In this blog post, Kanika Sharma, a student at Campus Law Center and pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, discusses on Capital Gains Tax and How is it calculated?
Introduction to Capital Gains Tax
In accordance with the Finance Act of 2016, which took effect for the fiscal year of 2016-17, the meaning of capital is any property of any kind which does not include stock-in-trade, personal effects, agricultural land and certain specified bonds as stipulated by the legislature, whether or not it is connected with the business or the profession of the taxpayer. Even though personal affects have been excluded from the legal definition of the term “capital asset” which includes apparel, furniture, etc. the legislature also states very clearly that there are certain categories of property which will not be excluded from the purview of this definition. This includes, jewellery, archaeological collections, drawings, paintings, sculptures, or any work of art. Furthermore, any securities held by a Foreign Institutional Investor which has invested in such securities in accordance with the regulations made under the Securities and Exchange Board of India Act, 1992 will always be treated as capital asset, hence, such securities cannot be treated as stock-in-trade.
Defining Capital Asset is critical to Capital Gains Tax
The purpose of defining a “capital asset” is to determine clear boundaries of what will qualify as capital and what will not, so as to avoid any confusion or give rise to any dispute. Capital needs to be defined as capital gains are taxed in India, as is the common practice in many other countries. Capital gains refers to the difference calculated between the cost of acquisition of some asset along with the cost of any improvements made upon that asset, as well as any cost incurred in connection with the transfer and the value of sale consideration upon such transfer of property.
Capital gains can be classified into long-term capital gains (LTCG) and short-term capital gains (STCG) depending on the period for which the capital asset has been held by the transferor before any transfer of property is made. The rate of taxation as well as any corresponding tax benefits, e.g. in cases of re-investment, are determined on the basis of which category any capital asset falls within, which is why it is important to determine which category any asset should be a part of.
Categories of Capital Assets
A short-term capital asset is any property which is held by the taxpayer for less than 36 months, with the exception certain assets like shares (equity or preference) which are listed in a recognized stock exchange in India or units of equity oriented mutual funds, listed securities like debentures and Government securities, Zero Coupon Bonds among others. In all such cases, the period of holding is required to be 12 months instead of 36 months.
Whereas, a long-term capital asset is, automatically, an asset which is held by the taxpayer for more than 36 months, with the same exception of those assets exempted from the short-term capital asset category. Consequently, one may understand short-term capital gain and long-term capital gain as that gain which is arising from the transfer made of the respective assets belonging to either category. However, there are certain exceptions to this rule, such as depreciable property, which includes assets such as vehicles, computers, heavy equipment, etc., are normally considered to be long-term capital assets. Nevertheless, they are taxed as short-term capital gains.
Computation of Capital Gains
Long-term Capital Gains
In the case of long-term capital gains, the value of profit made in each transfer is calculated by taking into consideration not just the profit made through the sale, but a multitude of other factors as well, such as the year in which the transferred property was purchased and the year in which the subsequent sale was made. In order to determine the value of long term capital gains, firstly one takes into consideration the full value of the sales consideration of the asset. To this amount, certain costs are deducted, these include- expenditure incurred wholly and exclusively in connection with transfer of capital asset (E.g., brokerage, commission, advertisement expenses, etc.), indexed cost of acquisition and indexed cost of improvement, if any.
Indexation is the process by which one accounts for the rise in the value of the asset concerned owing to inflation, on the basis of this the cost is adjusted. This benefit can be availed only for assets that fall in the category of long-term capital assets. The central government has also notified a “cost inflation index” which is a table of yearly rates to be taken into consideration when the relevant calculations are being made. Indexation takes into consideration, during computation, the year of acquisition, the year of transfer, the cost inflation index from the year of acquisition and the cost inflation index from the year of transfer.
Therefore, the formula is as follows:
Cost of acquisition × Cost inflation index of the year of transfer of capital asset
Cost inflation index of the year of acquisition
Similarly, the indexed cost of improvement on any long term capital asset is also calculated.
Exemptions to Long-term capital gains tax:
The first exemption to long term capital gains tax is for any individual or a Hindu Undivided Family wherein the sale of a residential house property is involved, provided that if such gains are used to purchase or construct another residential house, whether it involves the use of the whole amount or not. Furthermore provided that, any such new residential property should be purchased within one year prior to or two years after the date of transfer of the existing property. If there is construction involved, then the new house should be constructed within three years from the date of transfer.
Similarly, this exemption also extends to the same individual or Hindu Undivided Family wherein sale of any capital asset is involved, which is not residential property. Provided that if the net consideration is invested in purchase or construction of a residential house, here the time restrictions applicable are the same. This is conditional upon the fact that the taxpayer should not own any other residential property or house (in India) other than the new asset on the date of transfer. The exemption applicable will be in proportion to the amount invested in relation to the net sale consideration.
Another exemption is in cases where gains are invested in bonds of National Highways Authority of India and Rural Electrification Corporation, here the time limit applicable is six months from the date of transfer. However, the exemption is limited to Rs. 50 lakh in such a case. Furthermore, exemption up to Rs. 50 lakh can be claimed only in one financial year, even if the specified period of six months covers two financial years.
Calculation of exemption amount:
The exempt amount is calculated by dividing the amount invested with the net sale consideration and then multiplying that amount with the capital gain resulting from the transfer. In some cases, it is not always necessary for the capital gains to be reinvested or used immediately, even though they are required to be invested as per the timelines mentioned in Income Tax law, i.e. two/ three years from the date of transfer, it is possible that such investment may not be made before the due date of filing of return. This unused capital gain or net consideration can be deposited in a separate account maintained with a nationalized bank under the Capital Gain Account Scheme (CGAS). Such investment needs to be made before the due date of filing of return of income in order to claim exemption and should be utilised only for specified purposes within the stipulated time period. In case the amount deposited in CGAS is not utilised within the specified period, it shall be charged as LTCG of the year in which the time limit for making the requisite investment expires.
Generally, in the case of long term capital gains the amount of tax applicable is 20%, plus surcharge and cess as applicable, but in certain special cases, the gain may be (at the option of the taxpayer) charged to tax @ 10% (plus surcharge and cess as applicable). The benefit of charging long-term capital gain @ 10% is available only in respect of long-term capital gains arising on certain transfers such as transfer of securities listed in a recognised stock exchange in India, zero coupon bonds, etc.
Short Term Capital Gains
Short-term capital gains are calculated by deducting from the full value of consideration received upon transfer, the cost of acquisition, the cost of improvement and also by subtracting the expenditure incurred wholly in connection with the relevant transfer. Short-term capital gains are of two kinds; those that fall within the purview of S. 111A and those that do not.
Section 111A is applicable in case of gains arising on transfer of equity shares or units of equity oriented mutual-funds or units of business trust, from 1.10.2004 through a recognised stock exchange. This transaction is liable to securities transaction tax (STT). An equity oriented mutual fund is specified under section 10(23D) wherein it qualified that 65% of the invested funds, out of total proceeds are invested in equity shares of domestic companies. Such gain is charged to tax at 15% (plus surcharge and cess as applicable).
Short-term gains that are not covered by s. 111A include gains from sale of equity shares other than through a recognised stock exchange, sale of shares other than equity shares, gains on debentures, bonds and Government securities, capital gain from sale of assets other than shares/units like immovable property, gold, silver, etc. In such cases, amount of tax levied is calculated at normal rate of tax, which is determined on the basis of the total taxable income of the taxpayer.
Therefore, exemptions in short term capital gains tax are based on different income brackets, wherein a person whose income is below a certain level is exempt from paying this tax, this is known as the Basic exemption. The basic exemption limit applicable in case of an individual for the financial year 2016-17 is as follows : For resident individual of the age of 80 years or above, the exemption limit is Rs. 5,00,000. For resident individual of the age of 60 years or above but below 80 years, the exemption limit is Rs. 3,00,000. For resident individual of the age below 60 years, the exemption limit is Rs. 2,50,000. For non-resident individual irrespective of the age of the individual, the exemption limit is Rs. 2,50,000. For Hindu Undivided Family, the exemption limit is Rs. 2,50,000.
The law is clear and unambiguous when it comes to taxation. The various exemptions take into consideration exceptional cases wherein taxation may not be feasible or desirable. The legislative intent is clear, to provide a clear and systematic method whereby one can determine which category each asset will fall into and compute how much tax will be paid upon the sale of each of these assets. With the present law, that objective can be achieved, as it leaves little room for speculation.