Capital Gains Explained: Definition, Types, Exemptions & Tax Saving

What is Capital Gains Tax?

Any profit or gain resulting from the sale of a capital asset at a price exceeding the original purchase price is called a capital gain. The entire value of the sale becomes taxable under the income head ‘capital gain.’

The main elements of a capital gain are:

1. Capital assets

• Gold
• Real estate
• Investment
• Stocks
• Bonds
• Cars
• Property

2. Transfer of the capital assets mentioned above.

3. Any profit or gain resulting from such transfers of capital assets.

In case of loss on the sale of capital assets, no tax liability arises on the sale of the capital asset in question. This tax does not apply to inherited assets and assets received as gifts or as a partition of HUF (Hindu Undivided Family) property.

Capital assets

Any asset that is a significant piece of immovable property, jewellery, leasehold rights, vehicle, machinery, or intellectual property like patents, trademarks, etc. is termed as a capital asset. In Indian companies, capital assets include any direct rights such as management rights, ownership control, and other holding rights.

Assets exempt under capital gains

•     Any stock, raw material, or consumable held in trade to be employed as stock in the business. (Profits to be taxed as business income.)

•     Personal effects including furniture, accessories, etc. held for the purpose of self-consumption.

•     Any piece of agricultural land in a rural part of the country.

•     Special bearer bonds of 1991 and gold deposit bonds launched as part of the Gold Deposits Scheme of 1999.

•     6.5% gold bonds as well as national defense gold bonds issued by the Centre.

What are the types of capital assets?

Long-term capital assets: An immovable asset like land, building, house property, etc. that an assessee holds for longer than 24 months is known as a long-term asset. Movable assets like jewellery, vehicle, machinery, etc. too are termed as long-term assets if the assessee holds them for a period longer than 36 months.

Several assets are grouped under long-term assets if the assessee holds them for more than 12 months. These assets are:

•       Shares of a company (equity or preference). The company should be listed in India on a recognised stock exchange.

•     Bonds, debentures and government securities. They should be listed in India, on a recognised stock exchange.

•     Quoted or unquoted units of UTI.

•     Mutual funds units (equity-oriented), quoted or unquoted.

•     Quoted or unquoted zero-coupon bonds.

A capital gain is termed as Long-Term Capital Gain (LTCG) if assets are held for a significant duration that is longer than the specified period.

Short-term capital assets:

Capital assets sold before the expiry of a certain period are called short-term capital assets. The holding periods are defined above for different classes of investments. Holding these assets for a period shorter than the specified period brings them under Short-Term Capital Gains (STCGs).

Rate of tax on capital gains – Long-term & short-term

The LTCG tax is 20%, except on the sale of equity shares and units of equity-oriented funds.  It is 10% over and above Rs. 1 lakh in equity shares and units of the equity-oriented fund.

Short-term capital gains are included in a taxpayer’s return of income tax. He is taxed as per his income tax slab when the Security Transaction Tax (STT) is not applicable. When the STT is applicable, short-term capital gain is taxed at 15%.

Capital gains indexation

The concept of indexation of cost of acquisition and improvement considers the adjusted inflation over the years of holding an asset.  It is done by applying a Cost Inflation Index (CII).  It increases the base of costs and reduces capital gains.

Indexed cost of acquisition:

Cost of acquisition / Cost inflation index (This is for the year in which the asset was first acquired by the seller or 2001-02, whichever is later) x Cost inflation index of the year when the assets are transferred.

Indexed cost of improvement:

Cost of improvement x Cost inflation index (CII) of the year in which asset transfer takes place/ Cost inflation index of the year in which the improvement takes place.

Methodology for computation of capital gains

Short-term capital gains:

The full value of consideration after deducting expenditure incurred entirely and exclusively for such sale, cost of acquisition, and cost of improvement.

Long-term capital gains:

After deducting expenditure incurred entirely and exclusively for such sale, the full value of consideration was the indexed cost of acquisition and the indexed cost of improvement.

In the case of a house property’s sale, the expenses deductible from the sale price are:

• Brokerage or commission paid towards the process of obtaining a buyer.
• Cost incurred for stamp papers.
• Travel expenses relating to the transfer. These may take place even after the transfer has been done.

In the case of inherited property, expenses incurred in connection with the procedure concerning the inheritance, will, obtaining the executor’s succession certificate, etc. are also allowed in several cases.

With sales of shares, the deductible expense is the broker’s commission paid on the sold shares. (The Securities Transaction Tax (STT) is not allowed to be deducted as an expense.)

In the case of jewellery, expenses incurred on a broker’s services relating to obtaining a buyer are allowed as a deductible expense.

The expenses deducted under the head of capital gains are not allowed to be deducted under any other head of Income Tax return. You can claim these only once.

Tax exemptions

These exemptions are available either fully or partially.

Section 54: The capital gain on a residential property’s sales proceeds is exempt if those proceeds are utilised to purchase another residential property. This is subject to the following conditions:

• The assessee in question should be an individual or a Hindu Undivided Family (HUF).
• Sales proceeds are less than the purchase cost of the newly acquired property.
• The property purchase should take place either 1 year before the sale of property takes place or within 2 years of the date of sale.
• The property purchase should take place either 1 year before the sale of property takes place or within 2 years of the date of sale.
• In the case of a property under construction, the same should be constructed within three years from the date of transfer of the previous property.
• The newly acquired property is not allowed to be sold further within 3 years of such construction or purchase.
• The property that is newly acquired should be situated or located in India only.

Section 54F: The benefit under section 54F can be gained by selling any other asset such as agricultural land within a specified limit of 10 km from a city. It is also applicable in case of jewellery, debt funds, valuable paintings, etc. 54F grants deduction to buy a house property from the sales proceeds of any capital asset. The conditions applicable are as follows:

• The purchase should be made either 1 year before or within 2 years of the sale.
• In the case of a property under construction, it should be completed within 3 years of the sale date.
• The new property should not be sold within 3 years of the date of acquisition.
• It should be situated in India.
• The person should have only one residential property on the date of transfer.
• Any other property should not be purchased within 1 year of the sale or constructed within 3 years of the sale event.
• The assessee in question should be an individual or a Hindu Undivided Family (HUF).
• Sales proceeds are less than the purchase cost of the newly acquired property.

Section 54EC: Capital Gain Bonds issued by the National Highways Authority of India (NHAI) and Rural Electrification Corporation (REC) are allowed as exemption from capital gains tax up to a specified limit of Rs. 50 lakhs. The duration is for 5 years. The interest amount earned on these bonds is taxable. Capital gains on real estate transactions are eligible under this deduction.

For example: On purchasing an asset for Rs. 12 lakhs and selling it for 22 lakhs, and then investing the entire 22 lakhs in NHAI/REC capital gain bonds; such a transaction would not attract the capital gains tax.

Tax savings under capital gains

In several cases, capital gains resulting from an agricultural land sale are fully exempt from income tax or are not taxed under the head of capital gains.

• Capital gains arising out of compensation received on compulsory acquisition in case of urban agricultural land are exempt. This is defined under Section 10 of the Income Tax Act.
• If you are into trading in the agricultural land business, then it is taxable under the head ‘business and profession’.
• Rural agricultural land is not considered a capital asset. Therefore, gains arising from the sale of such land are not taxable under the head of capital gains.

Also read:
What Is a Universal Account Number? How to get your UAN?
Everything You Need to Know About PPF Account: Benefits & Features
Types of deductions under section 80C. What is included under 80C?