What is capital gain and how capital gain tax has arrived?

Updated: As per the amended finance act 2020

Any gain arising on the transfer (by sale or exchange) of the capital asset is known as a capital gain. Capital gains are calculated on the cost of acquisition and cost of improvement expenses of a capital nature incurred in making any additions or alterations to the capital asset by the seller. The inflation-indexed cost price of the property sold is also considered for this purpose and the gain (profit) made by the seller is taxed as a part of the ‘income’ for that year. Capital gain taxes do not apply to the transfer of Stock in trade, raw materials held for business, items like a car, furniture held for personal use, rural agriculture land, gold deposit bonds, special bearer bonds-1991, 6.5% gold bonds (1977) &7% gold bonds(1980), and  National defense gold bonds(1980) under income tax act. However, when personal effects like jewellery, archaeological collections, drawings, and paintings are sold, the capital gain tax will be applicable. Capital gains are not applicable to an inherited property as there is no sale, only a transfer of ownership. Further, the Income Tax Act has specifically exempted assets received as gifts by way of an inheritance or will. However, if the person who inherited the asset decides to sell it, capital gains tax will be applicable.

Relaxation in respect of the circle rate increased from 5% to 10% on the purchase of immovable property

The Finance act 2020 has relaxed with an amendment in section 56(2)(x) whereby in case any land or building is purchased at a value less than the stamp duty valuation, the difference is deemed as income from other sources.  However as per the amendment, in case the stamp duty value does not exceed 110% of the actual consideration paid, then, there will be no deemed income in the hands of the buyer of land and building under this Section 56(2)(x).  Nevertheless, in case the stamp duty value exceeds 110%, then the entire difference including the threshold exemption of 10% will be considered as income from other sources.

Fair market value for the substituted cost of acquisition as of 1st April 2001 to be on the basis of stamp duty valuation

As per the provision of section 55 of the Income Tax Act, while computing capital gain in respect of a capital asset held on or before 01.04.2001, the cost of acquisition can be substituted by fair market value as of 01.04.2001. There were several disputes on the fair market value as of 01.04.2001 predominantly in respect of land and building.  The Finance Bill, 2020 addressed this problem by inserting a proviso in Section 55 to the effect that in respect of land or building or both, the fair market value as of 01.04.2001 shall not exceed the stamp duty value, wherever available, of such asset as on 01.04.2001.  Consequently, where circle rates have been notified by the State Government as of 01.04.2001, the same will be the basis for computing fair market value as of 01.04.2001.  However, where circle rates have not been notified by the State, then the fair market value shall be computed in accordance with the comparable instances available of that period. Actually, circle rates were first notified in the year 2007 and not notified on 01.04.2001.

Short-term capital gain and Long term capital gain on sale of equity shares/Bonds/units of equity-oriented fund :

Capital assets are separated into short-term capital assets and long-term capital assets. An asset held for a period of 36 months or less is a short-term capital asset. An asset that is held for more than 36 months is a long-term capital asset. The criteria for 36 months have been reduced to 24 months for immovable properties such as land, building, and house property from FY 2017-18. Some assets like Equity or preference shares in a company listed on a recognized stock exchange in India, Securities (like debentures, bonds, govt securities, etc.) listed on a recognized stock exchange in India, quoted and unquoted units of UTI, equity-oriented mutual fund, Zero-coupon bonds, are considered short-term capital assets when these are held for 12 months or less. This rule is applicable if the date of transfer is after 10th July 2014 (irrespective of what the date of purchase is). When these short-term capital assets are held for a period of more than 12 months, they are considered long-term capital assets.

You can offset capital gains from equity-oriented funds against any capital loss incurred on the sale of these funds. However, a long-term capital loss can be set off only against long-term capital gains. If you cannot adjust your capital losses in the same year, you are allowed to carry them forward for the next eight years. You can set off these losses against your capital gains in the following years. However, you must file your ITR and show these losses even when you don’t have any income.

Tax  applicable on assets acquired by gift, will, succession or inheritance :

In case an asset is acquired by gift, will, succession or inheritance, the period for which the asset was held by the previous owner is also included when determining whether it’s a short-term or a long-term capital asset. In the case of bonus shares or rights shares, the period of holding is counted from the date of allotment of bonus shares or rights shares respectively.

Tax on Short-Term and Long-Term Capital Gains:

• Long-term capital gains tax (Except on the sale of equity shares/ units of the equity-oriented fund): Tax applicable 20%.

• Long-term capital gains tax on the sale of Equity shares/ units of equity-oriented fund: Tax applicable 10% over and above Rs 1 lakh

• Short-term capital gains tax, when securities transaction tax is not applicable, the short-term capital gain is added to your income tax return and the taxpayer is taxed according to his income tax slab.

• Short-term capital gains tax when securities transaction: Tax applicable 15%.

For equity-oriented schemes, (Any fund that invests more than 65% inequities of their total portfolio is called an equity fund):

• If the investment is held for 12 months or less, it is termed a short-term capital gain and taxed at 15%. If the investment is held for more than 12 months, it is termed as long-term capital gain (LTCG) and taxed at 20%, in case the total LTCG for the year is above Rs 1 lakh.

Exemption of tax available on capital gains for residential properties:

If you sell a residential property or land after holding it for more than two years, you are liable to pay a long-term capital gains tax of 20 percent after indexation. For example, if you sell a residential property or land after holding it for more than two years and you make a gain (profit) of Rs 100 lakh out of the transaction, then you may end up paying Rs 20 lakh as tax. If you reinvest this gain (profit) of 100 lakhs in another property you get a 100% tax exemption on the capital gain (The maximum amount of capital gains that you can re-invest in another property and get a complete exemption is Rs 2 crore. If your capital gain is higher than 2 crore, you will have to pay capital gains tax on the amount exceeding Rs 2 crore). There is confusion in the minds of some people that whether to use the entire sale proceeds of sold property to buy a new property or whether only the capital gains amount would be sufficient to get tax exemption.  Section 54 of the income tax act clarifies this matter.  Section 54 provides that if a house property held for the long term has been sold or transferred and the gains have been invested in another residential house, one can get an exemption either on the capital gains earned or the cost of the new asset, whichever is lower. It means you need not reinvest the entire proceeds of the property sold to get long-term capital gain tax exemption. You only have to reinvest the capital gains amount in another property to save LTCG tax. Earlier, the tax exemption was available only when you have invested your capital gains in one property. However, Budget 2019 allowed people to invest their capital gains in two properties either through outright purchase or construction. But, this reinvestment option will also have to remain within the overall limit of Rs 2 crore.

The time limit for reinvestment:

The reinvestment in another property should be made within two years from the day of selling the old property to buy or construct a new property to be eligible for the tax exemption. As per section 54F of the income tax act,  even if a person buys a  new property up to one year prior to selling his old property, is also eligible to claim capital gain tax exemption by showing the investment as reinvestment of property sold. In this case, one has to declare the capital gains amount that he has used to buy the property as a re-investment of capital gains. If the new house is under construction, the construction should be completed within three years from the sale of the old property to claim capital gain tax exemption. 

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