Capital gains taxation is a significant aspect of the financial landscape, impacting individuals and investors. When you sell or transfer a ‘capital asset,’ such as securities, the resulting profits or gains are subject to taxation. This article aims to demystify capital gains, their taxation, and ways to reduce the tax burden.
Capital gains and its taxation
Any profits or gains arising from the transfer of a ‘capital asset’, is chargeable to tax under the heading of ‘Capital Gains’.
A capital asset is any asset other than:
(i) any stock-in-trade consumable stores or raw materials held for the purposes of business or profession (but any securities held by a Foreign Institutional Investor which has invested in such securities in accordance with the regulations made under the Securities and Exchange Board of India Act, 1992, will always be treated as capital asset and will not be treated as stock-in-trade);
(ii) personal effects, that is, movable property (including wearing apparel and furniture) held for personal use by the taxpayer or any member of his family dependent on him, but excludes— (a) jewellery; (b) archaeological collections; (c) drawings; (d) paintings; (e) sculptures; or (f) any work of art.
(iii) Agricultural Land in India outside the jurisdiction of a municipality or cantonment board and their contiguous areas up to a certain distance, as below :
| Population of the municipality or cantonment board | Distance from its boundary (measured aerially) |
| more than 10,000 but not more than 1 lakh | 2 kms |
| more than 1 lakh but not more than 10 lakh | 6 kms |
| more than 10 lakh | 8 kms |
(iv) 6 1/2 percent Gold Bonds, 1977, or 7 percent Gold Bonds, 1980, or National Defence Gold Bonds, 1980, issued by the Central Government; Special Bearer Bonds, 1991;
(v) Gold Deposit Bonds issued under the Gold Deposit Scheme, 1999,
(vi) or deposit certificates issued under the Gold Monetisation Scheme, 2015.
‘Transfer’ of a capital asset means the sale/exchange/ relinquishment of the asset or extinguishment of a right; compulsory acquisition by government; conversion from business asset to stock-in-trade; maturity/redemption of a notified zero coupon bond or a notified infrastructure debt fund; allowing possession under part-performance but excludes change of ownership by partition of HUF, gift, will, irrevocable trust, and certain amalgamation/demerger of companies; conversion of preference shares to equity shares; conversion of gold into an Electronic Gold Receipt issued by a Vault Manager and vice versa, etc.
This article focuses on capital gains arising from transfer of “Securities”. “Securities” are defined in Sec. 2)42A), read with Section 2(h) of the Securities Contract (Regulation) Act, 1956. “Securities” include shares, scrips, stocks, bonds, debentures, debenture stock, or other similar marketable securities issued by a company; Units of any mutual fund scheme; Government securities and rights or interests in securities; derivatives; units or any other instrument issued by any collective investment scheme to the investors in such schemes; and security receipts issued by an asset reconstruction company to any qualified buyer evidencing the purchase or acquisition by the holder of an undivided right, title, or interest in the financial asset involved in securitisation.
Capital gains arising from the transfer of a capital asset are termed ‘short term’ or “long term”, depending on how long the transferor has had the capital asset in his ownership. The computation of Capital gains is discussed later in this article. The rate of tax depends on both the nature of the asset as well as whether the Capital gains is short term or long term.
Rate of tax on Capital gains on the transfer of securities:
The rate of tax depends on the period for which the asset has been held (i.e. short term or long term) and the type of asset (i.e., immovable or movable assets, as below.
| Type of asset | Period of holding | Short Term/ Long Term | Rate of Tax |
| Equity Shares | Up to 12 months for shares listed in recognised stock exchange
Up to 24 months for unlisted shares Tax Rate on STCG: (i) if STT is paid on transfer) iii) if STT is not paid on transfer) |
Short Term | (i) 15%
(ii) Capital gains is added to Total Income, and taxed at applicable tax rates on total income. |
| More than 12 months for shares listed in recognised stock exchange
More than 24 months For unlisted shares Tax rates on LTCG: (a) For shares on which STT has been paid on both sale and certain types of acquisition). (For both residents & non-residents) (b) For other shares: (i) For residents (ii) For non-residents |
Long Term | (a) 10% on Capital gains over and above Rs 1 lakh of Capital gains.
(b) (i) 2% after availing of the benefit of indexation. (ii) 10% for unlisted shares/securities without availing of the benefit of indexation. |
|
| Unit of UTI Zero coupon bonds | Lip to 12 months | Short Term | Capital gains is added to Total Income, and taxed at applicable tax rates on total income |
| More than 12 Months | Long Term | 20% (after availing of the benefit of indexation) |
|
| Up to 12 months | Short Term | Capital gains is added to Total income, and taxed at applicable tax rates on Total Income | |
| More than 12 months (Sec 112) | Long Term | 20% ( after availing of the benefit of indexation) | |
| Equity-oriented | Up to 12 months | Short Term | |
| Mutual funds* And Units of a Business Trust | Tax Rate on 5TCG:
(i) if STT is paid on transfer) (ii) if STT is not paid on transfer |
(i)15%
(ii)Capital gains Is added to Total income, and taxed at applicable tax rates on total income. |
|
| More than 12 months
Tax Rates on LTCG: (a) for units on which STT has been paid on transfer). (For both residents & non-residents) (b) for shares other than as described above) (i)For residents (ii) For non-residents |
Long Term | (a)10% on Capital gains over and above Rs 1 lakh of Capital gains.
(b) (i)20%, after availing of the benefit of Indexation (ii)10%, without availing of the benefit of indexation |
|
| Other mutual funds (debt- oriented funds) & Market-linked debenture | Up to 36 months | Short Term | Capital gains is added to Total Income, and taxed at applicable tax rates on Total Income |
| More than 36 months | Long Term | (i) If transferred before 1.4.2023
20% with indexation. 10% without indexation (ii)If transferred on after 1.4.2023: Capital gains is added to Total Income, and taxed at applicable tax rates on Total income |
|
| Other movable assets | Up to 36 months | Short Term | Capital gains is added to Total Income, and taxed at applicable tax rates on Total Income |
| More than 36 months | Long Term | 20% |
* Equity Oriented Fund means (i) a Mutual Fund Scheme where the investible funds are invested in listed equity shares in domestic companies to the extent of more than 65% of the total proceeds of such a fund or 90% in another fund, which in turn invests 90% in listed equity shares in domestic companies, and (ii) certain unit-linked insurance policies issued after 1.22021, depending on the premium amount payable.
The period of holding, may, under some circumstances e.g., an asset received by succession, inheritance, or partition of HUF, include the period in which it was held by previous owners. For bonus shares and rights shares, the period starts from the date of allotment. For shares received under an ESOP, it starts from the date of exercise of the option.
>> Deductions under Chapter VI-A of the Income Tax Act 1961
> Deductions available under Chapter VI-A i.e., Sections 80C to 80U shall be allowed from the gross total income, only after excluding the short term Capital gains derived from transfer of equity shares, equity oriented funds or units of a business trust, and long term Capital gains from all types of assets.
>>How to tax profit on transactions in Futures and Options
> Profit from trading in Futures and Options (whether it is equity, commodity, or currency) on recognized exchanges can be classified as non-speculative business income. The profits on trading in Futures and Options trading are taxed as per the applicable tax slab. Losses on such F&O trading can be set off against profits from business.
>>How to compute Capital gains arising on sale of equity/preference shares, mutual funds, and other securities
> Capital gains are calculated differently for short term and long term Capital gain.
Some definitions, first:
- Full value consideration: The consideration received or due to be received by the transferor as a result of the transfer of his capital assets
- Cost of acquisition: The actual value for which the capital asset was acquired by the transferor. The cost of acquisition, may under some circumstances e.g., asset received by succession or inheritance or partition of HUE, be the cost incurred by previous The cost of acquisition of bonus shares is nil. The cost of acquisition of shares acquired under an ESOP is the Fair Market Value on the date of exercise of the option by the employee. The calculation of this FMV is as provided for in the Income Tax Rules, 1962.
>> Cost of improvement: Expenses incurred in making any additions or alterations to the capital asset by the transferor In the cases where the capital asset becomes the property of the taxpayer otherwise than purchase by the transferor, the cost of improvement incurred by the previous owner would also be included). a
Note: The cost of acquisition of the asset or the cost of improvement thereto excludes the deductions claimed under “Income from House Property” on the amount of interest on the loan taken, or claimed under the provisions of Chapter-VIA. Cost of acquisition of a unit of a business trust shall be reduced by any non-taxable sum received by a unit holder from the business trust. Cost of acquiring bonus shares is to be taken as nil.
- Indexed cost of acquisition
=Cast of acquisition X CII for the year in which the asset is transferred
CII for the year in which the asset was first held by the seller, or 2001-02″, whichever is later
(*changed from the year 1981-82)
(*CII=Cost Inflation Index)
- Indexed cost of improvement
= Cost of improvement X CII for the year in which the asset is transferred
CII for the year in which the expenditure was incurred, or 2001-02′, whichever is later
(*changed from the year 1981-82)
(*CII=Cost Inflation Index)
- Short term Capital gains = Full value consideration received by the transferor minus expenses incurred exclusively for such transfer* minus cost of acquisition minus cost of improvement.
- Long term Capital gains = Full value consideration received by the transferor minus expenses incurred exclusively for such transfer minus indexed cost of acquisition minus indexed cost of improvement.
*e.g., brokerage, commission, advertisement expenses, etc.
>>Why is the base year of the Cost Inflation Index changed to 2001 from 1981?
Earlier, 1981-82 was considered as the base year, with Cost Inflation Index (CII) denoted as 100. For properties acquired before 1.4.1981, the cost of acquisition was deemed to be the Fair market Value of the asset in the year 1981. But, taxpayers were facing hardships in getting the properties valued which were purchased before 1st Apri1,1981. Tax authorities were also finding it difficult to rely on the valuation reports.
Hence, the government decided to shift the base year to 2001 so that valuations could be done quickly and accurately.
So, for a capital asset purchased before 1st April, 2001, taxpayers can take higher of actual cost or FMV as of 1st April 2001, as the purchase price and avail benefit of indexation.
It may be noted, however, that for listed equity shares purchased before 1.2.2018, the long term Capital gains tax computation for AY 2019-20 and subsequent Assessment Years stands on a different footing, as discussed below.
>> Special provisions for listed equity shares/listed equity—oriented Mutual fund:
For LISTED shares/Mutual Fund units acquired by the transferor before February 1, 2018, while computing the LTCG arising from the sale/transfer, the cost of acquisition of the listed instrument shall be deemed to be the higher of following:
(a) The actual cost of acquisition of such an asset; or
(b) The lower of following:
(i) Fair market value of such asset as of January 31, 2018; or
(ii) Actual sales consideration accruing on its transfer
The fair market value of a listed equity share shall mean its highest price quoted on the stock exchange as on January 31, 2018. However, if there is no trading in such shares on January 31, 2018, the highest price of such shares on a date immediately preceding January 31, 2018 on which trading happens in that share shall be deemed as its fair market value.
In case of units which are not listed on a recognised stock exchange, the net asset value of such units as of January 31, 2018 shall be deemed to be its FMV. In a case where the capital asset is an equity share in a company which is not listed on a recognised stock exchange as on 31-1-201.8 but listed on the date of transfer, the cost of unlisted shares as increased by cost inflation index for the financial year 2017-18 shall be deemed to be its FMV.
Illustration 1
Q: In the month of September, 2015, X purchased 100 shares of XYZ Ltd. @ Rs. 2,000 per share from the Bombay Stock Exchange. These shares were sold through the NSE in June 2018 Rs. 4,900 per share. The highest price of XYX Ltd. shares quoted on the stock exchange on January 31, 2018 was Rs. 3,800 per share. What will be the Capital gains in this case?
A: Shares were purchased in July, 2016 and were sold in June, 2018, i.e., sold after holding them for a period of more than 12 months, and, hence, the gain will be long-term Capital gains (LTCG).
In the given case, shares are sold after holding them for a period of more than 12 months, shares are sold through recognised stock exchange. Therefore, the cost of acquisition of X Ltd. shares shall be higher of:
(a) Cost of acquisition, i.e., 2,00,000 (2,000 x 100);
(b) Lower of:
(i) Highest price quoted as of 31-1-2018 i.e., 3,80,000 (3,800 x (II) 100Y;
(ii) Sales consideration, i.e., 4,90,000 (4,900 x 100).
Thus from above, the cost of acquisition of shares shall be Rs. 3,80,000. Accordingly, long term Capital gains taxable in hands of the transferor would be Rs. 1,10,000 (i.e., 4,90,000-3,80,0003. He would be liable to pay at the rate of 10% on Rs. 10,000 (i.e., gains exceeding Rs. 1,00,000).
Illustration 2
Q: A person purchased equity shares in December 1995 for Rs. 28,100. These shares are sold outside a recognised stock exchange in April, 2018 for Rs. 5,00,000. Assuming he does not have any other taxable income in India, what will be his tax liability (excluding cess, as applicable)?
A In this situation, since the sale was not through a recognised stock exchange) he has the following two options:
|
Particulars |
Option 1 (Avail indexation) |
Option 2 (Do not avail indexation) |
| Full value of consideration Less: Indexed cost of acquisition (Rs. 28,100 x 272/100) |
5,00.o00 76,432 |
5,00.000 ———- |
| Less: Cost of acquisition | ——— | 28,100 |
| Capital Gain | 4,23,568 | 4,71,900 |
| Tax @ 20% on Rs. 4,23,568 | 84,714 | |
| Tax @ 10% on Rs. 4,71,900 | 47,190 |
From the above computation, it is clear that he should exercise option 2, since in this situation the tax liability comes to Rs. 47,190, which is less than tax liability under option 1, i.e., Rs. 84,714.
>> Save on Capital gains tax
The Income Tax Act, 1961, provides for some deductions to save tax on long term Capital gains on sale of such assets, being equity shares, mutual funds, securities, etc. by investing in certain assets. Exempted amount of capital gain:
(i) If the cost of new asset is more than or equal to the net consideration of the asset sold, the entire Capital gains is exempt.
(ii) If the cost of the new asset is less than the net consideration of the asset sold, the exempt amount of Capital gains = Capital gains x the cost of the new asset.
Net consideration received on sale of asset
The exemptions provided are:
Section 54EE; The transferor can invest in units of a specified fund as notified by the Central Government) within 6 months from the date of transfer of the capital asset.
Additional conditions:
(i) If a new asset is sold within 3 years, the amount exempted under this section earlier will be considered as long term Capital gains in the year of its
(ii) If a loan is taken on the security of the new specified asset within 3 years, the same will be treated as Capital gains.
(iii) Investment in specified units should not exceed Rs. 50 lakh during the current and succeeding fiscal years.
Section 54F: The transferor can invest in a residential house property in India.
Additional conditions:
1. Purchase of the house is to be made within 1 year before or 2 years after transfer.
OR, construction of the house within 3 years from transfer.
2. If the amount is not utilized before the due date of filing of return, the same can be deposited in a Capital gains account in a bank, to be utilized subsequently with the above time limits. The amount not so utilized will be taxable as Capital gains at the end of three years.
3. To be eligible for this deduction, the individual/HUF cannot (i) own more than two house properties (i.e., other than the existing House property and the new house property) on the date of transfer of the security, nor (ii) purchase another house property (other than the new house property) within 1 year (or constructed it within 3 years) from the date of transfer of the asset.
4. If the transferor purchases another house property (other than the new house property) within 2 years or constructs within 3 years, the amount of exemption allowed earlier will be chargeable as Capital gains in the year of purchase/construction of the new asset,
5. If the new house property is sold within 3 years from the date of its purchase or construction, the amount of deduction claimed u/s 54F earlier shall be taxable as long term Capital gains in the year of the sale of this house property.
6. The maximum deduction allowable u/s 54F is Rs. 10 This limit also applies to deposits made in a Capital gains account.
>> Can an individual/HUF adjust the basic tax exemption limit against long-term Capital gains (LTCG)?
A resident individual/HUF can adjust the exemption limit against LTCG; however, first any income other than LTCG is to be adjusted against the exemption limit, and then the remaining limit if any) can be adjusted against LTCG. Unadjusted LTCG will be taxed at the applicable rate for LTCG.
A non-resident individual and non-resident HUE cannot adjust the exemption limit against LTCG.
>> Set off and Carry forward of Capital losses:
Losses under all sources or heads of income in the year can be set-off against Capital gains of that year. Short term capital losses incurred during the year can be set off against income from only Capital gains of that year. Long term Capital loss can be set off only against Long term Capital gains. Any unabsorbed Capital loss can be carried forward to beset off against Capital gains of the subsequent years. However, in order to be legible for carry forward, the ITR claiming the carry forward loss has to be filed on or before the due date for the year of incurring the loss. The carried forward ST Capital loss can be set off only against any Capital gains of the subsequent years. Carrying forward LT Capital loss can be set off only against LT Capital gains of the subsequent years. Unabsorbed capital losses can be carried forward for set-off for eight successive years after the year of incurring the loss.
>> Securities Transaction Tax (SIT)
SIT is a tax levied at the time of sale and purchase of equity shares, equity-oriented mutual funds, futures and options, debentures, bonds, government securities, etc. While STT levied can be claimed as a deduction against profits of business if the transactions form part of the business of the assessee, no deduction is allowed against Capital gains if the securities had been held as investments by the seller.
Conclusion:
Understanding capital gains and their taxation is crucial for financial planning. Whether you’re dealing with equity shares, mutual funds, or other securities, the tax implications vary based on the type of asset and the holding period. Knowing these nuances can help you make informed investment decisions and explore opportunities to minimize your tax liability. Stay tuned for Part 2, where we’ll delve further into strategies for saving on capital gains tax.
