Chapter 8: Capital Gains

Basic Concepts

Section 45 of the Income Tax Act states that any gains arising from transfer of a capital asset shall be chargeable under the head ‘capital gains’ in the previous year when transfer takes place.
The important constituents under this head are – capital asset, transfer, sale consideration, cost of acquisition and the date of purchase and transfer.

Classification of Capital Assets

• Stock-in-trade, consumable stores or raw material held for the purpose of business or profession
• Movable property held for personal use of the assessee or any member of his family, dependent on him, such as wearing apparel, furniture, car, scooter, TV, refrigerator, musical instruments, gun, revolver, generator, etc.
• Agricultural land in India, satisfying certain conditions as to its location, the actual cultivation etc. will not be considered as capital asset.
• Bonds such as 6% Gold Bonds,1977, 7% Gold Bonds, 1980, National Defense Gold Bonds, 1980, Special Bearer Bonds, 1991, Gold Deposit Bonds issued under Gold Deposit Scheme, 1999, Deposit certificates issued under the Gold Monetization Scheme, 2015
• The personal effects such as jewellery, precious or semi-precious stones, whether or not set in any furniture, utensil or other article or worked or sewn into any wearing apparel, archaeological collections, drawings, paintings, sculptures, any work of art are not considered as personal effects and any gain arising from their sale shall be charged to tax.
  Classification | Depending on the period of holding, an asset can be classified as long-term capital asset or short-term capital asset.

Types of Capital Asset-

Short-term vs. Long-term Capital Asset

Capital assets are categorized into short-term and long-term for the purpose of computing capital gains. Short-term capital assets are subject to a higher incidence of tax compared to long-term capital assets. The distinction between the two is based on the period for which the asset is held before its transfer.

General Rule

A capital asset is considered short-term if it is held for not more than 36 months before transfer. A capital asset is considered long-term if it is held for more than 36 months before transfer.

Exceptions

Exception 1: Unlisted shares of a company and immovable property (land or building) are treated as short-term capital assets if held for not more than 24 months before transfer.

Exception 2: Listed shares of a company, listed securities (debentures, bonds, derivatives, government securities, etc.), units of UTI, units of Equity Oriented Fund, and zero coupon bonds (listed or unlisted) are treated as short-term capital assets if held for not more than 12 months before transfer.

Exception 3: Depreciable assets are always treated as short-term capital assets, regardless of the period of holding.

Table 8.1: Overview of holding periods of capital assets

Special Provisions for Calculating Period of Holding of Capital Assets

The period of holding of a capital asset is calculated from the date of purchase or acquisition until the date of transfer. However, in certain cases, the period of holding of a capital asset is determined in accordance with special provisions.

Special Provisions for Calculating Period of Holding of Capital Assets

Topic: Transfer of Property

Transactions not regarded as transfer

The following table provides a summary of transactions that are not regarded as transfers for the purpose of capital gains, as per the Income-tax Act.

Computation of Capital Gains from Transfers-

Computation of capital gains from transfer refers to the process of calculating the taxable profit or gain that arises from the sale of a capital asset. The computation of capital gains is different for short-term and long-term assets due to the availability of indexation benefit in the latter case.

1. In case of short-term capital gains:
   Short-term capital gains arise when a capital asset is held for less than 36 months before its sale. The computation of short-term capital gains is as follows:

• Full value of consideration received on the sale of the asset
• Less: Expenditure incurred wholly and exclusively in connection with the transfer
• Less: Cost of acquisition of the asset
• Less: Cost of improvement of the asset
• Less: Exemption under Sections 54B, 54D, 54G and 54GA

The difference between the full value of consideration and the above deductions gives the short-term capital gain or loss.

2. In case of long-term capital gains:
   Long-term capital gains arise when a capital asset is held for more than 36 months before its sale. The computation of long-term capital gains is as follows:

• Full value of consideration received on the sale of the asset
• Less: Expenditure incurred wholly and exclusively in connection with the transfer
• Less: Indexed cost of acquisition of the asset
• Less: Indexed cost of improvement of the asset
• Less: Exemption under Sections 54 to 54GB

Calculation of Full Value of Consideration:

The full value of consideration is the amount of consideration received or receivable by the owner of an asset in exchange for the transfer of such an asset. Here are some key points to note about its calculation:

1. Calculation in commercial sense: As per the Income Tax Act, the full value of consideration is not defined, and thus it should be understood in a commercial sense according to the prevalent usage.
2. Received in cash or kind: The consideration may be received in cash or kind, and if it is received in kind, then the fair market value of such assets is taken as the full value of consideration.
3. Special Cases: In some cases, the calculation of the full value of consideration is different from the general principle, such as in the conversion of capital asset into stock-in-trade, transfer of securities allotted under ESOPs as a gift or under an irrevocable trust, redemption of rupee denominated bonds by non-residents, transfer of unquoted shares for less than its fair market value, transfer of land or building or both, capital asset distributed on liquidation of a company, and when the consideration for transfer is not ascertainable.
4. Calculation in Special Cases: The full value of consideration in these cases shall be calculated as per the specific rules applicable to each case. For instance, in the case of transfer of land or building or both, the actual consideration or valuation adopted for stamp duty purposes, whichever is higher, is taken as the full value of consideration. Similarly, in the case of transfer of unquoted shares for less than its fair market value, the actual consideration or the fair market value of such shares on the valuation date computed as per section 50CA, whichever is higher, is taken as the full value of consideration.

Expenditure allowed as deduction in computing capital gain

Particulars Expenditure amount (Rs.)

Brokerage or commission
Stamp duty
Registration fee
Travelling expenses
Legal expenses
Other expenses incurred wholly and exclusively in connection with transfer

Note: No deduction allowed for sum paid on account of STT, CTT while calculating capital gains from sale of securities.

Cost of Acquisition-

Cost of acquisition is the amount of money that an investor or taxpayer pays to acquire a particular asset, such as a stock, bond, mutual fund, or real estate property. The cost of acquisition is an important concept in taxation as it determines the amount of capital gains or losses when an asset is sold or disposed of.

In India, the cost of acquisition of various assets is determined based on different rules and provisions. For instance, the cost of acquisition of listed equity shares, units of equity-oriented mutual funds or units of business trusts that were acquired before 31st January 2018 and sold after 1st April 2018 is the higher of the actual cost of acquisition or the fair market value as on 31st January 2018 or the full value of consideration, whichever is lower.

The cost of acquisition for any other asset, which was acquired on or before 31st March 2001, is the price actually paid for acquisition or the fair market value as on 1st April 2001, whichever is higher. However, for assets acquired after 1st April 2001, the cost of acquisition is the price actually paid for acquisition.

The rules for determining the cost of acquisition for other types of assets, such as right shares, bonus shares, sweat equity shares, and shares allotted under ESOP, are also different.

It is important to determine the correct cost of acquisition as it directly impacts the capital gains or losses that an individual has to pay taxes on. Inaccurate calculation of cost of acquisition can result in an incorrect amount of tax liability and may lead to penalties and interest charges.

Indexed cost of Acquisitions-

Indexed cost of acquisition is a method used to calculate the cost of a capital asset that adjusts for inflation. The calculation involves two steps: first, calculate the actual cost of acquisition of the capital asset, and second, multiply this cost by the Cost Inflation Index (CII) of the year in which the asset is being transferred and divide by the CII of the year in which the asset was first held by the taxpayer or the CII of 2001-02, whichever is later.

The benefit of indexation is not available for certain long-term capital assets, including listed equity shares, units of equity-oriented mutual funds or units of business trust, except that taxable under Section 112A , bond or debenture ( except Capital Indexed Bonds and Sovereign Gold Bonds ) , investment in securities by non-residents in foreign currency, depreciable assets, slump sale, units purchased in foreign currency by offshore funds, securities as referred to in Section 115AD purchased by FPIs, GDRs purchased in foreign currency, and unlisted securities purchased by a non-resident.

Cost of Improvement-

Conversion of Capital Gains Earned in Foreign Currency into Indian Rupees:

Tax Rates on Capital Gains-

Table 1: Tax Rates on Short Term Capital Gains

Table 2: Tax Rates on Long Term Capital Gains

Table 3: Tax Rates on Long Term Capital Gains under Section 112A

Note: The long term capital gains tax under section 112A will apply only if the gains exceed Rs. 1,00,000 in a financial year.

Table: Summary of Taxation of capital gains on Equity shares/ Equity oriented mutual funds, listed or unlisted (Section 111A and Section 112A)

Table-: Summary of Taxation of Capital Gains on Listed Investments (Apart from Section 111A and Section 112A)

1. Other Units listed on the Indian Stock exchange such as Long term (held for more than 36 months):

• For residents: 20% after indexation plus applicable surcharge plus cess (section 112).
• For non-residents: 20% after indexation plus applicable surcharge plus cess (112).

2. Other securities listed on Indian Stock Exchange such as Debentures, bonds, preference shares, listed equity shares transferred without payment of STT, etc. except Sovereign gold bonds:

• For long term (held for more than 12 months):
• For residents: 20% after indexation or 10% before indexation, whichever is less – plus applicable surcharge plus cess (112).
• For non-residents: 20% after indexation or 10% before indexation, whichever is less – plus applicable surcharge plus cess (112), except in the case of shares or debentures of an Indian company bought in foreign currency where the capital gains are calculated in the prescribed manner in foreign currency, and tax rate of 10% is applicable.
• For short term (held for 12 months or less):
• Treated as regular income, and normal tax rates apply.

3. Sovereign Gold Bonds (all are listed on Indian Stock Exchanges):

• For long term (held for more than 12 months):
• If sold on the exchange or otherwise, the tax is 20% after indexation or 10% before indexation, whichever is less – plus applicable surcharge plus cess (112). Redemption is not regarded as transfer, and hence not taxable if redeemed.
• For non-residents: If bought when resident and sold on the exchange when non-resident, then sold on the exchange or otherwise, the tax is 20% after indexation or 10% before indexation, whichever is less – plus applicable surcharge plus cess (112). Redemption as allowed in the scheme is not regarded as transfer, and hence not taxable if redeemed.
• For short term (held for 12 months or less):
• Treated as regular income, and normal tax rates apply if sold on exchange or otherwise. Redemption is not regarded as transfer and hence not taxable if redeemed.

Note that an initial exemption limit of 2.50 lakhs is available to NRIs also for this Income. Indexation is not allowed on Debentures or Bonds. However, indexation is allowed on Sovereign Gold Bonds.

Table: Summary of Taxation of capital gains on unlisted investments

Note:

• # Indexation is not relevant for short term capital gains. Capital gains will not be taxed to the extent by which all other taxable income falls short of minimum chargeable to tax – Rs. 2.50 lakhs/ Rs. 3 lakhs/Rs. 5 lakhs as applicable. Chapter VIA deductions are not available for special rate (112,112A or 111A) taxation.
• @ Rebate under section 87A not available to Non residents. Indexation is not relevant for short term capital gains. For investment in Share and debenture in Indian Company – If original investment made.

Exemption for capital gains-

Note: The Income-tax Act provides exemption from capital gains tax subject to certain key conditions, which are summarized in the table above. The type of assessee, original capital asset, nature of the original capital asset, nature of new capital asset, and time limit allowed for investment are the key parameters for each section.