Taxation of Capital Gain in India: Everything You Need to Know

Understanding the taxation of capital gains in India is crucial for anyone looking to invest in property, stocks, or other assets.

Understanding how capital gains are taxed will assist you in making better financial decisions, regardless of experience level.

This blog will cover the basics of capital gains, types, exemptions, and the tax implications for individuals in India.

What is Capital Gain?

A capital gain is the amount of money obtained when a capital asset is sold. These assets can include stocks, bonds, real estate, and more. When the selling price of the asset is higher than its purchase price, the difference is called a capital gain.

Types of Capital Gains

There are two types of capital gains in India:

1. Short-Term Capital Gain (STCG): This is the profit earned from selling an asset held for a short period. The period varies depending on the type of asset.
2. Long-Term Capital Gain (LTCG): This is the profit earned from selling an asset held for a longer duration. The duration also varies by asset type.

Taxation of Short-Term Capital Gains

Short-Term Capital Gain Tax on Different Assets

Short-term capital gains are taxed differently based on the type of asset sold:

• Equity Shares and Equity Mutual Funds: STCG on these assets is taxed at a rate of 15%. This is applicable if Securities Transaction Tax (STT) is paid on the sale.
• Other Assets: For other assets like debt mutual funds, property, or gold, STCG is added to your income and taxed as per your applicable income tax slab.

Calculation of Short-Term Capital Gains

The formula for calculating STCG is straightforward:

STCG=Sale Price−(Purchase Price+Expenses Incurred on Sale)

Example:

If you bought shares worth ₹1,00,000 and sold them for ₹1,20,000 within a year, your STCG would be:

STCG= 1,20,000−1,00,000 = ₹20,000

If STT was paid, you would be taxed 15% on this ₹20,000.

Taxation of Long-Term Capital Gains

Long-Term Capital Gain Tax on Different Assets

LTCG is taxed at different rates depending on the type of asset:

• Equity Shares and Equity Mutual Funds: If the gain exceeds ₹1 lakh in a financial year, LTCG is taxed at 10% without the benefit of indexation.
• Other Assets: LTCG on other assets like real estate, debt mutual funds, and gold is taxed at 20% with the benefit of indexation.

Calculation of Long-Term Capital Gains

To calculate LTCG, use this formula:

LTCG= Sale Price−(Indexed Cost of Acquisition + Indexed Cost of Improvement+Expenses Incurred on Sale)

Understanding Indexation

Indexation is a method to adjust the purchase price of an asset for inflation. It helps reduce the overall tax liability on LTCG. The government provides Cost Inflation Index (CII) numbers each year for this purpose.

Example:

Suppose you bought a property in 2005 for ₹30,00,000 and sold it in 2023 for ₹80,00,000. The indexed cost of acquisition is calculated using the CII. Let's assume the CII for 2005 was 117 and for 2023 is 348.

Indexed Cost= CII in 2005/CII in 2023 ​ × Original Cost

= 117/348 ​ × 30,00,000 ≈ ₹89,23,077

LTCG= 80,00,000 − 89,23,077= −₹9,23,077

In this case, there would be no LTCG as the indexed cost is higher than the selling price.

Exemptions and Deductions

Exemptions on Long-Term Capital Gains

The Income Tax Act provides certain exemptions to help reduce your tax liability on LTCG:

1. Section 54: Exemption on the sale of residential property if the gains are invested in another residential property within a specific time.
2. Section 54EC: Exemption if the capital gains are invested in specified bonds like REC, NHAI, etc., within six months of the transfer. The maximum investment limit is ₹50 lakh in a financial year.
3. Section 54F: Applicable when the entire sale proceeds (not just the gain) from the sale of any asset other than a house property are invested in a residential house.

Conditions for Exemption

The new property or bonds should not be sold within a specified period (usually three years) to avail of the exemption. The exemption amount is limited to the capital gains.

Also Read: Which is Right Accounting Methods in India: Cash vs. Accrual

How to Report Capital Gains in Your Income Tax Return

Reporting capital gains accurately in your income tax return is crucial to avoid penalties. Here’s how you can do it:

1. Identify the Type of Asset: Determine if the asset sold falls under short-term or long-term gains.
2. Calculate the Gain: Use the formulas mentioned above to calculate your gain.
3. Fill the Correct ITR Form: If you are a salaried individual, fill out ITR-2. For business income, fill out ITR-3 or ITR-4.
4. Include Exemptions and Deductions: Mention any exemptions or deductions claimed under the relevant sections.

Key Takeaways and Tips

Tips for Reducing Capital Gains Tax

• Hold Assets Longer: Holding an asset for a longer duration can convert STCG to LTCG, reducing the tax rate.
• Utilize Exemptions: Make use of the exemptions provided under the Income Tax Act.
• Indexation Benefit: For non-equity assets, leverage indexation to reduce taxable gains.

Common Mistakes to Avoid

• Incorrect Calculation: Ensure correct computation of gains, considering all costs and exemptions.
• Failing to Report Gains: All gains, even if exempt, should be reported in your return.
• Ignoring Indexation: Always apply indexation for long-term gains on non-equity assets.

Additional Aspects of Capital Gain Taxation in India

Taxation for Non-Resident Indians (NRIs)

For Non-Resident Indians (NRIs), the taxation rules for capital gains differ slightly from residents:

• Short-Term Capital Gains (STCG): For equity shares and equity mutual funds, STCG is taxed at a flat rate of 15%. For other assets, STCG is taxed at the applicable slab rate of the NRI.
• Long-Term Capital Gains (LTCG): LTCG on equity shares and mutual funds exceeding ₹1 lakh is taxed at 10% without indexation benefits. For other assets, the rate is 20% with indexation benefits. Additionally, NRIs are subject to a TDS (Tax Deducted at Source) on the capital gains.

Set-Off and Carry Forward of Capital Losses

Capital losses, both short-term and long-term, can be used to reduce your tax liability:

• Set-Off of Losses: Short-term capital losses can be set off against both short-term and long-term capital gains. On the other hand, only long-term capital gains may be deducted from long-term capital losses.
• Carry Forward of Losses: If the capital losses cannot be entirely set off in the same financial year, they can be carried forward for up to 8 assessment years. To carry forward these losses, you must file your income tax return before the due date.

Specific Tax Treatment for Bonus Shares and Rights Shares

The tax treatment of bonus shares and rights shares is unique:

• Bonus Shares: The cost of acquisition for bonus shares is considered zero, and the holding period is counted from the date of allotment. If sold within 12 months, the gain is treated as STCG and taxed at 15%. If held for more than 12 months, the gain is LTCG and taxed at 10% (if gains exceed ₹1 lakh in a year).
• Rights Shares: The cost of acquisition for rights shares is the amount paid to subscribe to them. The date of allocation marks the beginning of the holding period. Taxation rules for STCG and LTCG apply similarly to regular equity shares.

Advanced Topics on Capital Gains for Businesses and Firms

For businesses or firms, capital gains taxation can involve more advanced planning:

• Depreciable Assets: Gains from the sale of depreciable assets, like machinery, are considered short-term gains, regardless of the holding period. The capital gain is calculated based on the difference between the sale price and the written-down value of the asset.
• Business Reorganization: In cases of mergers, demergers, or other forms of business reorganization, specific provisions under Sections 47, 50B, and 50C may apply to defer or calculate capital gains differently.

Exemptions Under Various Sections of the Income Tax Act

In addition to the commonly known Sections 54, 54EC, and 54F, other exemptions can apply:

• Section 54B: Exemption on capital gains from the sale of agricultural land if the gains are reinvested in another agricultural land within a specified period.
• Section 54D: Exemption for gains arising from compulsory acquisition of land and building forming part of an industrial undertaking if reinvested in acquiring another land or building for industrial purposes.
• Section 54GB: Exemption on capital gains arising from the transfer of residential property if invested in a new startup or small and medium enterprise (SME) business.

Tax Implications on Gifts and Family Settlements

Gifts and family settlements can also trigger capital gains tax:

• Gifts: If you receive an asset as a gift, there is no capital gains tax at the time of receipt. However, when you sell the gifted asset, the holding period of the previous owner is considered to determine whether the gain is short-term or long-term.
• Family Settlements and Partitions of HUFs: Transfers due to family settlements or partitions of Hindu Undivided Families (HUFs) are generally not considered transfers for capital gains tax purposes, provided they are genuine. However, subsequent sales of these assets by members could attract capital gains tax based on their holding period and cost of acquisition.

Detailed Indexation Benefits and Cost Inflation Index (CII)

The government provides a Cost Inflation Index (CII) to adjust the purchase price of assets for inflation. This adjustment helps reduce the tax burden on LTCG:

• CII Application: For assets like real estate or gold, where indexation benefits are available, the cost of acquisition and improvement is adjusted for inflation using the CII. This adjusted cost is then used to calculate the LTCG.
• Yearly CII Table: The CII numbers change yearly. For example, the CII for the financial year 2001-02 was 100, while for 2023-24, it is 348. This change significantly affects the indexed cost, thereby reducing the taxable gains.

Also Read: Understanding Tax Liability: Your Complete Guide

Specifics on Bonds Under Section 54EC

Section 54EC provides a method to save on LTCG tax by investing in certain bonds:

• Eligible Bonds: Bonds issued by the Rural Electrification Corporation (REC), National Highways Authority of India (NHAI), or any other bonds notified by the Central Government are eligible for this exemption.
• Investment Limits and Lock-in Period: The maximum investment permissible in these bonds is ₹50 lakh in a financial year, and the lock-in period is five years.

Summing Up!

Understanding the taxation of capital gains in India is essential for all investors.

By knowing the rules, rates, and exemptions, you can make smarter investment decisions and save on taxes. Whether it's planning your investments or filing your returns, staying informed is key to optimizing your tax liabilities.

By following these guidelines, you can navigate the complexities of capital gains taxation in India more effectively. Happy investing!