Capital Gains

What is Capital Gain?

Capital gain refers to the increase in the value of an asset or investment due to a rise in its price. This gain occurs when the selling price of an asset exceeds its purchase price. Capital gains apply to a wide Range of assets, including stocks, Bonds, Real Estate, Mutual Funds, and even intangible assets like goodwill. Capital gains are considered taxable Income and must be reported during tax filing.

For example, if you purchase a property for INR 50 lakhs and later sell it for INR 70 lakhs, the INR 20 lakhs profit represents a capital gain.

Categories of Capital Gain

Capital gains are broadly categorised into short-term and long-term gains:

• Short-Term Capital Gains (STCG): When a capital asset is held for less than a specified period (one year for equity assets in India), the profit earned upon its sale is termed as short-term capital gain.

• Long-Term Capital Gains (LTCG): When a capital asset is held for a longer period (over one year for equity assets in India), the profit earned is considered a long-term capital gain.

Additionally, capital gains can result in losses when the sale price of an asset falls below its purchase price. Such losses are called capital losses and may be Offset against gains to reduce the taxable amount.

Realised and Unrealised Capital Gain

Capital gains can be further classified into two types:

Realised Capital Gain

Realised gains occur when an asset is sold for a higher price than its purchase price. For example, if you sell shares of a company after holding them for six months, and the selling price is higher than the buying price, the profit qualifies as realised capital gain. Realised capital gains are subject to taxation.

Unrealised Capital Gain

Unrealised gains refer to the increase in the value of an asset that has not yet been sold. For example, if you own a stock that has appreciated in value but have not sold it, the gain is considered unrealised. Unrealised gains are often reflected on paper and do not attract Taxes until the asset is sold.

Tax Implications

Realised gains are taxed based on their classification as short-term or long-term. Unrealised gains are not taxable but may impact your overall Net worth and asset valuations during the Accounting period.

Criteria for Income to be Considered Capital Gain

Not all transactions involving assets are treated as capital gains. Below are the specific criteria:

• Inheritance Exclusion: Capital gains tax does not apply to assets inherited or transferred through a will, as there is no sale involved.
• Tax on Sale by Inheritor: If the inheritor decides to sell the asset, capital gains tax will apply to the sale transaction.
• Exemptions for Gifts: The income tax Act exempts capital gains on assets received as gifts under certain conditions, such as gifts from relatives or during marriage.
• Taxable Year: Capital gains are taxable in the financial year when the transfer or sale of the capital asset occurs.

For instance, if you inherit a piece of Land valued at INR 20 lakhs and later sell it for INR 30 lakhs, the INR 10 lakhs profit is taxable as capital gain.

Tax on Capital Gains in India

The taxation of capital gains in India depends on their classification as short-term or long-term:

Tax Rate on Short-Term Capital Gains

Short-term capital gains are taxed at 15% (plus applicable surcharge and cess) if they arise from equity investments. For other assets, such as debt mutual fund, the Tax Rate is based on the individual’s income tax slab.

For example:

If you sell equity shares within a year and earn INR 50,000 as a profit, the tax payable will be 15% of INR 50,000, i.e., INR 7,500 (plus cess).

For short-term gains on debt mutual funds, the tax rate may range from 5% to 30%, depending on your income bracket.

Tax Rate on Long-Term Capital Gains

Long-term capital gains exceeding INR 1 lakh from equity investments (stocks or Equity Mutual Funds) are taxed at 10% (plus cess). Gains below INR 1 lakh are exempt. For other assets, such as property or gold, the tax rate is 20% with the benefit of indexation.

Example:

If you earn INR 3 lakhs as long-term capital gains from stocks in a financial year:

• Exempted amount: INR 1 lakh
• Taxable amount: INR 2 lakhs
• Tax Liability: 10% of INR 2 lakhs = INR 20,000 (plus cess).

For long-term capital gains on debt mutual funds or real estate, indexation benefits help reduce the taxable amount by adjusting the purchase price for Inflation.

Exemptions and Deductions

Several exemptions and deductions are available under Indian tax laws to reduce the burden of capital gains tax:

Section 54: Exempts long-term capital gains from the sale of a residential property if the proceeds are reinvested in another residential property.

• Section 54EC: Allows exemption for gains reinvested in specified bonds, such as those issued by NHAI or REC, within six months of the sale.

• Section 54F: Exempts gains from the sale of assets other than residential property if the entire sale proceeds are invested in purchasing or constructing a residential property.

Example: If you sell a house for INR 80 lakhs and reinvest the amount in a new house within the specified period, the entire capital gain may be exempt from taxation under Section 54.

Factors Affecting Capital Gains

• Holding Period: The duration for which the asset is held determines whether the gain is short-term or long-term.

• Indexation: For long-term gains, the cost of acquisition is adjusted for inflation, reducing the taxable gain.

• Type of Asset: Different assets attract different tax rates and exemptions.

• Transaction Costs: Brokerage fees, stamp duty, and other expenses incurred during the transaction can reduce the taxable gain.

Why Understanding Capital Gains is Important?

Understanding capital gains helps investors and taxpayers plan their investments and optimise tax liabilities. For example:

• Timing asset sales strategically to minimise tax.
• Taking advantage of exemptions and deductions.
• Avoiding unnecessary short-term transactions to benefit from lower long-term tax rates.

By effectively managing capital gains, individuals can maximise their investment returns while adhering to tax regulations.

Capital gains are an integral aspect of financial planning and investment management. Proper knowledge of applicable tax laws, exemptions, and calculation methods can help optimise returns and ensure compliance with regulations.