This article is written by Maanvi Jain of ILS Pune.

Capital Gain

Any profit or gain that arises from the sale of a ‘capital asset’ is a capital gain. This gain or profit is considered as income and hence charged to tax in the year in which the transfer of the capital asset takes place. This is called capital gains tax, which can be short-term or long-term.

Capital Asset

A capital asset has been defined under Section-2(14) of the Income Tax Act.

It includes-

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

Some examples of capital assets are land, building, house property, vehicles, patents, trademarks, leasehold rights, machinery, and jewelry.

Certain Things are Not Considered Capital Asset

There are certain things which are not considered as capital assets.

• Any stock, consumables or raw material, held for the purpose of business or profession
• Personal goods such as clothes and furniture held for personal use
• Agricultural land in rural India
• 6½% gold bonds (1977) or 7% gold bonds (1980) or national defense gold bonds (1980) issued by the central government
• Special bearer bonds (1991)
• Gold deposit bond issued under the gold deposit scheme (1999)

Long Term Capital Gain

Section-29A and Section-29B of the Income Tax Act, 1961 define the long-term capital asset and long-term capital gain respectively.

• “Long-term capital asset” means a capital asset which is not a short-term capital asset.
• “Long-term capital gain” means capital gain arising from the transfer of a long-term capital asset.

Long-Term Capital Assets

An asset which is held for not more than 36 months or less is a short-term capital asset.    This criteria of 36 months have been reduced to 24 months in the case of immovable property like land, building, and house property, from the financial year(FY) 2017-18. However, there is no change for movable property such as jewelry, debt-oriented mutual funds etc.                                                                                                                      Hence, an asset that is held for more than 36 months is a long-term capital asset.

Some assets are considered short-term capital assets when these are held for 12 months or less. This rule is applicable if the date of transfer is after 10th July 2014 (irrespective of what the date of purchase is).                                                                                     The list of such short-term capital assets is given below.              

• Equity or preference shares in a company listed on a recognized stock exchange in India
• Securities (like debentures, bonds, govt securities etc.) listed on a recognized stock exchange in India
• Units of UTI, whether quoted or not
• Units of an equity oriented mutual fund, whether quoted or not
• Zero coupon bonds, whether quoted or noWhen the above-listed assets are held for a period of more than 12 months, they are considered as a long-term capital asset.  

Calculation of Long-Term Capital Gains

Start with the full value of consideration

Deduct the following from full value consideration:

• Expenditure incurred wholly and exclusively in connection with such transfer
• Indexed cost of acquisition
• Indexed cost of the improvement
• From this resulting number, deduct exemptions provided under sections 54, 54EC, 54F, and 54B

This amount is a long-term capital gain.

The terms mentioned herein are defined as under :

• Full value consideration – The consideration received or to be received by the seller in exchange for his assets, which he has transferred. Capital gains are chargeable to tax in the year of transfer, even if no consideration has been received.
• Cost of acquisition-The value for which the capital asset was acquired by the seller.
• Cost of improvement – Expenses incurred to make improvements to the capital asset by the seller.

Indexed Cost of Acquisition/Improvement

Cost of acquisition and improvement is indexed by applying CII (cost inflation index). It is done to adjust for inflation over the years. This increases one’s cost base and lowers the capital gains.

Indexed cost is calculated as:

Inflation-indexed cost price is = Actual/Original price *(CII for the year of sale/CII for year of purchase).

Illustration:

For an asset purchased in 2002 for Rs. 10,000 and sold in 2014, the inflation-indexed cost price will be calculated as:

(Rs 10,000 *(240 / 105)) = Rs 22,857(Approx.)

Given that CCI for 2002 is 105 and CCI for 2014 is 2401. The list for revised CCI is given on the government website of Income Tax of India.

Change in Long-Term Capital Assets after Budget, 2018

Applicability of Long-Term Capital Gain

The new long-term capital gains (LTCG) tax regime will be applicable to individuals selling these three things:

• equity or
• equity mutual fund (MF) units or
• even units of a business trust.

Section-10(38) of the Income Tax Act, 1960 lays down an exception and exempts tax on the transfer of long-term capital assets of equity shares, equity-oriented mutual funds and unit of business trust in certain situations.

Consequences of the New Tax Regime

From henceforth, both the security transfer tax as well as the Long-Term Capital Gain will apply. Hence, the investor will have to pay two taxes.

Rules for Calculation of Long-Term Capital Gain

The following are the rules for the calculation of LTCG :

• Purchase and sale before 31/1/2018– Exempt under Section 10(38)
• Purchase before 31/1/2018 and sale after 31/1/2018 but before 1/4/2018- Exempt under Section 10(38)
• Purchase before 31/1/2018 and sale on or after 1/4/2018 – LTCG will be applicable but not on gains accrued before 31/01/2018 (the cost of acquisition or the fair market value whichever is higher is taken from 31/01/2018 for the calculation of LTCG).
• Purchase after 31/1/2018 and sale on or after 1/4/2018- LTCG will be applicable.

A Method of Determining the Cost of Acquisition (“COA”)

Cost of Acquisition of such investments has been specifically laid down according to which the cost of acquisition of such investments shall be deemed to be the higher of these two costs:

• Cost of acquisition before 31/01/2018 or
• The fair market value on 31/01/2018.

Capital Gain/ Loss = Sale Price – Revised Cost of  Acquisition on 31.1.2018.

In this way, the capital gain will be less, and the tax levied will also be less.

Illustrations that explain how Long-Term Capital Gain is to be calculated

These are certain illustrations that help to understand the calculation of  LTCG.2

• When an acquisition (CA) is done before 31st January 2018 at a value less than the fair market value (FMV) on 31st January 2018 and is sold (S.P) on 1st April 2018 at a higher prize than acquisition prize and fair market value, then  

S.P- FMV= LTCG  

• When an acquisition(CA) is done before 31st January 2018 at a value less than the fair market value(FMV) on 31st January 2018 and S.P on 1st April 2018 is also lower than fair market value, then

FMV=S.P

S.P- S.P= 0 = LTCG

• When an acquisition(CA) is done before 31/01/2018 at a value more than the fair market value(FMV) on 31st January 2018 and is sold(S.P) on 1st April 2018 at a higher price than acquisition price, then  

S.P- CA = LTCG

Further, the FMV would be the highest price quoted on the recognized stock exchange on 31 January 2018. In case there is no trading of the said asset in such stock exchange, the highest price on a day immediately preceding 31 January 2018 shall be considered to be the FMV.

Exemption Under the Said Rule

• The new LTCG tax of 10% would be levied only on LTCG of an individual exceeding Rs 1 lakh in one fiscal. For example, if an individual’s LTCG is Rs 1,30,000 in the Financial year (FY) 2018-19 from these two instruments then only Rs 30,000 will face the new LTCG tax.
• When a property is received on inheritance or as a gift, it is not taxable for the receiver.

When the capital from the property is used to purchase or construct another house3.

• The assessee ( an individual or HUF but not a company or firm) is exempted when he buys a residential property and not a commercial property.

It is irrelevant whether he resides there or not.

• The house should be bought before one year or after two years of transfer of the original asset. If more than one house has been bought exemption will be towards only one house. Flats in the same building will be considered one house if treated as one residential unit4. The date of taking possession is considered for the above clause and not the date of registration of title deed.5
• The house should be constructed within three years of transferring the original asset. The date of commencement of construction is irrelevant provided it is completed within the stipulated period.6
• If the amount of capital gain is more than the cost of ‘new asset’: Capital gain charged to tax = Capital gain – Cost of ‘new asset’. Such capital gain is charged under section 45 in the previous year of transfer of the ‘original asset’.
  • If the amount of capital gain is not more than the cost of ‘new asset’: Capital gain charged to tax = Nil. (this method of calculation is also applicable to S-54B)
• An exemption granted under this section is withdrawn when the ‘new asset’ is transferred within 3 years of its purchase or construction.
  • Capital gain charged to tax = Capital gain on transfer of ‘new asset’.
  • Cost of acquisition – For this purpose, cost of acquisition of ‘new asset’ = Actual cost of acquisition of ‘new asset’ – Capital gain exempted earlier under this section.

Tax exempted when capital gain used to purchase agricultural land.7

• The asset (long term or short term asset) transferred by an individual assessee (not a HUF, firm or company) should be an urban land (not rural as not within the meaning of “capital asset” under S-2(14)) which was being used by assessee or his parents for agricultural purposes for a period of 2 years immediately preceding the date of its transfer.
• The ‘new asset’ can either be rural or urban agricultural land provided it is acquired within two years of the transfer of the ‘original asset’.
• The amount of capital gain arising on transfer of ‘original asset’ to the extent it is not utilized by the assessee for the purchase of ‘new asset’ before the due date of furnishing return of income under section 139(1), should be deposited before the due date of filing return under section 139(1).

Account – The deposit should be made in the Deposit Account in any branch (not being a rural branch) of a public sector bank in accordance with the Capital Gains Accounts Scheme, 19888.

The amount deposited within the specified time limits and conditions is deemed to be utilized for acquiring ‘new asset’. Therefore, in such a case the cost of ‘new asset’ = Amount already utilized for acquiring ‘new asset’ + Amount deemed to be so utilized under the scheme. Thus, capital gain chargeable to tax is computed as above after taking such adjusted cost of ‘new asset’.

When the deposit is not utilized within the prescribed time limit, capital gain charged to tax = Amount not so utilized. Such capital gain is charged under section 45 for the previous year in which the period of two years from the date of transfer of ‘original asset’ expires. In such a case, the assessee is entitled to withdraw the deposit in accordance with the scheme.

(This provision is also applicable to Section-54)

Capital gains which arise from the transfer by way of compulsory acquisition (the power of government to acquire any rights in the private property of an individual) under any law may be exempted from tax.

The capital asset (long term or short term) may be any land or building used by an assessee for business or industrial undertaking for at least two years previous to the transfer.

The capital gains to be exempted from tax should be utilized for purchasing any land or building or rights in any land or building for the purpose of (a) shifting or re-establishing the said undertaking, or (b) setting up another industrial undertaking. It should be constructed within three years from the date of transfer.

Advantages Of The New Regime Under Budget, 2018

• The higher of the two- Cost of Acquisition or Fair market value is taken. Hence the amount of capital gain is less and hence the tax levied will also be less.

• • A person selling after 31st January 2018, only the actual gains after 31st January 2018 will be taxed.
• The government can compensate the less GST collected by collecting these taxes.
• Long-term Capital Loss (LTCL) – Long-term capital loss arising from the transfer made on or after 1st April 2018 will be allowed to be set-off and carried forward in accordance with existing provisions of the Act. Therefore, it can be set-off against any other long-term capital gains and unabsorbed loss can be carried forward to subsequent eight years for set-off against long-term capital gains.

Disadvantages of the new regime under Budget,2018

• Both the Security Transfer Taxes and the Long Term Capital Gain are levied deterring the domestic as well as foreign investors from investing.
• The benefit of indexation of the cost of acquisition for calculating the new tax regime will no longer be applicable
• The property inherited is not taxed is a misconception. When the inheritor or the receiver of this gift of property, sell it, capital gains on the sale are taxable for the inheritor. The capital gain may either be long term or short term depending on whether the house was held for 36 years or more. The calculation of the long-term capital asset will be done by taking the cost of acquisition paid by the owner. It may be your father or your grandfather from whom he also inherited the property. The cost of acquisition can either be that or the fair market value on 31st January 2018 whichever is higher.
• Long-term capital loss (LTCL) –  As the exemption from long-term capital gains under clause (38) of section 10 will be available for the transfer made between 1st February 2018 and 31st March 2018, the long-term capital loss arising during this period will not be allowed to be set off or carried forward.

Endnotes

1. Refer here for the revised list of CII- https://www.incometaxindia.gov.in/charts%20%20tables/cost-inflation-index.htm
2. https://www.incometaxindia.gov.in/Lists/Latest%20News/Attachments/216/FAQ-on-LTCG.pdf
3. Section-54 of the ITA,1960.
4. Addl. Commissioner of Income Tax, Delhi-II vs. Vidya Prakash Talwar (30.04.1981 – DELHI): MANU/DE/0082/1981.
5. Commissioner of Income Tax vs. Shahzada Begum (21.03.1988 – APHC): MANU/AP/0061/1988.
6. Commissioner of Income Tax vs. J.R. Subramanya Bhat (09.06.1986 – KARHC): MANU/KA/0053/1986.
7. Section-54B of the ITA,1960.
8.  {GSR No. 724(E), dated 22nd June 1988}.