Capital Gains Tax in India

Capital gains are essentially what you hear about whenever someone says they sold their stocks, mutual funds, or real estate for a profit. However, many people rarely talk about the tax implications of these gains. In India, tax compliance and investment strategy are significantly impacted by capital gains tax. 

Whether you're a novice to the world of investing or a seasoned investor, it's imperative that you comprehend this tax. Let's explore capital gains tax and how it affects the choices you make with your money.

What is Capital Gains Tax in India?

Capital gains tax in India is a tax on the profit that you earn from the sale of an asset. These assets can include property, shares, bonds, or mutual funds. The tax is not on the total amount received from the sale, but rather on the gain or profit that is realised. Here’s what you need to understand about income tax on capital gains:

1. Types of Capital Gains: Capital gains are classified into two categories:

• Short-Term Capital Gains (STCG): If you sell an asset within a short period of owning it (for instance, within 36 months for property and 12 months for stocks and equity mutual funds), the profit is termed as short-term capital gains.

• Long-Term Capital Gains (LTCG): If the asset is held for a longer period (more than 36 months for property and more than 12 months for stocks and equity mutual funds), the profit is classified as long-term capital gains.

2. Tax Rates: The tax rate for capital gains depends on the type of gain:

• STCG is generally taxed at the same rate as your income tax slab.

• LTCG has a fixed tax rate, which is lower than the regular income tax rates. For example, LTCG from equity funds is taxed at 10% for gains exceeding ₹1 lakh without the benefit of indexation.

3. Indexation Benefit

For LTCG on certain assets like debt mutual funds and property, you can take advantage of indexation, which adjusts the purchase price of the asset for inflation, thereby reducing the taxable gain.

Capital gains tax is an essential aspect of financial planning in India. It encourages holding investments for a longer duration and impacts the net returns from investment decisions.

Defining Capital Assets

In the context of capital gains tax, understanding what constitutes a 'capital asset' is crucial. A capital asset is broadly defined as any kind of property held by an individual, regardless of whether it is connected to their business or profession. This definition encompasses a wide range of items, including:

• Real Estate: This includes land, buildings, and house property.
• Securities: Shares, bonds, debentures, mutual fund units, and other financial instruments.
• Physical Assets: Jewelry, vehicles, and other personal possessions.
• Intellectual Property: Patents, copyrights, trademarks, and the like.

Essentially, if you own something that can be sold or transferred and is not meant for personal use, it's likely a capital asset. There are a few exceptions, such as personal goods (clothing, furniture for personal use), agricultural land in rural areas, and certain specified bonds, which are not considered capital assets for the purpose of capital gains tax. This is important to understand if you get any kind of income from capital gains.

Types of Capital Assets

Capital assets are categorised mainly based on the duration for which they are held before the sale. This categorisation is vital as it determines the type of capital gain (short-term or long-term) and the applicable tax rate. The two primary types are:

• Short-Term Capital Assets: An asset is classified as a short-term capital asset when it is held for a shorter duration. For instance, stocks and equity mutual funds, if held for less than 12 months, are considered short-term capital assets. The period for classification can vary based on the type of asset.

• Long-Term Capital Assets: Assets held for a longer period are termed as long-term capital assets. For example, stocks and equity mutual funds held for more than 12 months fall into this category. The period criteria vary depending on the nature of the asset.

Understanding these classifications is essential for calculating capital gains tax accurately. Different assets have different thresholds for what constitutes a short-term or long-term holding period, impacting the tax treatment of any gains arising from their sale.

Classification of Inherited Capital Asset

When it comes to inherited capital assets, the classification for tax purposes is unique:

• Inherited Property: An inherited asset is typically considered a long-term capital asset, regardless of how long the inheritor has held it. This is because, for tax purposes, the period of holding includes the time for which the asset was held by the previous owner(s).

• Cost of Acquisition: The cost of acquisition of the inherited asset is generally considered to be the cost for which the original owner purchased it. This is used to calculate capital gains when the inheritor eventually sells the asset.

• Exemption from Inheritance Tax: In India, there is no inheritance tax. However, capital gains tax is applicable when the inheritor sells the asset.

This classification has significant implications for tax planning, especially when dealing with ancestral properties or assets that have been in the family for generations.

Tax on Equity and Debt Mutual Funds

On or before 1 April 2023		Effective 1 April 2023
	Short-Term Gains	Long-Term Gains	Short-Term Gains	Long-Term Gains
Debt Funds	At tax slab rates of the individual	10% without indexation or 20% with indexation whichever is lower	At tax slab rates of the individual	At tax slab rates of the individual
Equity Funds	15%	10% over and above Rs 1 lakh without indexation	15%	10% over and above Rs 1 lakh without indexation

Tax Rules for Debt Mutual Funds

Debt mutual funds are treated differently from equity funds for tax purposes. Here’s how capital gains tax applies to debt mutual funds:

Classification Period: For debt mutual funds, if the holding period is less than 36 months, it is considered a short-term capital asset. If held for more than 36 months, it is a long-term capital asset.

Tax Rate:

• Short-Term Capital Gains (STCG): Gains from debt funds held for less than 36 months are taxed as per the individual's income tax slab rate.

• Long-Term Capital Gains (LTCG): Gains from debt funds held for more than 36 months are taxed at 20% with indexation benefits.

• Indexation Benefit: The indexation benefit allows investors to adjust the purchase price of the debt fund units for inflation, effectively reducing the taxable gains.

Understanding these rules is crucial for investors in debt mutual funds, as the tax implications can significantly affect the net returns from these investments.

How to Calculate Long-Term Capital Gains?

Calculating long-term capital gains (LTCG) involves a few key steps:

• Identify the Sale Price: This is the amount you receive from selling the asset.

• Determine the Indexed Cost of Acquisition: For assets like property and debt mutual funds eligible for indexation, adjust the purchase price for inflation. The Income Tax Department publishes cost inflation index (CII) numbers to facilitate this calculation.

• Formula: Indexed Cost of Acquisition = Original Purchase Price × (CII of Sale Year / CII of Purchase Year)

• Calculate the Gain: Subtract the indexed cost of acquisition (and any improvement costs, if applicable) from the sale price.

• Formula: LTCG = Sale Price - Indexed Cost of Acquisition - Indexed Cost of Improvement (if any)

• Apply the Tax Rate: Apply the relevant tax rate (e.g., 20% with indexation for debt mutual funds) to the calculated gain.

For assets like equity and equity mutual funds, where indexation is not applied, simply subtract the original purchase cost from the sale price and apply the applicable tax rate (10% for gains over ₹1 lakh). If you’re wondering how to show this on your tax, this is the calculation you must follow. 

How to Calculate Short-Term Capital Gains?

Short-term capital gains (STCG) are simpler to calculate as they don't involve indexation. Here’s the process:

• Determine the Sale Price: This is the total amount you received from the sale.

• Calculate the Purchase Cost: Use the actual cost at which the asset was acquired.

• Calculate the Gain: Subtract the purchase cost from the sale price. Formula: STCG = Sale Price - Purchase Cost

• Apply the Tax Rate: STCG is taxed as per your income tax slab rates. So, the tax rate depends on your total taxable income for the year.

Remember, specific rules and exemptions may apply depending on the type of asset. It's advisable to consult with a tax professional for accurate calculations, especially for complex transactions.

What are Deductible Expenses?

When calculating capital gains, certain expenses incurred in connection with the sale and maintenance of the capital asset can be deducted. These deductible expenses include:

• Brokerage or Agent Fees: Costs paid to a broker or agent for arranging the sale of the asset.

• Legal Costs: Expenses related to legal services for the sale transaction.

• Cost of Improvements: Any expenses incurred for renovating or improving the asset, which adds to its value, are deductible. However, routine maintenance costs are not included.

• Transfer Charges: If any costs were incurred in transferring the asset, such as stamp duty or registration fees, these can be deducted.

It's important to maintain proper documentation of these expenses as they play a crucial role in reducing capital gains and consequently tax liability.

Indexed Cost of Acquisition/Improvement

The Indexed Cost of Acquisition and Improvement is a concept used in the calculation of long-term capital gains to adjust the purchase and improvement costs of an asset for inflation. This ensures that the increase in prices over time is factored into the calculation, leading to a more equitable tax assessment. Here’s how it works:

• Cost Inflation Index (CII): The CII is published by the Income Tax Department and is used to adjust the cost of acquisition and improvement.

• Indexed Cost of Acquisition: This is calculated by multiplying the original cost of acquisition with the CII of the year of sale and dividing by the CII of the year of purchase.

• Formula: Indexed Cost of Acquisition = Original Cost of Acquisition × (CII of Sale Year / CII of Purchase Year)

• Indexed Cost of Improvement: Similarly, for any improvements made to the asset, the costs are indexed using the CII.

Formula: Indexed Cost of Improvement = Cost of Improvement × (CII of Sale Year / CII of Improvement Year)

The use of indexation is particularly beneficial in reducing the taxable capital gain, especially for assets like real estate and debt mutual funds, where the holding period is long, and inflation can significantly impact costs.

Exemption on Capital Gains

Capital gains earned from the sale of assets can sometimes be exempted from tax under certain conditions, as outlined in the Income Tax Act. Here are some of the key exemptions:

• Section 54: Section 54 offers an exemption on long-term capital gains from the sale of a residential house property, provided the amount is reinvested in purchasing or constructing another residential property in India.

• Section 54F: Section 54F exemption is for long-term capital gains from the sale of any capital asset other than a residential house, provided the net sale consideration is invested in purchasing or constructing a residential house property.

• Section 54EC: This section allows exemption on capital gains if the amount is invested in specific bonds issued by entities like NHAI or REC. The investment must be made within 6 months of the sale, and there’s a lock-in period for these bonds.

• Section 54B: It provides exemption on capital gains arising from the sale of agricultural land, subject to certain conditions.

These exemptions are provided to encourage investment in specific sectors and assist taxpayers in managing their capital gains efficiently.

Section 54: Exemption on Sale of House Property on Purchase of Another House Property

Section 54 of the Income Tax Act offers a specific exemption that's quite beneficial for homeowners:

• Applicability: This exemption applies to the long-term capital gains arising from the sale of a residential house property.

• Conditions for Exemption:

• The taxpayer must reinvest the capital gains in purchasing another residential house property within 2 years after the date of the sale or construct a house within 3 years.
• The new property must be located in India.
• The exemption is applicable only on the investment of capital gains, not on the entire sale consideration.
• The taxpayer cannot own more than one residential house, other than the new one, on the date of transfer of the original property.

• Amount of Exemption: The exemption is equal to the amount of capital gains reinvested or the capital gains, whichever is lower. If the entire gain is not reinvested, the remaining part is taxable.

• Reinvestment in Only One Property: The exemption is available only if the reinvestment is made in a single residential house property.

This exemption under Section 54 is a significant relief for taxpayers who are reinvesting in residential property, making it a popular option for tax planning in case of property sales.

Section 54F: Exemption on Capital Gains on Sale of Any Asset Other Than a House Property

Section 54F of the Income Tax Act offers a tax exemption on long-term capital gains arising from the sale of any capital asset other than a residential house property, under the following conditions:

• Eligibility: The exemption is available when the net sale consideration is invested in purchasing or constructing a single residential house property in India.

• Conditions for Exemption:

• The new residential property must be purchased one year before or two years after the sale, or constructed within three years after the sale of the asset.
• The taxpayer should not own more than one residential house, other than the new one, at the time of sale.
• The entire net sale consideration, not just the capital gain, must be invested to claim the full exemption. If only a part of the net sale consideration is invested, the exemption is allowed proportionately.

• Lock-in Period: The new property cannot be sold within a period of three years from the date of its acquisition or construction.

• Consequences of Non-Compliance: If the conditions are not met, or the new house is sold within three years, the exemption claimed will be revoked, and the capital gain will become taxable.

Section 54F encourages investment in residential property by offering tax relief on the sale of assets like shares, bonds, land, etc., making it a beneficial provision for diversifying investments into real estate.

Section 54EC: Exemption on Sale of House Property on Reinvesting in Specific Bonds

Section 54EC provides an exemption from capital gains tax if the gains are reinvested in certain specified bonds. This applies to long-term capital gains from the sale of any asset, including house property:

• Eligible Bonds: The bonds eligible for this exemption are specifically issued by the National Highways Authority of India (NHAI) or the Rural Electrification Corporation (REC).

• Investment Period: The investment in these bonds must be made within 6 months of the date of sale of the asset.

• Limitation on Investment: The maximum amount that can be invested in these bonds is ₹50 lakh in a financial year.

• Lock-in Period: These bonds come with a lock-in period of 5 years. Early redemption is not permitted.

• Interest Rate: While these bonds offer a safe investment route, the interest rate is typically lower than market rates and is taxable.

• Exemption Amount: The exemption under Section 54EC is equal to the amount invested in the bonds, subject to the overall limit of ₹50 lakh.

This exemption under Section 54EC is particularly useful for those looking for safe investment options while saving on capital gains tax, albeit with a lower return compared to other investment avenues.

When Can You Invest in a Capital Gains Account Scheme?

The Capital Gains Account Scheme (CGAS) comes into play when you have sold a capital asset and intend to reinvest the gains to avail of tax exemptions under sections like 54, 54F, or 54EC, but haven’t done so yet. Here’s when and how you can utilise the CGAS:

• Purpose of CGAS: It allows taxpayers to park their capital gains temporarily until they find a suitable avenue to reinvest and claim tax exemptions. This scheme ensures that the gains are not used for any purpose other than investment as specified for claiming the exemption.

• Time Frame: You should invest in the CGAS before the due date of filing your income tax return, typically July 31st of the assessment year, to claim the exemption for that financial year.

• Types of Accounts: There are two types of accounts under CGAS - Type A (savings account) and Type B (term deposit). Funds in Type A are more readily accessible, while Type B usually offers a higher rate of interest but with certain withdrawal restrictions.

• Withdrawal for Investment: The amount deposited in the CGAS must be used for the purchase or construction of a new property or in the specified bonds within the time frame stipulated under the respective sections of the Income Tax Act.

• Consequences of Non-Utilisation: If the amount deposited in the CGAS is not utilised within the specified period for the purchase or construction of property or investment in bonds, it will be treated as capital gains of the year in which the specified period ends.

Investing in the CGAS is a wise move for taxpayers who have earned capital gains but need some time to plan their reinvestment to avail tax benefits.

Saving Tax on Sale of Agricultural Land

The sale of agricultural land in India can have various tax implications, and under certain conditions, the gains from such a sale can be exempt from tax:

• Classification of Land: The tax exemption depends on whether the agricultural land is classified as rural or urban. As per the Income Tax Act, rural agricultural land is not considered a capital asset, and hence gains from its sale are not taxable. Urban agricultural land, however, is considered a capital asset, and gains from its sale are subject to capital gains tax.

• Conditions for Exemption: For urban agricultural land, exemptions under sections like 54B can be availed. Under Section 54B, if the capital gain from the sale of agricultural land is reinvested in purchasing another agricultural land within 2 years of the sale, the gain is exempt from tax.

• Holding Period: The agricultural land should have been used by the taxpayer or his parents for agricultural purposes for at least two years immediately preceding the date of transfer.

• Reinvestment Requirement: The new agricultural land purchased to claim the exemption should not be sold within a period of three years from the date of its purchase.

Understanding these nuances can significantly impact the tax liability arising from the sale of agricultural land and can lead to substantial tax savings if planned correctly.

Section 54B: Exemption on Capital Gains From Transfer of Land Used for Agricultural Purposes

Section 54B of the Income Tax Act, 1961, offers a specific exemption on capital gains arising from the transfer of agricultural land. This exemption is particularly relevant for taxpayers who are engaged in agricultural activities. Here's how it works:

• Eligibility: The exemption under Section 54B is available to individual taxpayers or Hindu Undivided Families (HUFs).

• Condition for Exemption: The agricultural land must have been used by the taxpayer or his parents for agricultural purposes for a period of at least two years immediately preceding the date of transfer.

• Reinvestment of Capital Gains: The capital gains from the sale must be reinvested in purchasing new agricultural land within a period of two years from the date of sale. If the entire amount of capital gains is not reinvested, the exemption will be allowed proportionately.

• Lock-In Period for New Land: The new agricultural land purchased to claim the exemption should not be sold within three years from the date of its acquisition. If it is sold within this period, the exemption claimed will be revoked in the year of sale of the new land.

• Documentation and Compliance: Proper documentation and timely compliance with the reinvestment conditions are crucial to avail of the benefits under Section 54B.

This provision is a boon for farmers and agricultural landowners, providing them a tax relief avenue while encouraging the continuity of agricultural activities.

Conclusion

Understanding capital gains and the various tax implications associated with them is crucial for effective financial planning and decision-making. Whether it’s the sale of property, shares, or agricultural land, being aware of the nuances of capital gains tax can lead to significant tax savings and informed investment strategies. The Indian Income Tax Act provides several exemptions and benefits like Section 54, 54F, 54EC, and 54B, which, if utilised wisely, can substantially reduce tax liabilities. 

FAQs

• What is Capital Gains Tax?

Capital gains tax is a tax on the profit made from selling certain types of assets, such as property, stocks, or bonds. It's calculated based on the difference between the selling price and the original purchase price of the asset.

• What are the types of capital gains?

There are two types of capital gains: Short-Term Capital Gains (STCG), where the asset was held for a short duration (usually less than 36 months for property and less than 12 months for stocks), and Long-Term Capital Gains (LTCG), where the asset was held for a longer period.

• How are capital gains taxed in India?

In India, STCG is taxed as per your income tax slab rates, while LTCG is taxed at a fixed rate, which varies depending on the type of asset (e.g., 20% for property with indexation, 10% for equity over ₹1 lakh without indexation).

• What is indexation and how does it affect LTCG?

Indexation is a method to adjust the purchase price of an asset for inflation. It's applicable to LTCG, reducing the taxable gain by increasing the purchase price, thereby leading to lower taxes.

• Can you get an exemption from capital gains tax?

Yes, exemptions are available under sections like 54, 54F, and 54EC of the Income Tax Act if the gains are reinvested in specific ways, such as purchasing another property or investing in certain bonds.

• What is the Capital Gains Account Scheme (CGAS)?

The CGAS is a provision where you can deposit your capital gains to claim tax exemption, provided you plan to reinvest them but haven’t done so by the time of filing your income tax return.

• What is Section 54B of the Income Tax Act?

Section 54B provides exemption on capital gains from the sale of agricultural land, provided the gains are reinvested in purchasing new agricultural land within two years of the sale.

• Are there any special rules for calculating capital gains on inherited property?

For inherited property, the capital gain is calculated from the original purchase price paid by the person who bequeathed the property. The holding period also includes the period the property was held by the previous owner.

• How is capital gain calculated on the sale of shares or mutual funds?

For shares or equity mutual funds, if sold within 12 months, it's considered STCG and taxed as per your income tax slab. If sold after 12 months, it's LTCG and taxed at 10% for gains exceeding ₹1 lakh.

• Is agricultural land subject to capital gains tax?

Gains from the sale of rural agricultural land are exempt from capital gains tax. However, urban agricultural land is subject to capital gains tax, and exemptions may be applicable under certain conditions.