This article has been written by Varalika Mendiratta. 

Introduction

The concept of Capital Gains Tax was introduced in the Indian Tax Regime in 1997 and since then it has gone through many transitions over time. The understanding of this tax is relevant for a common man or a billionaire as it covers a wide range of taxation aspects. The Capital Gains Tax is contained under the Income Tax Act, 1961 and has gone through many amendments since the time it was stemmed. Whether an individual is investing his/her capital income in a new house or selling an old one or investing their gains from the sale of any residential property into any securities, etc., they need to be aware of the notion of Capital Gains which revolves around these phenomena.

The new Budget was presented by the Finance Minister, Nirmala Sitharaman, on 1st February 2020, which brought about crucial changes in the structure of Capital Gains Tax in India which makes this topic an exigent issue to be discussed and dwelled upon.

The Capital Gains Tax in general terms means the tax levied on the profit made by an individual from the sale of Capital Assets. To do an in-depth analysis of the topic and understand the working of the Capital Gains Tax, we first need to address the concept of “Capital Asset” and “Capital Gain” and then move forward to the exemptions provided by the Income Tax Act surrounding this topic and further discuss the implications of changes in the Capital Gains Tax introduced by the Budget of 2020.

What is a Capital Asset?

The Capital Gains Tax is levied on the amount which is received as profit through the sale or transfer of Capital Asset, thus, to explore the concept of Capital Gains Tax, it is very imperative to understand, what is Capital Asset?

According to section 2(14) of the Income Tax Act, Capital Asset includes:

(a) property of any kind which is held by an assessee, and it is irrelevant whether or not it is connected with his business or profession.

(b) Any kind of securities held by a Foreign Institutional Investor [as per defined under the clause{a} of the explanation to Section 115AD which has invested in such securities by the regulations made under the Securities and Exchange Board of India (SEBI) Act, 1992.

However, it is to be noted that there are certain items excluded from the definition of ‘Capital Asset’ which are as follows:

(i) any stock-in-trade [other than the securities referred to in sub-clause {b} as mentioned above], consumable stores or raw materials held for his business or profession.

(ii) personal effects, this refers to any kind of movable property (including wearing apparel and furniture) held by the taxpayer for his personal use or for the use of any of his family members who are dependent upon him, but this excludes:

(a) jewellery;

(b) archaeological collections;

(c) drawings;

(d) paintings;

(e) sculptures; or

(f) any work of art.

The term “jewellery” as mentioned above includes:

• any kind of ornament which is made up of platinum, gold, silver or any other precious metal or an alloy which is made up of one or more of such precious metals, such alloy may or may not contain any precious or semi-precious stone, and it may or may not be sewn into any wearing apparel.
• any kind of precious or semi-precious stone, which may or may not be set into any furniture, utensil, or any other article, or sewn into any wearing apparel.

iii) Agricultural land in India, which should not be situated:

1. within such an area which comes under the jurisdiction of a municipality (whether known as a municipality, municipal corporation, notified area committee, town area committee, town committee, or by any other name) or a cantonment board and the population of such area should not be less than 10,000;
2. any area which falls within the range of the distance measured aerially, taking into consideration that such area should not be:

• more than 2 kilometers away from the local limits of any municipality or cantonment board referred to in item (a) and it should have a population of more than 10,000 but not exceeding 1 lakh; or
• more than 6 kilometers away from the local limits of any municipality or cantonment board referred to in item (a) and it should have a population of more than 1 lakh but not exceeding 10 lakhs; or
• more than 8 kilometers, from the local limits of any municipality or cantonment board referred to in item (a) and it should have a population of more than 10 lakhs.

iv) 6½ percent Gold Bonds, 1977, or 7 percent Gold Bonds, 1980, or National Defence Gold Bonds, 1980, issued by the Central Government;

(v) Special Bearer Bonds, 1991, issued by the Central Government;

(vi) Gold Deposit Bonds issued under the Gold Deposit Scheme, 1999, or the deposit certificates issued under the Gold Monetisation Scheme, 2015.

Capital Assets are divided into two categories; Short-Term Capital Asset and Long-Term Capital Asset, which are discussed as follows:

Long-Term Capital Asset

Assets that are owed for more than 36 months are termed as Long-Term Capital Assets. However, there are certain assets which are considered as Long-Term Capital Asset if they are held for more than 12 months, these assets include:

• Based mutual funds (whether quoted or not);

• Equity Zero Coupon bonds (whether quoted or not);

• Equity and Preference shares which are listed and recognized by a stock exchange of India;

• Other securities like debentures, bonds, etc., which are listed and recognized by a stock exchange of India;

• UTI (Unit Trust of India) units (whether quoted or not).

Short-Term Capital Asset

The capital assets which are held by an individual for 36 months or less are termed as Short-Term Capital Asset. However, there has been a reduction in the period pertinent from the financial year 2017-18, wherein, immovable property like building, land, house, etc which are owned for less than 24 months would be considered as Short-Term Capital Asset.

What is Capital Gain?

Capital gain refers to the net profit which a seller receives by selling his capital assets at a price that exceeds the original purchase price. To be eligible for taxation during the current fiscal year, the transfer of the asset sold must have been done in the previous financial year. However, if any loss occurs in the sale of such capital assets, the tax would be exempted. Capital gains tax is not levied on “inherited assets or assets procured through gift or partition of HUF (Hindu Undivided Family) property”.

Types of Capital Gains Tax

The Capital Gains Tax is divided into two types or categories; Short-Term Capital Gains Tax and Long-Term Capital Gains Tax, these two categories are discussed at length as follows:

• Long-Term Capital Gain Tax

To be qualified to be taxed under Long-Term Capital Gains Tax the capital asset must be held for 36 months or more immediately preceding the date of its transfer. However, in case of financial capital assets including; debentures, preference shares, zero-coupon bonds (whether quoted or not), Unit Trust of India units (whether quoted or not), all securities which are listed and recognized by a stock exchange, etc., the time duration is more than 12 months.

The tax rate of Long-Term Capital Gains under Income Tax Act, 1961, is fixed at 20% in case of gains earned from Long-Term Capital Assets (except units of equity-oriented funds and equity shares). It is extremely imperative to note that 10% Long-Term Capital Gains Tax is levied on listed securities of more than Rs 1 lakh and the exemption from indexation benefit is applicable on capital gains which are earned after 31st January, 2018, however, the earnings from such capital gains before the mentioned date will remain tax-free. For the unlisted securities the rate applied is 20.8% along with indexation.

• Short-Term Capital Gains Tax

Short-Term Capital Gains Tax is applied to the sale of capital assets which are held by the owner for less than 36 months immediately preceding the date of its transfer, however, there has been a reduction in the time pertinent from the financial year 2017-18 wherein, immovable property like building, land, house, etc which are owned for less than 24 months would be subject to Short-Term Capital Gains Tax, as mentioned before as well.

In case of financial capital assets including; debentures, preference shares, zero-coupon bonds (whether quoted or not), Unit Trust of India units(whether quoted or not), all securities which are listed and recognized by a stock exchange, etc., the time to be considered under Short-Term Capital Gains Tax is less than 12 months, while in case they are unlisted, the time is less than 24 months.

The Short-Term Capital Gains Tax is payable at a rate of 15% on the capital gains earned from the sale of listed securities on which STT i.e. Securities transaction Tax is already paid. In case where STT is not applicable and Debt Funds, the capital gain is added to the income of the taxpayer and he/she is taxed per their income slab.

Exemptions under capital gains tax

There are certain exemptions laid down in the Income Tax Act which allow the individuals to pay lower taxes on the income they earn through the sale of capital assets and it thus helps them to safeguard a part of their capital gain by availing benefits given by such exemptions. An individual must be aware of these exemptions to benefit from them.

Firstly, to avail certain exemptions under the Long-Term Capital Gains, an individual needs to fulfill some age and income criteria, which are as follows:

• Individuals who are a resident of India having an annual income of Rs. 5 Lakhs and are of the age of 80 years or above.

• Individuals who are a resident of India having an annual income of Rs. 2.5 Lakhs and are below the age of 60 years.

• Individuals who are a resident of India having an annual income of Rs. 3 Lakhs and are of the age of 60 years or above.

• A Hindu Undivided Family having an annual income of Rs. 2.5 Lakhs.

• Individuals who are not residents of India having an annual income of Rs. 2.5 Lakhs.

Let us understand this concept better with an Illustration:

Mr. Raj is a 40-year-old resident of India with an annual income of Rs. 2.5 Lakhs. On selling his old property which he had owned for 9 years, he made a Long-Term Capital Gain of Rs. 3.5 Lakhs. Now, his Long-Term Capital Gains will be adjusted against his income which will give a net result of Rs. 1 Lakh, and now the suitable Long-Term Capital Gains tax rate would be applied to such adjusted amount of Rs. 1 Lakh.

Furthermore, there are certain important case-specific exemptions in capital gains tax, which are discussed as follows:

Exemption under Section 54

Exemption from the payment of Long-Term Capital Gains Tax under Section 54 of Income Tax Act is related to the sale of Residential Property by an individual or Hindu Undivided Family (HUF), this exemption is subject to certain conditions which are as follows:

• The residential property for sale must have been held for over 3 years and the new property must have been constructed within 3 years from the transfer or sale of the concerned property.

• The capital gains from the sale of residential property shall be invested in the purchase of another residential property within 1 year before or 2 years after the transfer of the sold property.

• The capital gains proceeds shall be equal to or less than the cost of the new house.

• To avail the benefit of such Capital Gains Exemption, the exempted amount must be invested in the purchase or construction of one residential property only. However, through the Finance Act 2019, an exception was added to this point, which stated that in the case where Capital Gains amount does not exceed Rs. 2 Crores, the exemption from the payment of Capital Gains Tax can still be availed if the exempted amount is invested in the construction or purchase of two residential houses, also, this exemption of purchasing 2 houses can be claimed only once.

• If before the due date of filing the return of income, the amount received through capital gains is not utilized for any of the above-mentioned purposes, then the benefit of exemption can be availed by depositing it under Capital Gains Deposit Accounts Scheme, 1988.

Exemption under Section 54B

Exemptions under section 54B of the Income Tax Act can be availed when there is a sale of Agricultural Land and the capital gains received from such sale are reinvested to buy another Agricultural Land by an individual or Hindu Undivided Family (HUF). This section applies to both Short-Term and Long-Term Capital Assets. Certain conditions to avail such exemption are as follows:

• Such Agricultural Land must be in use by the individual or his parents or a member of the family (in case of HUF) for a minimum duration of 2 years immediately preceding the date of transfer.

• The exemption will be applicable if the new land is bought within 2 years from the date of transfer of the old land.

• The exemption will be withdrawn if the taxpayer who claimed the exemption, transfers the new piece of land within 3 years from when it was acquired.

• If the amount of capital gain is equal to or less than the new asset such capital gain will not be taxed.

Exemption under Section 54 EC

Exemptions under Section 54 EC of the Income Tax Act can be claimed where the capital gains from the sale of Long-Term Capital Asset is invested into Long-Term Specified Assets of National Highway Authority of India (NHAI) or Rural Electrification Corporation (REC), certain conditions to avail such exemption are as follows:

• The capital gains received from the sale of Long-Term Capital Assets shall be invested into the above-mentioned Specified Assets within six months of the sale of Long-Term Capital Assets.
• There shall be no withdrawal of the amount invested in these Specified Assets before the completion of 5 years from the date of investment.
• These Specified assets shall not be used as a collateral security against any loan.

Exemption under Section 54 F

Exemption under Section 54 F of Income Tax Act can be claimed by an individual or a Hindu Undivided Family in case of the sale of a Long-Term Capital Asset (other than residential house) when the capital gain proceeds from it are invested in purchasing a residential property. The conditions to avail such exemptions are discussed as follows:

• The new residential property must have been purchased either 12 months before the sale of a Capital Asset or 24 months after the transfer of the capital asset.

• In case only a part of the capital gain is invested in buying/constructing a residential property then only the amount which was invested will be exempted from the capital gains tax, the balance will still be taxable.

• It is essential that on the date of transfer of the capital asset, the assessee shall not own more than one residential property exclusive of the new house purchase.

• The exemption would not be applicable if the assessee purchases any other new house (apart from the original house purchased) within 12 months or constructs the same within 36 months.

Impact of Budget 2020 on Capital Gains Tax

“We are now subservient to the global rally which we have been for several months. In January, we kind of broke away from that, but we give up everything on Saturday. So now, we’re back to Coronavirus, we’re back to the U.S. macro we’re back to the Fed. Those are the factors that have been driving India.”

These were words of Ridham Desai (head of India Equity Research and India Equity Strategist at Morgan Stanley India) in an interview with BloombergQuint.

The Budget of 2020 was expected to bring about a glaring revival of growth to accelerate the Indian economy but this goes without saying that it received tons of critical reviews for bringing about significant complexity in the Indian tax regime and failing to provide a necessary stimulus to the market. The new tax regime has significantly removed, if not all, a major part of the exemptions that were available to the taxpayers before 2020. However, the taxpayers are given an option to choose between filing their income tax returns under the new tax regime or the old tax regime of 2019, as they deem fit. According to Nirmala Sitharaman, the current Finance Minister of India, the removal of exemptions along with the decrease in the tax rates is a step towards simplifying the tax structure as too many exemptions created a conundrum in the minds of a middle-class man as to what to choose to get the maximum tax relief. It is upon the people how they want to invest or utilize the extra income in their hands. But the critics argue that the new tax regime ruins the investment and savings culture in the country.

The major takeaway from the Budget 2020 related to Long-Term Capital Gains was the scraping of DDT i.e. the Dividend Distribution Tax. In India, DDT was introduced in 1997 at the rate of 75% to have an efficient tax collection but it was scrapped in 2002. Yet again, in line with the provision introduced through the Finance Act of 2003, the companies were to pay DDT at 15% but after the inclusion of cess and surcharge the total figure came to be around 20%. This move was fairly predictable since the DDT had received a lot of criticism by companies remarking it as a burden and also DDT was seen as a hurdle to foreign portfolio investments in India.

But a major step which came along with this move which received widespread criticism was the taxation of dividends received on the securities held by the investors as the same was removed on the part of the companies by abolishing DDT. Now the investors of the company are the ones who will be facing a major setback and will have to pay higher taxes on their income. The TDS i.e. the Tax Deducted at Source to be levied on residents having dividend of over Rs. 5,000 will be at the rate of 10%, meanwhile the TDS to be paid by NRIs, having dividends of over Rs. 5,000 is fixed at the rate of 20%.

Conclusion 

The structure of Capital Gains Tax in India has witnessed many changes since it was first introduced in 1997. To understand the notion of Capital Gains Tax, one needs to be well versed with the concept of Short-Term and Long-Term ‘Capital Assets’ and ‘Capital Gains’ and how they affect the income of an individual. Time constraints are of utmost value to determine under which category of tax your capital gain will fall.

India was the only country in the world that was still levying the DDT regime. There was significant clamor in the market for the complete elimination of Long-Term Capital Gains Tax but the Budget 2020 brought about a different picture with it in its entirety. On one hand, the abolishing of DDT opened up many avenues for the promotion of Foreign Direct Investment (FDI) in the country and a step towards bringing India in line with the global norms, but on the other hand, it cannot be ignored that it has brought extra burden on the shoulders of the shareholders of securities who now will have to pay tax on their dividend income. Furthermore, it is believed that by the removal of exemptions that were availed by investing in certain schemes, the budget lacks an investment push.

The world economy is at its all-time low as we are facing the hazards of this catastrophic pandemic. The Indian economy is also facing major consequences of COVID-19 and is barely able to breathe. There is no shred of doubt that there is a lot which is yet to be unraveled in the future as we step out of these rough times and see the practical implications of the changes implemented in the Long-Term Capital Gains Tax through the Budget of 2020, whether it boosts up the foreign investment portfolio and helps in further growth of the economy or will it hamper the growth economy, are the questions which will be answered in the future.