Introduction

Capital gains are a critical aspect of the Indian taxation system, impacting investors and taxpayers. They represent the profit earned from the sale of capital assets such as stocks, real estate, and mutual funds. This article provides an overview of capital gains as defined by the Indian Income Tax Act, including types, calculation, taxation, and strategies for managing capital gains.

What Are Capital Gains?

Capital Gain Definition: Under the Indian Income Tax Act, a capital gain arises when a capital asset is sold for more than its purchase price. The profit or gain is classified as income and is subject to tax in the year the sale transaction occurs.

Types of Capital Gains:

1. Short-Term Capital Gains (STCG): Gains from the sale of a capital asset held for 36 months or less (12 months for listed securities, units of equity-oriented mutual funds, and zero-coupon bonds).
2. Long-Term Capital Gains (LTCG): Gains from the sale of a capital asset held for more than 36 months (12 months for listed securities, units of equity-oriented mutual funds, and zero-coupon bonds).

Calculating Capital Gains

To calculate capital gains, the cost of acquisition, cost of improvement, and expenses related to the transfer must be considered:

Formula: Capital Gain=Full Value of Consideration−(Cost of Acquisition+Cost of Improvement+Expenditure on Transfer)

Capital Gains Tax

Tax Rates: Capital gains are taxed differently based on their classification as short-term or long-term:

• Short-Term Capital Gains (STCG): For listed securities, units of equity-oriented mutual funds, and zero-coupon bonds, STCG is taxed at 15%. For other assets, STCG is taxed at the individual’s applicable income tax slab rates.
• Long-Term Capital Gains (LTCG): For listed securities and units of equity-oriented mutual funds, LTCG exceeding INR 1 lakh is taxed at 10% without the benefit of indexation. For other assets, LTCG is taxed at 20% with indexation benefits.

Indexation Benefit: Indexation allows taxpayers to adjust the purchase price of an asset for inflation, thereby reducing the taxable capital gain. This benefit is available for long-term capital assets other than those taxed at 10%.

Exemptions and Deductions

1. Section 54: Exemption on LTCG from the sale of a residential property if the gain is reinvested in another residential property within a specified period.
2. Section 54EC: Exemption on LTCG if the gain is invested in specified bonds issued by NHAI or REC within six months of the sale, subject to a limit of INR 50 lakh.
3. Section 54F: Exemption on LTCG from the sale of any long-term asset other than a residential house, provided the net sale consideration is reinvested in a residential house.

Strategies for Managing Capital Gains

1. Tax-Loss Harvesting: Selling loss-making investments to offset gains from profitable investments to reduce the overall taxable capital gains.
2. Holding Period Management: Timing the sale of assets to benefit from long-term capital gains tax rates and indexation benefits.
3. Investing in Tax-Saving Bonds: Utilizing Section 54EC bonds to defer or reduce tax liabilities.
4. Reinvesting in Residential Property: Leveraging exemptions under Sections 54 and 54F by reinvesting gains in residential properties.

Capital Gains and Investment Strategy

Investors should integrate capital gains considerations into their investment strategies. Understanding the timing of asset sales, the tax implications of different types of gains, and the benefits of various exemptions can significantly enhance financial planning and investment returns.

While providing consultancy related to Capital Gain from many people living in India or NRIs having property in India, we come across many queries, out of that the most frequent query raised has been mentioned below:

What will be the cost of acquisition in case the property is acquired by GIFT / Will

In India, the cost of acquisition for a property acquired through gift or will is determined based on the cost to the original owner, with some specific rules and provisions under the Indian Income Tax Act. Here’s a detailed explanation:

Cost of Acquisition for Property Acquired by Gift or Will

1. Property Acquired by Gift:

• If the property is acquired as a gift from a relative, the cost of acquisition is the same as the cost at which the original owner (the person who gifted the property) acquired it.
• For capital gains calculation, the holding period of the previous owner is also considered. This means that if the previous owner held the property for a significant period, the current owner can benefit from the long-term capital gains (LTCG) tax rates and indexation benefits, depending on the duration for which the property was held by the original owner.

2. Property Acquired by Will or Inheritance:

• Similar to property acquired by gift, if the property is inherited through a will or succession, the cost of acquisition is the same as the cost to the original owner (the person who bequeathed the property).
• The holding period of the previous owner is also taken into account when calculating the holding period for capital gains tax purposes. This allows the current owner to potentially benefit from the long-term capital gains tax rates and indexation.

Example Scenarios

Scenario 1: Gifted Property

• Suppose A gifts a property to B. A had originally purchased the property for INR 10 lakh in 2010.
• When B sells the property in 2024, for capital gains calculation, the cost of acquisition will be INR 10 lakh (the cost to A).
• B can also include the holding period of A (from 2010 to 2024) to determine whether the gain is short-term or long-term.

Scenario 2: Inherited Property

• Suppose C inherits a property from D, who purchased it for INR 15 lakh in 2005.
• When C sells the property in 2024, the cost of acquisition for capital gains calculation will be INR 15 lakh (the cost to D).
• The holding period of D (from 2005 to 2024) will also be considered to determine if the gain is short-term or long-term.

Important Points to Note

• Indexation Benefit: For long-term capital assets, indexation can be applied to adjust the cost of acquisition based on the inflation index provided by the Income Tax Department. This helps in reducing the taxable capital gain by considering inflation.
• Definition of Relative: The term “relative” is specifically defined in the Income Tax Act for the purpose of gifts. It includes immediate family members such as parents, siblings, and spouses, among others.

The cost of acquisition for properties acquired by gift or will in India is based on the original cost to the previous owner, with the benefit of considering their holding period for determining capital gains. This provision helps in reducing the tax burden on the recipient by allowing them to take advantage of the original acquisition cost and holding period, potentially qualifying for long-term capital gains tax benefits and indexation.

Understanding these rules is crucial for accurate capital gains calculation and effective tax planning when dealing with inherited or gifted properties.

Important Decisions considered here are :

• Case Name : The Commissioner of Income Tax Versus Manjula J. Shah ( Bombay High Court)
• The Commissioner of Income Tax
  Versus Gautam Manubhai Amin (Gujarat High Court)