What is Capital Gain Tax and How is it Calculated?

Are you planning to sell your stocks sometime soon? Then, be prepared to pay a tax on the growth value of your stocks at the time of their sale. Capital investments like stocks, mutual funds, or real estate assets usually attract a capital gains tax when they are sold higher than their buying price.

What is Capital Gains Tax?

Capital gains are the value at which the capital assets grow by the time of their sale since their purchase date. Capital gains are calculated only when the price at which the assets were sold is higher than its original price of purchase. Capital assets mostly include shares, mutual funds, or any real estate property like house, land, etc.

Capital gains derived from the sale of any of the above capital assets are treated as ‘income’ and thus become taxable and are termed as capital gains tax. The capital gains tax is a one-time tax payable during a financial year in which the sale of capital assets took place.

It must be noted that capital gains tax is not levied on inherited properties, as it is not a sale transaction, and the Income Tax Act of India exempts such assets as gifts by way of will or inheritance. However, when the inheritor decides to sell it, capital gains tax shall be applicable on the rise in property value.

Capital Assets in India

Common kinds of capital assets in India include open land, constructed properties, vehicles, machinery, jewellery, patents, trademarks, leasehold rights, stocks, and mutual funds. Exempted categories of capital assets in India comprise:

1. Personal goods such as clothing and furniture
2. Agricultural land in rural areas
3. Special bearer bonds
4. Gold Deposit Bonds issued under gold deposit scheme, 1999 or Deposit certificates issued under Gold Monetisation Scheme, 2015
5. Any stock, raw material, or consumables held for the business or professional purpose

Capital Assets in India are further classified into two main types: short-term and long-term.

• Short-Term Capital Assets

Capital assets held for upto a period of 36 months are called short-term capital assets. For immovable assets like land or properties, this period has been reduced to 24 months since FY 2017-18, and since then, properties or land held upto a period of 24 months are treated as short-term capital assets.

Few capital assets like equity shares in a listed company, government securities, equity mutual funds, zero coupon bonds, held for less than 12 months are also considered as short-term capital assets. Tax levied on gains made from the sale of short-term capital assets is called the short-term capital gains (STCG) tax.

• Long-Term Capital Assets

Capital assets held for 36 months or more are classified as long-term capital assets.  However, capital assets like equity shares in a listed company, securities, equity mutual funds, zero coupon bonds held for over 12 months are also treated as long-term capital assets. Tax applicable on the gains acquired from the sale of the long-term capital assets is called long-term capital gains (LTCG) tax.

Calculation of Capital Gains Tax

Computation of Capital Gains Tax depends on the type of capital gain and holding period – STCG or LTCG. It is essential to understand few terms associated with the calculation of capital gains tax, as listed below:

1. Full Value Consideration
   It is the consideration received by the seller in exchange for the sale of a capital asset
2. Cost of Acquisition
   It is the value of the capital asset at the time of acquisition by the seller
3. Cost of Improvement
   It is the cost of renovation incurred by the seller while making any alterations to the asset
4. Cost Inflation Index (CII)
   Also called the capital gain index, is a value mostly used to calculate the tax on LTCG. The value is fixed every year by the Government of India
5. Indexed Cost of Acquisition
   It is computed by applying the current CII to the present terms. It is normally a ratio of CII of the year when the asset was sold by the seller to the CII of the year when the asset was acquired or the financial year 2001-2002, whichever is later, further multiplied by the cost of acquisition.
   Indexed Cost of Acquisition = {CII of the year during the sale of an asset / latest of (CII of the year during acquisition (or) CII of FY 2001-2002)} * Cost of Acquisition
6. Indexed Cost of Improvement
   It is computed by multiplying the ratio of CII of the year that required asset improvement and CII of the year when the actual improvement was done, with the cost of the improvement.
   Indexed Cost of Improvement =      (CII of the year when asset improvement was required / CII of the year when asset was improved) * Cost of Improvement

• Tax on STCG

Calculation of tax on STCG is fairly simpler, and can be done so using the formula given below:

STCG = Full Value Consideration – [Cost of Acquisition + Cost of Improvement + Transfer Cost]

The gains value, thus obtained, is added to the total annual income, and taxed as per the individual’s income slab eligibility.

• Tax on LTCG

Computing LTCG is a slightly long process, given the indexation process and inflation factor involved in it. LTCG can be computed as:

LTCG = Full Value of Consideration – [Indexed Cost of Acquisition + Indexed Cost of Improvement + 

                                                                           Cost of Transfer]

Tax Exemption on Capital Gains

The Indian Income Tax Act allows for a slew of tax exemptions on capital gains in the following cases:

• Section 54 allows an individual to avail tax exemption on capital gains earned if those gains are used to buy another house within 2 years of the sale of previous property or construct a new house within 3 years from the sale date
• Section 54EC entitles an individual to tax exemption on capital gains if the entire gains are invested in NHAI or Rural Electrification Corporation (REC) bonds worth under Rs. 50 Lakhs
• Upon sale of agricultural lands that do not fall within the limits of a municipal body
• When the entire amount received through the sale of a property is invested in a small or medium scale industry, provided the machinery and tools are purchased within 6 months from the date of sale.

Conclusion

To sum up, earnings capital gains can be quite lucrative with various investment options in the market, especially with reduced taxing on stocks or shares. While the tax on STCG from listed shares stands at 15 percent as per u/s 111A of the Income tax Act, the tax on LTCG above Rs. 1 Lakh from listed shares in a financial year stands at 10 percent under u/s 112A of the IT Act. Similarly, in the case of unlisted shares, the tax on LTCG is levied at 20 percent.

FAQs

1. What is Capital Gains Tax?
   Capital gains accrued from the sale of capital assets such as shares, mutual funds, or property are deemed as taxable ‘income’ and the tax levied on such income is termed as the capital gains tax.
2. What are the Capital assets that do not attract any Capital gains tax?
   As per the Indian Income Tax Act, capital assets that are passed over as gifts of will or through inheritance do not attract capital gains tax. However, any sale of inherited properties shall be levied by a capital gains tax.
3. What are the different types of capital gains tax?
   Depending on the capital gains and holding period of the capital assets, capital gains tax can be classified into Long-term Capital Gains (LTCG) Tax and Short-term Capital Gains (STCG) Tax.
4. What are LTCG and STCG?
   LTCG refers to the gains accumulated on capital assets held for more than 36 months, and on few listed equity shares, mutual funds, and coupon bonds, held for more than 12 months. On the other hand, STCG is the value accumulated on capital assets held for less than 36 months, or on few listed equity shares, mutual funds, and bonds held for less than 12 months.
5. How much tax is applicable on LTCG and STCG from listed shares?
   As per u/s 111A and 112 A of the Indian Income Tax Act, a 15 percent tax is levied on STCG from listed shares and a 10 percent tax is levied on LTCG above Rs. 1 Lakh from listed shares.