Capital Gain is the profit earned when an individual sells his own capital asset(s) for a price more than the purchase price. And the capital gain tax is charged on the gain or profit as it is termed as income. In this blog, we shall discuss what capital asset and capital gain tax are and how to calculate it.
What do you mean by Capital Gain?
The gain or profit raised during the sale of a capital asset is called capital gain. This profit is considered as income and therefore, is tax chargeable. The tax is chargeable in the year in which the capital transfer takes place. Notably, the capital gain tax is not applicable when the capital is inherited by the means of gift or will.
What are Capital Assets?
The business asset includes any kind of asset held by an individual. This asset may or may not be related to his business or profession. The examples of capital assets can be land, house property, jewelry, vehicle, machinery, building etc. The following assets are not called as capital asset:
- Any consumable or raw material, stock, etc. held for business or profession purpose.
- Personal goods – furniture or clothes held for personal use.
- Agricultural land in the rural parts of India.
- Gold bonds issued by the central government- 6 ½ % gold bonds (issued in 1977), 7 % gold bonds (issued in 1980), and national defense gold bonds (issued in 1980).
- Special bearer bonds
- Gold deposit bonds
What are the types of Capital Assets?
The capital assets are of two types – short-term capital assets and long-term capital assets. The short-term capital assets are not held for more than 3 years (36 months). The criterion of 36 months is reduced to 24 months for the immovable property, such as land, building, etc. from 2017-18. For example, if you sell your capital asset after holding it for 24 months, the income raised from it in the forms of profit will be treated as long-term capital gain.
Long-term capital assets are the ones which are held for more than 36 months by an individual. The aforementioned 24 months criterion is applicable to the movable property, such as mutual funds, jewelry, etc. So, they will be counted as a long-term asset if held for more than 36 months.
What are the Types of Capital Gain Tax?
As with the capital assets, the capital gain tax is also of two types – short-term capital gain and long-term capital gain. Any gain or profit from selling a short-term asset is termed as a short-term capital gain. And profit earned from long-term assets are termed as long-term gains.
When is Capital Gain Applicable?
The capital gain tax is not applicable only when the asset is inherited and there is no sale involved. But, after inheriting, if the asset is sold by the recipient of the asset, then the capital gain tax is applicable. Notably, the tax will be applicable in the year in which the asset is sold.
What is the Capital Gain Tax Rate?
The following is the capital gain tax rate:
Capital gain tax on the sale of property: the rate is 20% on the sale of long-term land and building (held for more than 3 years).
Capital gain tax on the sale of jewelry: the rate is 20% on the sale of long-term gold, diamond, jewelry, and precious stone.
Short-term capital gains on Equity shares: it is chargeable at 15%.
Long-term capital gains on Equity shares: long-term capital gains are taxed at 20%.
How is Capital Gain Calculated?
The formulas are as follows:
Short-term capital gain = full value consideration – the cost of improvement – the cost of acquisition – the cost of transfer
Long-term capital gain = full value consideration – the indexed cost of improvement – the indexed cost of acquisition – the cost of transfer
- Indexed cost of acquisition is the cost of acquisition multiplied by [cost of inflation index (FY)/cost of inflation index (FY)]
- Indexed cost of the improvement is the cost of improvement multiplied by [cost of index (FY)/cost of inflation index (FY)]
Let’s understand this with the help of an example:
Example: Mrs. Shivangi purchases a house on June 6th, 2011 for Rs. 7,00,000. She spends additional Rs. 1,00,000 on its furnishing in June 2012.
Case 1: She sells her house on May 19th, 2013 for Rs. 20,00,000. The capital gain would be-
20,00,000 – 7,00,000 – 1,50,000 = Rs 11,50,000 (since it is a short term asset)
Case 2: She sells her house for Rs. 20,00,000 on March 9th, 2015. The capital gain would be:
20,00,000 – 8,38,819 – 1,62,803 = Rs. 9,98,378 (since it is long-term asset)
*Indexed cost of acquisition = 7,00,000 X 852*711 = Rs. 8,38,819
*Indexed cost of improvement = 1,50,000 X 852*785= Rs. 1,62,803
What are the Exemptions on Capital Gains?
It is essential to pay the tax. However, if people know the exemptions, they can be immensely benefited. The following are the exemptions:
- Exemptions on Sale of House Property: If the gain on capital on the sale of house property is reinvested for the purchase of another property, then it is exempted from the tax. However, the entire gain must be reinvested. In case the entire gain is not invested, the un-utilized amount is subject to tax.
- Exemptions on Investment in House Property: If the taxpayer sells other capital asset and reinvest the gains in the purchase of house property, commercial house property, etc., the exemptions are valid.
- Exemptions on investment in Pvt. Ltd. Company: The tax is exempted if the gains are used for investment on the shares of a private limited company or to purchase plant and machinery.
- Exemptions for Business assets: Under Section 54 D of IT Act, the tax is exempted if the gains are used for the purpose of business.