Capital gains
Incomes such as salary, rent and business income are regular and recurring incomes. These are earned in return for providing a particular service such as skills in case of the salaried, professional service or service in the form of permission to use property. However, these do not cover all sources of income. Incomes can arise out of the sale of capital assets such as your house, jewellery, land or even equity shares and mutual fund units. The profits that you make on such sale transactions will be charged to tax as capital gains.
Short term and long term asset
| Asset | Short term | Long term |
| Equity shares, mutual fund unit,zero coupon bond | Held for 12 months or less | Held for more than 12 months |
| Other assets like jewellery, land, property | Held for 36 months or less | Held for 36 months or less |
Tax treatment
The tax treatment is different for short term and long term as also for some instruments such as equity shares and equity mutual funds.
Short-term capital gains tax
Short-term capital gains are added to the total taxable income of the individual and therefore taxed at the relevant tax slabs. The gain in this case is simply the difference between the cost of purchase and the sale value of the asset.
Exception: In case of equity shares and equity mutual funds, short-term capital gains will be taxed at a flat rate of 15%. So instead of including this income to the total taxable income, the tax will be calculated and added directly to the total tax liability.
Long-term capital gains
Long-term capital gains are taxed at a flat rate of 20% irrespective of your income slab. However, there is an added benefit of indexation, which is available only on long-tem capital gains. Indexation is nothing but adjusting the cost of purchase of units to the cost inflation index as on the date of sale.
Indexed cost is calculated with the help of a table of cost inflation index that is provided by a notification in the official gazette each year. In the case of long-term holdings, the cost of purchase is adjusted to the present inflation index before deducting it from the sale value. So if you had bought debt mutual funds in April 2001 at Rs. 5,000 and sold them in August 2002 at Rs. 10,000, your cost of purchase will be adjusted to inflation. The inflation-adjusted cost would thus work out to Rs. 5,246. So your capital gain will be Rs. 4,753 on which you will be taxed at 20%.
Exception: Equity shares purchased after 1st March 2003 and equity mutual funds bought after 1st October 2004 are exempt from long-term capital gains tax. The intention is to encourage long-term savings in equities.
Another exception is in case of non-equity mutual funds, you will have an option to forego the benefit of indexation and pay long-term capital gain tax at 10% instead of 20%. Which option is more beneficial can be determined on a case-to-case basis.
Exemptions
Sale of residential house
If you have sold your residential house property for a profit, you will get some relief on the capital gains tax payable, if you fulfill certain conditions. Following are the conditions:
1. The house that you sell must have been owned by you for at least 3 years, which means it necessarily must be a long-term asset
2. Once you sell the house, you should buy a new house within two years from the date of sale. Alternately, if you have bought a house within one year before the sale of the existing house, you will be eligible for tax relief. If you are constructing a house, then you should do so within 3 years from the date of sale
3. The cost of the new house should be at least equal to the capital gain
Case study
Ashok Pai bought a house in November 1984 for Rs 5 lakh. He sold the house on 1st April 2003 for Rs 25 lakh. Thus, the long-term capital gains tax on this will be:
Sale value Rs 25 lakh
Indexed cost of
purchase
Rs 5 lakh X 463 / 125 Rs 18.52 lakh
Capital gains Rs 6.48 lakh
In order to save tax on this amount, Pai must buy a house within two years from 1st April 2003 or construct a house within 3 years from that date. He must buy a house of value at least of Rs 6.48 lakh. Had he already purchased a house before selling the existing one, he should have done so during the period from 1st April 2002 to 1st April 2003.
Sections 54EC provides exemptions on fulfillment of certain conditions. If you sell long-term assets and within six months, invest the sale proceeds in bonds of NHAI or REC (bonds of NABARD, NHB and SIDBI were earlier allowed but have been disallowed with effect from Finance Bill 2006), then you will get an exemption of either the invested amount or the capital gain amount, whichever is lower.
So suppose you have sold the units for Rs. 20,000, and the capital gain amounts to Rs. 12,000. If you invest the entire Rs. 20,000 in bonds as specified, your entire gain of Rs. 12,000 will be exempt. If you invest Rs. 9,000, only that much will be exempt from tax and Rs. 3,000 will be taxable.
Provisions of section 54ED have been abolished with effect from Finance Bill 2006.
