term capital gain/loss

Calculation of long term capital gains

1. Full Value of Consideration
2. Less: 
   a. Expenses in connection with such transfer 

b. Indexed cost of acquisition 
c. Indexed cost of improvement

= Long term capital gain/loss

From this capital gains/ loss, exemptions of Section 54, 54EC, 54F and 54B can be claimed for reducing the gains, and tax is exempt or less tax is charged on it.   

In the case of the sale of shares, certain expenses can be deducted from the full value of consideration known as brokers commission. Securities Transaction Tax (STT) is not a deductible expense.

You can also use a capital gains tax calculator for convenience.

Exemptions from Capital Gains

Tax savings can occur according to some sections of Capital Gains, such as:

Section 54: Sale of Residential House Property on Purchase of another Residential House Property

1. This exemption can be availed when a residential house property is sold and the proceeds are invested in purchasing one or two residential house properties. Earlier this condition was for the purchase of one house property only.
2. In purchasing two residential house properties, it's allowed only once in a lifetime and upto capital gains of Rs 2 cr. only.
3. The investment amount should be the number of capital gains.
4. The exemption is limited to the number of capital gains, even if the purchase cost of the asset is more.

Conditions

1. The new property should be purchased one year before or two years after the sale.
2. If the property is under construction, it should be completed in three years.
3. The new property should be held for a minimum of 3 years, else exemption would be taken back.

Section 54F: Capital gains on the sale of any asset other than a house property

1. If long-term assets other than a residential house property is sold, then this exemption can be used.
2. The entire sale amount should be invested.
3. The new property should be purchased one year before or two years after the sale.
4. If a property is under construction, it should be completed in three years.
5. The new property should be held for a minimum of three years, and else the exemption would be taken back.
6. If the entire sale consideration is invested then the entire capital gain is exempted. If a portion is invested, then a proportionate amount is exempted.

Section 54EC: Capital Gain Tax on Sale of Property on Reinvesting in specific bonds

1. If capital gains are invested in certain bonds, then Section 54EC can be availed.
2. Amount upto Rs 50,00,000 can be invested in the National Highways Authority of India (NHAI) or Rural Electrification Corporation Limited (RECL).
3. Money can be redeemed after 5 years; if it's redeemed before, the exemption is withdrawn. Earlier, this limit was for 3 years.

Section 54B: Capital Gains from Transfer of Land Used for Agricultural Purpose

1. If an individual/their mother or father/HUF has used agricultural land for 2 years and then transfers the land, capital gains from such sale are eligible for Section 54B.
2. The amount of exemption is capital gain or amount invested, whichever is lower.
3. Reinvestment should be done in agricultural land in 2 years.
4. The new agricultural land should be held for a minimum of 3 years; else, the exemption would be taken back.
5. If you cannot invest in 2 years, you can deposit the amount before the date of filing of return in any branch of the Bank according to the Scheme. The deposited amount can be used for exemption, and if it remains unused, it's treated as capital gains.

Also Read: Income Tax Slabs 2021 & Tax Rates For FY 2020-21/ FY 2019-20/ FY 2018-19

Tax Savings for Agricultural Land

There are certain cases where capital gains from agricultural land are exempt or not treated in capital gains.

1. Agricultural land in rural India is not treated as a capital asset, and hence no capital gains tax on it.
2. If your business is buying and selling agricultural land as stocks, they are taxable under profits and gains of business or profession.
3. If urban agricultural land is compulsorily acquired, then it's exempted from tax.

If your agricultural land does not fall under these three categories, you can seek exemption under Section 54B.

Conclusion

Capital gains tax India is one of the most complicated concepts to understand because of several conditions, types, exceptions and exemptions. You can save tax by strategically planning your choices by exemptions available and by other law provisions. In this article, we have tried to simplify these concepts for you. We hope you have gained significant knowledge regarding Capital Gains Tax in India. 

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