If you see the income tax act as a law, it’s complex, lengthy and tedious. However, if you see it as an art, you will find a humongous space for creativity. The Chartered Accountants are well versed with the latter part, as they understand the intricacies of the law. For common citizens, it is important to understand the basics of the law, so that they can understand and plan their taxes better. One important area in taxation is the computation of capital gains. It is rather one of the most complex and challenging tasks, and depending on the nature and number of transactions, can become an ardent task even for the experts. It is important to go following step by step methodology. In this article, we explore the basics of capital gains law.
What are Capital Gains?
Capital gains are profits that arise from the transfer of a capital asset by a taxpayer. Transfer can be by way of sale, exchange, relinquishment, etc. Capital assets are an expenditure like assets to be held as an investment, and not held as inventory, as in the case of a business. Capital gains can be short-term capital gains (STCG) or long-term capital gains (LTCG) based on the period for which such capital asset has been held by the taxpayer.
As per income tax law, the following items are not considered capital assets –
- Stock in trade or raw materials held for business or profession
- Items kept for personal use like television, air conditioner, furniture, etc
- Rural agricultural land
- Gold deposit bonds notified by the government
- Silver utensils, if kept for personal use item
Capital Gains Terminologies
Some of the important terminologies in the context of capital gains computation are as follows:
Sale value: The sale value refers to the value received (or receivable) on the sale of a capital asset. If the asset is a property, then the actual sale price can also be assumed to be the stamp duty value (SDV) of the property, if the actual consideration is lower than the stamp duty value. This is as per provisions under income tax law, as the tax department assumes that transactions below stamp duty value do not disclose the true consideration of the transaction, and therefore, taxes the higher of two – original consideration, or the stamp duty value, as the exchange of black money is rampant in property transactions. In the case of equity shares or mutual fund units, the selling price excluding the brokerage charges and securities transaction tax is considered the sale value.
Cost of acquisition: Cost of acquisition is the price at which the asset was purposed. In the case of equity and mutual funds, the brokerage charges paid to buy the asset are included in the purchase price. In the asset was received as a gift, then the cost of acquisition is considered to be the same as the price at which the person who gifted had bought it.
Cost of improvement: If a taxpayer has spent any money on repairs or modifications of the asset, the same is considered as the cost of the improvement. However, expenses which do not enhance the life or value of the asset are not considered a cost of the improvement.
Expenditure in connection with transfer: This includes brokerage charges, registry charges or any other expenses incurred while selling the asset, in short, selling expenses. Stamp duty, brokerage charges for the sale of property or equity shares and mutual funds, can be considered expenditures in connection with the transfer. However, securities transaction tax cannot be claimed as an expenditure here.
Indexation: Indexation applies to long term capital gains only. Since the cost of acquisition is as of the date of purchase, the same does not consider the inflation in prices over the year. Therefore, indexation incorporates the time value of money while computing the capital gains to make the computation just and fair. This is done using the Cost Inflation Index (CII).
Holding period: The holding period is the number of days or months for which the asset was held by the assessee. It starts from the date on which the asset was acquired by the assessee and ends when the asset is transferred. The date of transfer of the asset is not counted in the same. In case the asset is acquired by way of gift, the holding period is reckoned from the date on which the original buyer of the asset, had bought the same. Based on the holding period, the gains are considered short term or long term.
The holding period for various assets has been defined to identify long term and short term periods. In the case of listed equity shares, listed preference shares, and equity-oriented mutual funds, the holding period should be 12 months, for the gains to be considered as long term. In the case of unlisted equity shares, unlisted preference shares, and immovable properties such as land and building, the holding period must be at least 24 months, for the gains to be considered as long term. For debentures, debt-based mutual funds and other assets such as jewellery, the holding period must be 36 months, for gains to be considered as long term.
Computation of capital gains
Once all the relevant details have been extracted from the documents and deeds, the following procedure is to be followed for computing capital gains:
- Compute the holding period of the asset. Accordingly, determine whether the same is long term or short term.
- Identify the sale value of the asset and deduct the expenditure incurred in connection with the transfer or sale of an asset, to arrive at Net Sale Consideration.
- Identify the cost of acquisition, and compute the indexed cost of acquisition, if the holding period is long term.
- Identify the cost of improvement, and compute the indexed cost of improvement, if the holding period is long term.
- Deduct the cost of acquisition and the cost of improvement from the Net Sale Consideration to arrive at Short Term Capital Gains. In case of a long term holding period, deduct the indexed cost of acquisition and indexed cost of improvement from the Net Sale Consideration to arrive at Long Term Capital Gains.
Capital Gains Taxation Rates
There are different rates at which such capital gains are taxed. In the case of long term capital gains, the tax rate is 20%, except in the case of equity-oriented mutual funds units or equity shares, where the tax rate is 10% and the initial INR 1 lakh gain is exempt from tax.
In the case of short term capital gains, there is no special tax rate and it is charged to tax at normal slabs, like any other income. However, in the case of equity-oriented mutual funds units of equity shares, the tax rate is 15% and there is no exemption.