Everything you need to know about tax on capital gain

You must have come across the term tax on capital gains in your conversations with friends or family. But more often than not, you would have felt that there needs to be more clarity regarding the meaning of this term and its tax implications. To simplify things, we have created a beginners' guide on capital gains tax to help you in your investment decisions. 

If you own a real estate property or investment assets such as a stock, bond, or even gold that can be sold, then that item is called a capital asset. 

You make a profit if you sell this capital asset at a higher price than what you paid for it. After certain deductions, such as expenses on improvements, this profit is called capital gains. 

The tax on this gain or profit is called capital gains tax.

Note: Tax on Capital Gains differs from income tax as it is not on income per se. 

Understanding tax on capital gains  

To understand capital gains tax, we need to understand the conditions when it is levied and when it is exempted.  

Basically, four conditions must be met for tax on capital gain to come into play: 
 

• There should be a capital asset involved in the transaction; 

• The transaction involves a transfer of this capital asset; 

• This transfer should have been made in the previous year; 

• This transfer must yield profits for the seller. 

Under India's Income Tax Act 1961, "capital asset" will include the following: 
 

(a) Property or asset that may or may not be related to the taxpayer's business or profession. 

In the case of a company, "property" will include its rights, including rights of management or control. 

Also, if the company holds any assets other than its stock, those will be deemed capital assets. Therefore, any gains from selling these assets will fall under the purview of capital gains tax in India. 

(b) Securities held by Financial Institutional Investors (FIIs), which are in the business of buying and selling shares in the stock markets, will also be deemed property. 

Thus, any income arising from the sale of securities held by the FIIs will not be treated as business income but will come under Sections 111A, 112 and 112A of the Income Tax Act, which deal with short term capital gains tax and long term capital gains tax, explained later. 

(c) any unit linked insurance policy to which exemption under clause (10D) of section 10 does not apply on account of the applicability of the fourth and fifth provisos thereof

What types of goods or items are excluded from the "capital assets" umbrella and will therefore be exempt from capital gains tax in India?

Does the furniture in our homes come under the ambit of capital assets?  
 

No. Under the Income Tax Act, the following items, including household furniture, are exempt: 

• Any stock in trade, consumables or raw materials held by an individual or business to run a business or profession; an example would be the items for sale at a kirana store; 

• Personal items such as clothes or furniture that we all have for everyday use; however, items like jewellery, archaeological collections, drawings, paintings, sculptures or any work of art are not exempt. 

• Land for agriculture in any part of rural India;  

• Special bearer bonds that were released in 1991. 

• Gold deposit bonds under the Gold Deposit Scheme of 1999 or the Deposit Certificates issued under the Gold Monetisation Scheme 2015. These differ from Sovereign Gold Bonds (SGBs), which are subject to short term and long term capital gain tax. 

Types of Capital Gain
 

There are two broad types of capital gain, depending on the tenure of holding the asset.

These are the short term capital gain and long term capital gain; the taxes on them are called short term capital gain tax and the long term capital gain tax, respectively. It is calculated depending on the type of assets and their holding period.  

Short term capital gain 
 

Profits from the sale of an asset within 36 months of purchase/acquisition are known as short term capital gains.  

Short term capital gain tax is levied at 15% (plus surcharge and cess as applicable) or per the taxpayer's tax slab, depending on the asset. For instance, if an individual sells their Sovereign Gold Bonds within 36 months, then any profit will attract short term capital gain tax as per one's income tax slab. 

The tenure, however, is different for assets such as Mutual Funds and listed shares, where long term capital gain kicks in after 12 months.  

Short term capital gain is calculated by deducting the following expenses from the sale value- 

(i) expenses on improving the property

(ii) expenses incurred for acquiring the property

(iii) expenses on the transfer of the property. 

Long term capital gain
 

The opposite is true in this case.

Profit from selling an asset after holding it for more than 36 months is known as long term capital gain. For SGBs, this is levied at 20% if indexation is availed of or 10% if not.

Note: Indexation is a price adjustment done to reflect the inflationary effect. 

For non-moveable properties, the holding period is 24 months.  

That apart, profit from the sale of a few select assets is considered for short term capital gain tax even if the holding period is less than 12 months. These items are:  

• Equity shares listed on an Indian stock exchange. 

• Listed securities like bonds, debentures, etc.  

• UTI units. 

• Capital gain on Mutual Funds that are equity-oriented. 

• Zero-coupon bonds. 

These assets will be considered long-term capital assets if held for 12 months.

If an asset is inherited or received as a gift, then the period for which the previous owner owned that asset will be considered.  

In the case of bonus shares or right shares, the date of allotment becomes the beginning of the holding period. 

Given below is a duration chart on an income generated against the sale of asset: 
 

Here are a few helpful tips about tax exemptions on capital gains
 

You can claim tax exemptions under Sections 54, 54F and 54EC on profits earned for various assets, as explained below:  

Section 54
 

If you spend the amount earned by selling residential property on buying another property, the capital gains from the first sale will not attract any capital gains tax. But for this exemption, you must meet the following conditions:  

• The second property must be purchased within two years of the first sale or one year before ownership is transferred. 

• If you are buying an under-construction property, you must complete the purchase before three years have elapsed since the ownership transfer of the first property. 

• The new property can only be sold after three years have elapsed since the purchase. 

• The new property is in India.

Section 54F
 

Exemptions can be claimed under Section 54F if the capital gains are from the sale of long term assets other than a residential property (i.e. sale of gold, shares, jewellery, and bonds). It is to be noted that Budget 2023 has capped the benefit at Rs 10 Cr for Section 54 and 54F. However, if the earning is reinvested in any other asset, long term capital gains tax will be levied. 

Section 54EC 

You can be exempted from capital gains tax under Section 54EC if you reinvest the proceeds of selling a property in specific bonds within six months of the sale. You can redeem the invested amount after five years but cannot sell the bonds in this period.

Conclusion

Tax on capital gain is not as complicated once you know the basic rules of selling a capital asset. With the above points and guide, we hope it helps you understand the different tax implications and the classification of capital assets. Once you know the categories or bifurcations, it becomes easier to calculate your tax liability.

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