In this article we will discuss about capital gains on transfer of assets and its taxability in India. To start with let us understand what is meant by capital gains.
What is capital gain?
Capital gain means the gain that arises on the transfer of a ‘capital asset’. The gain will be taxed under the head ‘capital gains’ in the year in which the asset was transferred. To put it simply, it means the profit you generate from sale of any asset, say your house, jeweler etc.
What is meant by capital asset?
Now that we know that capital gain arise of the transfer of ‘capital asset’, it is important to understand the meaning of capital asset under the Income tax act.
Capital asset means any property held by a person (example securities, land, building, patents etc.). The definition of capital gains specifically excludes the following:
- Stock-in-trade, consumables or raw material
- Personal effects (excluding jewelry, archaeological collections, paintings, drawings, sculptures or any work of art)
- Agricultural land in rural areas
- 5% gold bonds, 7% gold bonds or national defense gold bonds
- Special bearer bonds
- Gold deposit bonds
Which means, any property held by you (except the above) would quality as a capital asset for income tax purposes. Which also means that whenever you sell a property, you have to check whether you are subject to income tax.
Short term capital asset and long term capital asset – the difference?
Before we understand the meaning of short-term capital asset and long-term capital asset, it is relevant to understand the need for such classification. Under the income tax law, the tax rate for gains arising on short-term capital asset and long-term capital asset is different. Therefore, it is very relevant for you to first identify, under which category your asset falls.
- Short term capital asset means a capital asset held by a person for not more than thirty-six (36) months.
- Long term capital asset means a capital asset held by a person for more than thirty-six (36) months.
However from the financial year 2017-18, the limit of thirty-six (36) months has been reduced to twenty-four (24) months with respect to land and building.
For shares (equity as well as preference shares) listed on recognized stock exchange (ie National Stock Exchange, Bombay Stock Exchange etc), units of equity oriented mutual funds, listed securities, units of UTI, zero coupon bonds, a period of twelve (12) months is applicable (ie if you hold these assets for more than 12 months, it would qualify as a long-term capital asset).
However the limit is twenty-four (24) months in respect of unlisted shares of a company (instead of thirty six months). Remember that unlisted securities (other than shares) will be called long term capital asset only when they are held for more than thirty six months.
How is capital gains computed?
|Full value of consideration (Sales value)||xxxx|
|Less: Expenses incurred on transfer (Eg. Brokerage, commission)||(xxxx)|
|Net sales consideration||xxxx|
|Less: Cost of acquisition (Indexed cost for long term capital assets)||(xxxx)|
|Less: Cost of improvement ( Indexed cost for long term capital assets)||(xxxx)|
Indexed cost = (Cost x Cost inflation index of the year of transfer)/ Cost inflation index of base year (1981-82 for FY 2016-17)
Note: STT paid on securities will not be allowed as expense incurred on transfer.
Tax on long term capital gains
Long term capital gains are taxable at the rate of 20% (plus education cess and surcharge, if any).
However, long term capital gains arising on transfer of equity shares or units of equity oriented mutual funds (mutual funds whose 65% of investible funds are invested in equity shares of an Indian company) or units of business trust are exempt from income tax if STT is paid on their sale.
An option of availing lower rate of 10% is available to a resident in respect of listed securities (other than units), zero coupon bond, provided indexation benefit is not taken. In other words, if indexation is done then the tax rate will be 20% and if indexation benefit is not taken the rate will be 10%. Whichever option is more beneficial to you can be adopted by you.
For non-residents, in respect of unlisted securities, tax shall be calculated at the rate of 10% without taking into consideration the indexation benefit and the benefits of first proviso of section 48 (related to foreign currency treatment). This is not optional.
Taxability of short term capital gains
Short term capital gains are liable to tax at normal slab rates. However, in case of short term capital gains arising on transfer of equity shares or units of equity oriented mutual funds (mutual funds whose 65% of investible funds are invested in equity shares of an Indian company) or units of business trust the tax shall be levied at the rate of 15% if STT is paid on their sale.
Adjustment of gains against the basic exemption limit
Basic slab limit means the level of income up to which a person is not required to pay any tax (eg. ₹ 2,50,000 for resident other than a senior citizen). Only a resident individual or HUF can adjust the basic exemption limit from capital gains (short term or long term). A non-resident or resident other than individual or HUF can’t adjust the basic exemption limit.
For eg. The income of a resident individual excluding long term capital gains is ₹ 1,00,000. Capital gains amount to ₹ 6,50,000. The basic exemption limit is Rs. 2,50,000. The remaining exemption limit after adjusting other income is ₹ 1,50,000 (2,50,000-1,00,000). This amount can be adjusted from capital gains. Only the remaining capital gains of ₹ 5,00,000 (6,50,000-1,50,000) will be taxable.
Exemption of capital gains tax
There are major three sections which provide for exemption of capital gains- section 54, 54F and 54EC. Let us understand each one separately-
- Exemption under section 54:
This section provides for exemption of long term capital gains on sale of house property to an Individual or HUF. The exemption will be available to you if you purchase another house property within a period of one year before or two years after the date on which the transfer took place or construct within a period of three years after the date of transfer one residential house in India.
The amount can be deposited in account under capital gain scheme before the filing of income tax return of the year. If it is not deposited and not utilized for purchase or construction before the filing of the income tax return, then capital gains won’t be exempt. Also, the property purchased or constructed shall not be transferred upto three years from date of purchase or construction. Also note that only the amount of capital gains need to be invested, not the entire sales consideration, in order to claim exemption.
- Exemption under section 54F:
This section provides for exemption of long term capital gains on sale of capital asset other than house property to an individual or HUF. The exemption will be available to you if you purchase within a period of one year before or two years after the date on which the transfer took place or construct within a period of three years after the date of transfer one residential house in India.
Net sales consideration has to be deposited and not capital gains. Let us take an example. Mr. A sells his commercial building for ₹ 40,00,000 and the long term capital gain work out to be ₹ 8,00,000. Suppose he purchases a residential property of ₹ 30,00,000. Now the exemption shall be restricted to ₹ 6,00,000 (8,00,000 x 30,00,000/40,00,000). The remaining ₹ 2,00,000 of long term capital gains shall be taxable.
The amount can be deposited in account under capital gain scheme before the filing of income tax return of the year. If it is not deposited and not utilized for purchase or construction before the filing of the income tax return, then capital gains won’t be exempt.
One more point that one should remember while claiming exemption under this section is that one should not own more than one residential house property on the date of transfer of asset.
- Exemption under section 54EC
This section provides for exemption of long term capital gains on sale of any capital asset. In order to claim this exemption you need to invest the amount of capital gains in specified bonds within six months of the date of transfer. Please note that the amount of exemption under this section is restricted to ₹ 50 lakhs i.e the total investment in the bonds for a particular transfer shall not exceed rs. 50 lakhs in the year in which transfer took place and the next financial year (Earlier there was a loophole and people used to take exemption of ₹ 1 crore by taking advantage of the provisions, which is not possible now).