The long and short of capitals gains tax

The long and short of capitals gains tax

Sold your mutual fund units, gold or house property? Understand how the gains and losses are taxed

With the Union Budget 2020-21 just a few days away, pre-Budget expectations are running high. Calls for a reduction in tax rates and increase in section 80C exemption limit are annual rituals. But the wish-list this year features an additional demand – abolition of long-term capital gains (LTCG) tax on equity and equity-oriented instruments imposed in the financial year 2018-19. Whether Finance Minister Nirmala Sitharaman accedes to this request on 1 February or not remains to be seen. On your part, you would do well to be aware of how gains – long and short – made on sale of capital assets, are taxed.

Know your capital assets and indexation

As per the Income Tax rules, any asset you own – whether or not it is connected to your business or profession – qualifies as a capital asset. This includes stocks, mutual fund units, bonds, company fixed deposits, gold and house property. Likewise, your jewellery or art collection will also be bracketed in this category. However, if you are a businessperson, any stock-in-trade, consumable stores or raw materials will not be treated as capital assets. Agricultural land in a rural area, subject to certain parameters, is also not termed a capital asset.

Any gains arising out of the sale of a capital asset are subject to capital gains tax. However, the taxable gains in some investments factor in indexation – the effect of inflation on your purchase price. Put simply, indexation is a tax facility that recognises that the price at which you had bought the asset years ago (cost price) would get inflated over the years because of inflation. The indexation facility pushes up your cost price, notionally only though, so that the gains (selling price less cost price) are lower than the actual amount. This softens the taxation blow.

On the other hand, if you have incurred a capital loss, you can set it off against capital gains made on other capital assets. However, while short-term losses can be set off against both long-term and short-term gains from any capital asset, long-term losses can be set off only against long-term capital gains. Your holding period determines whether you pay short or long-term capital gains. This threshold is different across asset classes.

Equity investments

The asset class includes equity and equity-oriented mutual funds, which are all subject to the same set of capital gains tax rules. The holding period for your equity investment to be considered long-term is one year. If you sell your holdings before one year, any profit made will be termed short-term capital gains (STCG). The current STCG tax rate is 15 per cent.

If sold after one year, the capital gains of over Rs 1 lakh will be subject to 10 per cent LTCG tax plus cess, without indexation benefits. However, the computation is not simple, thanks to the grandfathering provision introduced along with the tax.

For one, if the total aggregate gains made from the sale of your equity investments do not exceed Rs 1 lakh during a financial year, you will not have to pay any tax. Then, there is the grandfathering clause that ensures that the fair market value – that is, highest traded stock price or net asset value of your equity mutual fund units – as on January 31, 2018 (or stock price as on last traded date) will be considered as the cost of acquisition for computing LTCG. “However, if your actual cost of purchase is higher than your equity asset’s fair market value as on 31 January 2018, the former will serve as the cost of acquisition,” says chartered accountant Karan Batra, Founder and CEO, Chartered Club (see table).

If you hold unlisted shares of a company, the minimum holding period to qualify as a long-term capital asset will be two years. Any gains made after this period will be taxed at the rate of 20 per cent plus cess, after indexation.

Debt instruments

For debt and debt-oriented mutual fund units to acquire the long-term capital asset label, they have to be held for at least three years. If you sell it within three years, the profit will be considered short-term gains, added to your taxable income and taxed as per the slab rate applicable to you. LTCG tax rate is 20 per cent plus cess, with indexation benefits. Indexation takes into account the effect of inflation every year, notionally pushing up the cost of your acquisition, thus reducing the LTCG and tax to be paid on it.

If you hold listed tax-free bonds and trade them within one year of acquisition, the appreciation will be considered short-term in nature. They will be simply added to your income and taxed accordingly. If held for more than one year, the profit will be subject to LTCG tax of 10 per cent plus cess, without indexation benefits. However, interest earned will not be subject to any tax. Listed corporate bond holdings, too, acquire long-term status after one year. Interest earned, though, is subject to tax. For unlisted bonds, the relevant holding period to be considered long-term is three years. LTCG is taxed at 20 per cent plus cess, with indexation.

House property or land

In the case of immovable properties such as house or plot of land, the holding period to be bracketed as a long-term capital asset is two years. Any profits made on the sale will attract a 20 per cent LTCG tax, after indexation (see table).

Now, this entire LTCG can be tax exempt, courtesy provisions under section 54. “If you have purchased a residential house one year before the date of sale or transfer of the house in question, the exemption will apply. Likewise, if you buy another residential property within two years of the sale or transfer of the original one. In case you are constructing a house, this period gets extended to three years,” explains Archit Gupta, Founder and CEO, ClearTax. This benefit is available only to individuals or Hindu Undivided Families (HUFs), provided the new residential property is located in India. “The amount of exemption will be the lower of capital gains arising on transfer of residential house and investment made in purchase or construction of a new residential house property,” adds Gupta. Any balance amount will be taxed. Also, starting 2019-20, you can use the gains to acquire more than one house, provided the amount does not exceed Rs 2 crore. “However, this option can be availed only once in a lifetime,” points out Gupta.

The exemption can be claimed by investing the gains in certain specified long-term bonds, redeemable after five years, issued by the National Highways Authority of India or the Rural Electrification Corporation Limited (REC). You have make the investment within six months from the date of transaction.

Section 54GB offers yet another tax-free exit route. If such capital gains are invested in small or medium enterprises, they will not be taxable. Union Budget 2019-20 extended this benefit to start-ups entitled for the same under this section. “If you subscribe to 50 per cent or more equity shares of eligible startups, then tax on long term capital gains will be exempt provided that such shares are not sold or transferred within five years from the date of its acquisition,” explains Gupta. The start-ups will also be required to use the amount to purchase assets and cannot transfer asset purchased within five years from the date of its purchase.

Gold

Capital gains tax treatment for gold – physical as well as gold ETFs – is largely similar to that of debt instruments. While interest earned on sovereign gold bonds is taxable, capital gains on redemption at maturity are exempt. If you sell these bonds through the exchanges after three years, however, LTCG tax with indexation will come into play. If traded within three years, the gains, if any, will be added to your income and taxed at the applicable marginal tax rate.

Happy Investing

Source: Moneycontrol.com