A guide to long-term and short-term Capital Gains Tax:
Mr. Anil Gupta bought a property in the year 2013 and sold the same after 30 months as he was making decent gains on the investment, little did he realize that his gains were subject to short-term capital gains tax. If he had sold the property after completion of 3 years from the date of purchase, he would have saved on the taxes. This happened as he was not aware of the tax implication on Capital Gains.
In this article, let me simplify capital gains and its tax implications for you. Capital gain in simple words, is the profit you earn by transferring or selling a capital asset. Capital gains are taxable in the year in which the assets are transferred.
Capital gains are not applicable on the assets which are inherited as there is no sale involved and only a mere transfer is done. However, if the assets are sold by the person who inherits them, capital gains tax will be applicable.
Capital gains are classified into two categories:
1. Short-term Capital Gain: Capital gain arising on sale of a short-term capital asset is termed as short-term capital gain .
2. Long-term Capital Gain: Capital gain arising on transfer of a long-term capital asset is termed as long-term capital gain.
Note: Gain on a depreciable asset is always taxed as short-term capital gain.
What are Capital Assets?
Anything you own for personal or investment purpose is capital assets. It includes land and building, housing property, plant and machinery, jewellery, trademark, patents, mutual funds, securities, etc.
Capital assets do not include the following:
• Any stock-in-trade), raw materials or consumables stores held for the purpose of business or profession.
• Any movable property like wearing apparels, furniture, TV, car or scooter, generator, musical instruments, refrigerator, etc. held for personal use.
• Agriculture land held in rural areas.
• National Defence Gold Bonds, 1980 issued by central government, 6 ½ % Gold Bonds, 1977 or 7% Gold Bonds 1980.
• Special Bearer Bonds, 1991.
• Gold Deposit Bonds issued as per Gold Deposit Scheme, 1999.
Long-term and Short-term Capital Assets
Long-term capital assets are the assets which are held for more than 36 months such as a housing property. On the other side, assets held for less than or equal to 36 months are termed as short-term capital assets.
Equity mutual funds or any direct equity/shares held for less than or equal to 12 months fall under short-term capital assets. While those held for more than 12 months are categorised as long-term capital assets. On the other hand, debt mutual funds held for more than 36 months are categorised as long-term capital assets and if they are held for a duration of less than or equal to 36 months, they fall under short-term capital assets.
Budget 2017 has brought smiles on the face of the HNIs on two counts. The holding period of the property has been reduced to 2 years from 3 years.
Effective July 11, 2014, the assets which are held for less than or equal to 12 months and considered as short-term are listed below:
• Equity or preference shares held in a company listed on an Indian stock exchange.
• UTI units whether quoted or not.
• Units of equity oriented mutual funds.
• Zero coupon bonds whether quoted or not.
While computing taxes on Long-term capital gains you can avail the indexation benefit which is to offset the impact of inflation. Let me give you a brief introduction on Indexation and how the capital gain is calculated through Indexation.
What is Indexation?
Indexation is a technique used to adjust tax payments through a price index and offset the impact of inflation. The basis for indexation is to overcome the effect of inflation and pay tax on the real part of gains. In India, Cost Inflation Index is used for the calculation of inflation. The value of the index is calculated every year considering the base financial year as 1981-82 and the index value for the base year is 100.
However, Budget 2017 has changed the base year for calculating Indexed Cost of Acquisition from 1 April 1981 to 1 April 2001.
Cost Inflation Index Chart
How to calculate Capital Gain through Indexation?
Let me explain this through an example:
Suppose you bought 2000 units of debt fund at Rs. 100 per unit in the year 2004-05 and you sold the entire units in the year 2008-09 for Rs. 140 per unit, then:
Purchase Price = 2000 * 100 = Rs. 200,000
Sales Price = 2000 * 140 = Rs. 280,000
Indexed Cost of Acquisition = 200000 * (582/480) = 200000 * 1.2125 = Rs. 242,500
Capital Gain = Rs. 280,000 – Rs. 242,500 = Rs. 37,500
Capital Gain Tax = 20% of Rs. 37, 500 = Rs. 7,500
The below table illustrates the formulas used for the above calculation:
There are various determinants for tax implications on mutual funds. Let me take you through each of them in brief:
1. The Residential status of an individual: Based on the residential status of an individual i.e. Resident or Non- Indian Resident, mutual fund taxation is determined.
2. Mutual funds Category: Based on the equity or debt oriented mutual fund schemes, taxation is determined. Equity oriented mutual fund schemes are those in which more than or equal to 65% of scheme holdings are in equity or equity related instruments. In debt oriented mutual fund scheme the composition of equity and equity related instruments will be less than 65%.
3. Holding period: Based on the investment tenure, tax on capital gains is categorised into short-term capital gain and long-term capital gain.
Equity Mutual Funds
• If you keep invested in an equity oriented mutual fund scheme or in direct equity/shares for a period of more than one year, the profit/ gain earned on the scheme will be termed as long-term capital gain and is exempt from tax under Section – 10(38), Income-tax Act, 1961.
• If you have invested in equity oriented mutual fund scheme or in direct equity/shares and choose to withdraw the units before the completion of one year, the profit/gain earned on your investment will be termed as short-term capital gain, and the applicable tax rate will be 15% under Section – 111A, Income-tax Act, 1961-2014.
Debt Mutual Funds
• If you keep invested in a debt oriented mutual fund scheme for a period of more than three years, the profit/gain earned on the scheme will be termed as long-term capital gain, and the applicable tax rate will be 20% with indexation under Section – 112, Income-tax Act, 1961-2014.
• If you have invested in a debt oriented mutual fund scheme and choose to withdraw the units before the completion of three years, the profit/ gain earned on the scheme will be categorised as short-term capital gain and is taxable as per the income tax slab you fall in.
Table below illustrates the implied tax rates on capital gains for Resident Indians:
Computation of Capital Gains for Mutual Funds
Also read: Beginners Guide to Investing in Mutual Funds
Capital Gains on Housing Property
Land or a housing property held for more than 36 months is categorised as long-term capital assets and the gain or loss on sale of the property is termed as long-term capital gain/capital loss. On the other hand, any property held for less than 36 months fall under the category of short-term capital assets and the gain or loss on sale of the property is termed as short-term capital gain/capital loss. In Budget 2017, the holding period of the property has been reduced to 2 years from 3 years.
If there is a loss on sale of the property in a year, the capital loss can be adjusted against other capital gains in the same year. If the loss is not adjusted in the same year, then it can be adjusted any time during the next 8 years. However, the loss can be adjusted in the future years only if it the return was filed before the due date.
However, as the Budget 2017 becomes effective from 1 April 2017, the upper limit of capital losses has been fixed at Rs 2 lakh. Additionally, the unadjusted losses can be carried forward for 8 assessment years; but the adjustment is allowed only against the head “income from house property”.
For more details on impact of Budget 2017 on your tax liability, visit Should you invest in a second home or not
Tax rates on sale of property:
• Short-term capital gains are taxed as per the income tax slab of the property holder.
• Long-term capital gains are taxed at the rate of 20%.
Computation of Short-term Capital Gains on sale of property
Computation of Long-term Capital Gains on sale of property
It is important to evaluate the tax implications on capital gains much before you sell an asset. Do remember, Tax planning plays a vital role in personal financial planning, hence ensure that your financial actions are in line with your financial goals.