Earnings or gains create from the transfer of capital asset such as shares; bonds, mutual funds, real estate, gold, etc. are counted as capital gain. So, you need to have disclosed the profits in income tax returns (ITR) and pay tax on these gains.
Such gains are of two types—short term capital gain (STCG) and long term capital gain (LTCG) depending on the period of holding of an asset. Therefore, STCG and LTCG are taxed at different rates as per the income tax laws.
What is capital gain tax?
An investor or individual or company is liable to pay tax after selling an asset. But, only if you hold an asset with appreciating the value and do not sell it, then you do not have to pay capital gains tax.
Therefore, anyone who sells a capital asset must know that capital gains tax may apply on it. Actually, this capital gains tax is a government income on the profit that you made from selling certain types of assets.
Capital gain tax is applicable to any asset that rises in value over time – shares, bonds, mutual funds, real estate property, commercial space, etc.
In the Union Budget 2018-19, a significant reform made in Capital Gains tax on shares. All these rules are has been affected from February 1st, 2018.
Short term capital gain (STCG)
An investor if holds a stable asset for less than 36 months and sell it then it would be considered as a short term capital gain. However, now limit isn’t similar for stocks and bonds. Consequently, stocks, bonds or shares are faster-moving compared to real estate. Therefore, STCG occurs when you have owned a stock for a year or less before sale.
STCG rule is applicable only to shares and securities which are listed and also traded on the stock exchange. If you are trading unlisted, over-the-counter securities (OCT trade), off-exchange trading then the 36-month rule applies.
In India under section 111A of the Income Tax Act., tax rates for short-term capital gains are 15%. This section includes equity, shares, bonds, equity-oriented mutual-funds, and units of a business trust.
However, debt-oriented mutual funds and preference shares do not come under this section 111A. Therefore, the gains from these kinds of funds and shares added to the regular income and taxed according to normal individual income tax laws.
How to calculate short term capital gain tax?
Let’s have an instance to understand how to calculate STCG for equity shares.
Mukul Roy bought equity shares of Rs. 2 lakhs in January 2018 He sold the shares after 9 months on October 2018 at Rs. 2.8 lakh.
So, let us calculate the short-term capital gains tax in this transaction in the following way. Assume that the brokerage rate is 0.5% in this case.
Capital Gain = Selling price – (Brokerage at 0.5% + Buying price) = 280000 – (1400+200000) = Rs. 78600
Therefore, Short-term capital gains tax = (Short-term capital gain x STCG Tax rate) / 100 = (78600 x 15) / 100 = Rs. 11790
Long term capital gain (LTCG)
According to the Income Tax law, any stable asset that you hold before sale for more than 36 months or 3 years is considered as long-term capital gains.
However, in the case of stocks, bonds, and shares this tenure is more than 12 months instead of 36 months. Likewise, any unlisted securities or over-the-counter securities fall under LTCG only if you sold after 36 months.
Most importantly, due to the extended holding time inflation is a critical determinant while computing LTCG. Therefore, it depends on the current Cost Index Inflation (CII).
So, LTCG formulated as below.
Indexed Cost of Acquisition = (Actual buying price) * (CII of year of sale)/ (CII of Year of buying).
Therefore, Capital Gain = (Sale Price – Indexed Cost of Acquisition).
Long Term Capital Gains Tax = 20% of Capital Gain
Note: On the other hand, if the transfer/selling price of the capital asset is less than the buying price, then it will be termed as – loss under the head capital gains. So, depending on your asset holding period, it would be the long-term capital loss (LTCL) or short-term capital loss (STCL).
What is the cost inflation index (CII)
Cost Inflation Index (CII) is fixed and is declared every year by the government. CII is used to calculate year-by-year the estimated increase in the valuation of assets and goods due to inflation.
What is indexation?
Indexation is a process in which the price of an asset adjusted with the rise of inflation. So, it is very significant because the value of asset or goods never remain flat and varies with time. Assuredly, the computation of capital gain based on the original price is not the actual measure of profit. So, indexation takes into account inflation and provides the most reasonable figure for long-term capital gains.
Tax on long term capital gain
In India long term capital gains fall under Section 10(38) of the IT Act. LTCG was not taxable for all the gains made on or before 31st January 2018. But, LTCG taxation reforms after the Union Budget 2018-19.
Therefore, earlier exempted LTCG tax on equity shares, equity-oriented mutual-funds are subjected to tax without indexing if the amount of gain exceeds Rs.1 lakh.
Consequently, as per government rule, 10% tax is imposed at present on such long term capital gains. So, this implies that all the capital gains that more than Rs.1 lakh will be charged at 10% tax rate without any inflation indexation benefit. Further, this tax will be applicable shares sold after 1st April 2018.
Now, in the case of debt-oriented mutual funds, preference shares are subject to general LTCG tax rules. So, here you have to pay 20% tax for no-equity assets after inflation indexation and 10% tax without indexation.
The indexation rule increases buying price. Therefore, the capital gain decreases. So, you can apply the indexation formula to the buying price and calculate its 20% tax. Otherwise, you can calculate the 10% tax without indexation. After that, you have to select the tax slab that is the lower of the two.
Period of holding for capital assets (as on FY 2018-19)
|Asset||Period of Holding|
|Short Term||Long Term|
|Immovable Property (house, land)||Less than 2 year||More than 2 year|
|Movable Property (gold/jewelry)||Less than 3 year||More than 3 year|
|Equity Shares (Listed )||Less than 1 year||More than 1 year|
|Equity Shares (Unlisted )||Less than 3 year||More than 3 year|
|Equity Oriented Mutual Funds||Less than 1 year||More than 1 year|
|Debt Oriented Mutual Funds||Less than 3 year||More than 3 year|
|Bonds||Less than 3 year||More than 3 year|
Short term capital gain vs. long term capital gain:
So, here are the basic differences between short term and long term capital gains.
|Parameters||Short-term Capital Gain||Long-term Capital Gain|
|Related to||Short term capital assets||Long term capital assets|
|Time Duration of asset holding||Less than 12 months for listed shares and 36 months for regular assets||More than 12 months for listed shares and 36 months for regular assets and|
|Rate of taxation||15% (As per FY. 20018-19)||20% (this tax rate is subject to change as per the application)|
In conclusion, the capital gain is one of the crucial factors in income tax computation according to the income tax act. Now, the most crucial thing about capital gain is to understand the difference in duration of asset holding.
Short term capital gains and long term capital gains both are chargeable to tax as per IT act. Inflation rate also takes part in long term capital gain calculation.
Therefore, we need to have sufficient knowledge of capital gain, STCG, and LTCG before start investing in any kind of financial instrument.
Hopefully, this article is helpful. Please send your valuable feedback.