How often have you encashed paper profit by selling capital assets that have appreciated
considerably, only to find your gains disappear into the taxman’s pocket because
you’ve paid little or no heed to tax-planning? Well, with the right tax tactics, you
can maximize your gains from such transactions. But first, get acquainted with some
capital gains jargon.
What is a capital asset?
A capital asset is property of any kind held by a person,
irrespective of whether it is connected with the business. However, this does not include:
a. Stock-in-trade, raw materials and stores held for
business purposes.
b. Personal effects, that is, movable property, including
clothes and furniture, but excluding jewellery for personal use.
c. Rural agricultural land
d. Gold Deposit Bonds issued under the Gold Deposit Scheme
1999.
Other specific exclusions from the term ‘capital
gains’ are only of academic interest, and are hence not discussed here.
Short- and long-term assets
A capital asset that is held for less than three years is
deemed to be a short-term asset. If sold, it attracts tax at the normal rates. An asset
that has been held for more than three years is deemed a long-term asset, and attracts tax
at concessional rates when sold.
However, in the case of securities such as equity or
preference shares, debentures, government issuings, and units of mutual funds and the Unit
Trust of India (UTI), the assets are deemed short-term if they are held for less than a
year. Conversely, these assets are deemed long-term if they are held for more than a year.
What are capital gains?
In simple terms, a capital gain is the profit from the sale
of a capital asset (including investments such as shares and bonds). The loss on the sale
of such assets is treated as a capital loss. A capital gain on the sale of an asset is
chargeable to tax as capital gains in the year in which it is sold. Note: under the Indian
Income Tax Act, capital gains are taxed on even the transfer of a capital asset, not
merely on sale. The word ‘transfer’ includes the following:
a. The exchange or relinquishment of an asset or the
extinguishment of any rights in an asset.
b. The acquisition of an asset.
c. The conversion of an investment into stock-in-trade.
This means, if you buy, say, shares as an investment, and later want to trade in them,
then on the day you make the change, you will have converted your asset into
stock-in-trade. The difference in the cost and the market price on the date of the
conversion is treated as capital gains in your hand. However, this capital gain is liable
to tax not in the year of conversion, but in the year in which the converted asset is sold
or transferred.
d. In the case of immovable property like land or a
building, the transfer is complete when possession is handed over to the buyer. Thus, tax
is payable on the gains when possession is handed over even if the sale deed has not been
executed or the property registered.
e. Any transaction which in effect transfers or gives the
benefits of immovable property, for instance, in cases where you buy shares in a
co-operative society.
Tax incidence
The rate of tax that applies on the sale of an asset
depends on:
a. The type of asset being sold, whether it is long term or
short term. This, of course, depends on the period of holding.
b. The cost of the asset.
c. Your income bracket.
Short- and long-term gains
Short-term gains arise on the sale of a short-term asset
and are taxed at the normal rates of tax at 10 per cent, 20 per cent or 30 per cent
subject to surcharge. Long-term gains arise on the sale of a long-term asset and enjoy a
few tax benefits, resulting in a lower incidence of tax.
a. Cost of acquisition: If the capital asset being
sold was acquired before 1 April 1981, you can substitute the actual cost of the asset
with its fair market value as on 1 April 1981 if it is beneficial to do so.
b. Indexation: You can further enhance the cost of
acquisition–thus reducing your capital gains–by factoring in the cost inflation
index for the year in which the asset is being sold. The cost inflation index is published
by the central government after taking into account the consumer price index of urban
non-manual employees for a particular year. The announcement is made in the Official
Gazette. The benefit of indexation, however, excludes debentures and bonds.
c. Lower rate of tax: The rate of tax is only 20 per
cent plus surcharge as compared with the normal rates of tax at 10 per cent, 20 per cent
or 30 per cent subject to surcharge.
Assessees enjoy a further benefit in the case of long-term
capital gains arising from the transfer of listed securities or units of the Unit Trust of
India (UTI) and other mutual funds. If the tax payable at the rate of 20 per cent (plus
surcharge) after claiming the benefits of indexation is more than the tax payable at 10
per cent (plus surcharge) without indexation, the tax payable is now to be restricted to
10 per cent (plus surcharge).
How are capital gains computed?
Money received for the transfer
Less: Indexed cost of acquisition (calculated by
factoring in the cost inflation index for the year in which the asset is being sold).
Less: Indexed cost of improvement of the asset.
Less: Expenses incurred in the transfer (like
brokerage and legal expenses).
In cases where you have claimed depreciation on the asset,
the ‘written down value’ (the sum available after deductions for depreciation
each year) is to be taken as the cost of the asset while calculating capital gains. The
balance is the gross capital gain/loss. Deduct from this amount the permissible
exemptions, and the balance is your net gain/loss, chargeable to tax.
How does indexation work?
Let’s explain this with an example. If you had bought
an asset during financial year 1981-82 for Rs 40 lakh, and sold it in 1993-94 for Rs 1
crore, your capital gains will not be Rs 60 lakh. This is because you have to factor in
the cost inflation index in 1993-94, which is 244. Therefore, your net capital gain will
be:
| Cost in 1981-82 (base year, when cost
inflation index is 100) |
Rs 40 lakh |
| Cost inflation index in 1993-94 when the asset
was sold |
244 |
| Therefore, cost after factoring in the cost
inflation index on the sale price of Rs 40 lakh (Rs 40
lakh x 244/100) |
Rs 97.6 lakh |
Net capital gain (Rs 1 crore minus Rs 97.6
lakh)
|
Rs 2.4 lakh
|
The benefit of the cost of inflation index is also
available in the case of cost of improvement, but in this case, indexation is applicable
from the year in which the improvement is effected. For instance, let’s take a case
in which you buy an asset in 1981-82 for Rs 10 lakh and spend Rs 12 lakh to improve it in
1987-88. If you sell the asset in 1996-97 and incur brokerage and legal expenses of Rs 2
lakh, your cost of acquisition and cost of improvement will be indexed as follows:
a. Indexed cost of acquisition (index for 1996-97 = 305;
index for 1981-82 = 100) 305 x 10 lakh/100: Rs 30.5 lakh
b. Indexed cost of improvement (Index for 1987-88 = 150)
305 x 12 lakh/150: Rs 24.4 lakh
Your capital gains will thus be calculated as:
| Sale proceeds |
Rs 60.0 lakh |
| Less: |
| i) Indexed cost of acquisition |
Rs 30.5 lakh |
| ii) Indexed cost of improvement |
Rs 24.4 lakh |
| iii) Expenditure Rs |
2.0 lakh |
| Total |
Rs 56.9 lakh |
| Capital gains (Rs 60 lakh - Rs 56.9 lakh) |
Rs 3.1 lakh |
