What Is Capital Gains Tax In India: Types, Tax Rates, Calculation, Exemptions And Tax Saving

Capital Gain Taxes in India have come to play an integral role in financial planning but first investors need to understand what financial assets are. Financial investments are assets that provide investors with opportunities to grow their money. However, investors must understand that all investments may not produce the same results. Some investments earn more income than gains, while others do the opposite. Thus, it is crucial to balance your portfolio through diversification. You must be careful when investing and set clear financial goals. Defining your investment objectives allows you to align your investments and their returns. These returns may come either through income or gains.

Difference Between Gains And Income

An asset can produce revenue or income. When you invest, the returns can be earnings (interest) or growth (capital gains or dividends). Some assets offer both - income and gains.

The following comparison of income and gains shows how they impact returns from your investments: 

Recently, Budget 2024 made some headlines with changes in capital gain taxes. It has some crucial announcements, which can affect the investment planning of investors. Let’s discuss these amendments in detail.

What Are Capital Gain Taxes?

Understanding capital gain taxes starts with the question of what capital assets are.

Capital assets can be understood with the help of certain characteristics such as orientation of the investment, income and gains attractiveness, marketability etc.  There are several types of capital assets, such as house property, land, rights, patents, jewellery, market securities, paintings, etc.

Capital gain is the positive difference between the purchase and sale/transfer price of such capital assets. Capital gains is a taxable income, so assets acquired in the previous fiscal year qualify for taxation during the ongoing financial year. 

The Income-tax Act, 1961, also lists certain assets which are not considered as capital asset under Section 2(14) as follows:

i) Stock-in-trade, consumable goods or raw materials for business purposes

ii) Personal effects - movable properties for personal use like clothes, paintings, etc.

iii) Agricultural land as per the jurisdiction of the municipal corporation.

iv) Specified gold bonds in the act¹.

Classification Of Capital Gain Taxes

The capital gain taxes are classified based on the holding period of the concerned asset before its transfer or sale. In the Budget 2024, this classification was changed for some assets. Accordingly, gains from the transfer or sale of an asset can be classified as a short-term capital gain or a long-term capital gain.

• Short-term Capital Gain

For listed assets like equity shares, the holding period has to be less than 12 months to be classified as a short-term capital gain². This period is 24 months for assets like gold, bonds and debentures. For any other unlisted assets and immovable property (house, land, building, etc), this period is kept unchanged at 24 months. A short-term capital gain tax is applicable on the same. 

• Long-term Capital Gain

Gains from equity or equity-oriented funds having a holding period of more than 12 months are known as long-term capital gains. Gains from other assets with holding periods of more than 24 months are classified as long-term capital gains.

Capital gain tax classification of inherited assets is done by accounting for the period when the asset was held by its previous owner. These assets are inherited or received in a will or gift. The holding period for assets like bonus shares transferred by the company to existing shareholders will be classified based on the date of allotment.

Capital Gain Tax Rates In India

As per the recent amendments in Budget 2024, the short-term and long-term capital gain taxes will be as follows:

*Indexation refers to the technique of accounting for the effect of inflation. It determines the acquisition prices after considering the inflation index.

These changes were amended in the recent Finance Act, 2024. The rates are increased compared to the previous tax rates. The primary motive behind the increase in short-term capital gain taxes for equity and equity-oriented funds was to reduce volatility in the market. According to the government, the reduced tax is solely enjoyed by the high net worth individuals (HNIs).

How To Calculate Short-Term Capital Gains Taxes?

For example, an investor purchased listed equity shares worth INR 70,000/- in July 2023. However, assessing the market conditions, these shares were sold at INR 80,000/- in February 2024, within 12 months. 

Thus, it will be considered a short-term capital gain of INR 10,000/-.

Tax liability on this short term capital gain = 10,000 * 20% = INR 2000/-

How To Calculate Long-Term Capital Gains Taxes?

An investor purchased listed equity shares worth INR 25,000/- in December 2022. However, he sold these shares in February 2024, at INR 40,000/-. This holding period is more than 12 months. In this situation, it will be considered a long-term capital gain of INR 15,000/-

However, long-term capital gains less than INR 1.25 lakhs are tax-exempted. So, the tax liability in this case would be nil.

Now, let us take another scenario:

An investor purchased some listed bonds of INR 5 lakhs in May 2020. However, she sold them in January 2024 at INR 8 lakhs. This holding period is more than 24 months.

In such a situation, it will be considered long-term capital gain of INR 3 lakhs.

This gain is more than the limit of INR 1.25 lakhs. So, tax liability in this case would be INR 3,750.

Effect Of Increased Capital Gains

Investors are worried due to the change in tax rates. The increased taxes on equity and debt mutual funds can negatively impact the overall investor sentiment, as in recent years, mutual funds have become a preferred investment option. 

Changes were also made regarding the term ‘Specified Mutual Fund’. Due to this, the tax rules on debt mutual funds were changed. The term now includes only the mutual funds that allocate more than 65% of its funds in debt and money market instruments. Moreover, the indexation benefit on debt mutual funds was removed.

Deductible Expenses

Investors can claim certain deductions from their capital gain which can potentially lower their tax liability.

1. House Property Sale: Deduct these expenses from the total sale price:

• Brokerage, commission or stamp paper cost.
• Travelling expenses for any transfer procedure.
• For inherited property- expense related to will, succession certificate, executor, etc. (in some cases)

2. Sale of Shares: Only the broker’s commission, no Security Transaction Tax (STT).

3. Sale of Jewellery: Cost of any broker’s service is deductible.

Indexation Removed

Indexation helps investors determine the effect of inflation on their purchase price. It is processed with the help of the Cost Inflation Index (CII) in India. The indexed cost of acquisition/improvement reduces the final gain amount for taxation purposes. In Budget 2024, this indexation benefit was removed for all the asset classes.

The inflation index is calculated with the help of CII. For example:

Purchase period = January 2022. 

Sale period = March 2024

Purchasing year CII = 317

Sale year CII = 348

Inflation Index = Sale year CII/ Purchase year CII

Thus, inflation index = 1.09 (348/317)

Indexation and norm changes in debt mutual funds confused investors, and the question often asked was - How will this change in income tax rule affect the taxation of debt mutual funds?

Let’s understand this with a brief hypothetical example:

Similarly, indexation benefit removal affected the immovable properties as indexed costs reduce significant gains for taxation. However, after discussions in the Lok Sabha, amendments were made to provide an option to pay with long-term capital gain with or without indexation as per old and new tax rates.

Let us understand it with this example:

Ther has been a substantial increase in the tax liability after the indexation effect when it comes to property as an investment option. An investor must therefore thoroughly evaluate before choosing between the new and old schemes. 

Property investors can also claim exemption benefits on capital gains tax payments. Some exemptions are as follows:

• Section 54: Exemption on sale of house property on purchase of another house property (Exemption up to INR 2 crore capital gain)³
• Section 54B: Exemption on capital gains from transfer of land used for agricultural purposes. (It can help in saving taxes upon the sale of an agricultural land.)
• Section 54D: Capital gains on the transfer of land and building used for the industrial undertaking.
• Section 54F: Exemption on capital gains on the sale of any asset other than a house property (These gains can be from any property other than one for residential purposes).
• Section 54EC: Exemption on sale of house property upon reinvesting in specific bonds. (Provided this investment is less than INR 50 lakhs)⁴

When Can You Invest In A Capital Gain Account Scheme?

Capital gain account scheme, 1988 helps investors claim exemptions on capital gains on a property. Under the scheme, investors can deposit their gains from agricultural land in the capital gain account scheme to avail exemption benefits. The account should be opened before filing the income tax return. 

Takeaway

Capital gain taxes affect the investments of an investor. Understanding the classification of short-term capital gain taxes and long-term capital gain taxes helps determine the tax liability. The recent changes in Budget 2024 for capital gain taxes are crucial for understanding and planning one’s overall investment portfolio. To keep yourself updated with more personal finance related topics Sign up now to Grip Invest.

References:

1. The Income Tax Act, 1961 <https://tinyurl.com/incometaxact1>

2. Memorandum Explaining The Provisions In The Finance Bill, 2024 <https://tinyurl.com/thefinancebill>

3. The Income Tax Act, 1961<https://tinyurl.com/incometaxact1>

4. The Income Tax Act, 1961<https://tinyurl.com/incometaxact1>

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