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Capital Gain: Profit and Tax Strategies

Created on 23 May 2023

Wraps up in 12 Min

Read by 5.4k people

Updated on 23 Jun 2023

Capital gain taxes are often overlooked but can leave quite a dent in your pocket if not managed properly.

Capital gains tax (CGT) is a tax that's levied on the profit you make when you sell an asset, such as a stock, a property, or a piece of artwork. In other words, it's a tax on your financial gains, big triumphs, and your juicy profits.

So, let's say you bought some stocks for ₹1,00,000, and then after some time, you sold them for ₹2,00,000. In this case, the capital gain is ₹1,00,000, and depending on your tax bracket and the length of time you held the asset, you may owe some of that gain to the government through the payment of CGT.

I am now aware of your current thoughts. “Isn’t Income Tax enough? Why must I pay taxes on capital gains too? Also, could the government even track me if I don’t pay these?”

The public expects governments to provide the basic services that they promise, and one way they do this is by collecting capital gains taxes.

It's similar to buying a theme park ticket. Sure, you could try to sneak in, but paying the admission price and enjoying all the fun rides and attractions without fear of being caught is much easier and more enjoyable. Paying capital gains taxes ensures that you can live comfortably and worry-free in a society that provides access to infrastructure, public services, and other amenities. 

But wait, there's more! Did you know that not all capital gains are created equal? Oh yes, my friend. Short-term capital gains, which are profits made from selling assets you've owned for less than a year, are taxed at a higher rate. Comparatively, long-term capital gains, which are profits made from selling assets you've owned for more than a year, are taxed at a lower rate. By offering lower tax rates as a token of appreciation, the government is giving incentives to those who maintain their assets over time.

So, stop trying to weasel your way out of taxes. There is a reason the proverb "death and taxes are an inevitability of life" exists, after all. Plus, think of all the things that your tax goes towards, like building roads, funding schools, and keeping our country safe. It's similar to paying for a subscription service that you don't always use but know is necessary for the greater good.

In India, capital gains tax rates vary depending on the type of asset and how long you've held it. For example, if you sell shares or equity mutual funds within a year of purchase, you may be subject to short-term capital gains tax at a rate of 15%. But if you hold onto those assets for more than a year, you could be eligible for long-term capital gains tax at a lower rate of 10%.

So there you have it, Capital gains tax may not be the most glamorous topic, but it's an important one to understand if you want to make the most of your investments. And who knows, maybe one day you'll be thanking the government for taking a little bit of your hard-earned cash. Or maybe not.

Types of Capital Gains Tax (CGT)

Capital gains are essentially profits made by an individual by selling an asset. The profits arise as a reason of the value of the asset in question increasing. Another thing to notice is that the sale must be of an asset. So, a shopkeeper selling their daily stock does not earn capital gains. However the same shopkeeper selling their shop and earning a profit as a result of an increase in the value of said shop attracts capital gains. Capital earnings can be classified into two types:

Long Term Capital Gains Tax (LTCGT)

Ah, long-term capital gains - the sweeter, more mature version. Think of it like a fine wine - the longer it ages, the better it tastes. 

In finance terms, long-term capital gains refer to the profits you make when you sell an asset that you've held for more than 12 months or 24 months. The 12-month holding period applies to stocks and equity mutual funds, while the 24-month period pertains to every other asset class. The tax rate that applies to these two asset classes also differs from one another.

And guess what? The government actually rewards you for holding on to your assets for a longer period of time by offering lower tax rates on these gains. 

So, the good news is that the tax rates for long-term capital gains are lower than rates for short-term gains. The bad news is that the longer you hold on to your asset, the higher your gains may be, which means you may still end up paying a significant amount of tax.

Let's say you bought a property for ₹50 lakhs and held on to it for five years. The property market boomed, and you were able to sell it for ₹1 crore. Congrats, you just made a profit of ₹50 lakhs! But hold on - the taxman would want a cut from that. Since you held on to the property for more than two years, it's considered a long-term capital gain, and you'll have to pay tax at the rate of 20%.

Before you start cursing the taxman, remember that long-term capital gains can teach us valuable lessons about patience, perseverance and the power of compounding. Just like a marathon runner, you need to train hard, pace yourself, and keep your eye on the finish line. The longer you hold on to your assets, the more time they have to grow and appreciate in value.

But don't get too greedy - as the saying goes, "Don't let the tax tail wag the investment dog." In other words, don't make investment decisions solely based on the tax implications. Make sure you're investing in assets that align with your financial goals and risk tolerance.

In fact, legendary investor Warren Buffett once said, "Our favourite holding period is forever." I'm not saying you should never sell your investments, but you should think about the advantages of retaining them for the long term. 

Computation of LTCG (Long Term Capital Gains Tax)

LTCG taxation affects both movable assets, like mutual fund units, government securities, etc., and immovable assets, such as homes, land, and more. After owning these assets for 12 to 36 months, depending on the type of property, they are included in the LTCG tax calculation. 

To compute this tax: 
First, calculate the asset's sale value, the cost of acquisition and the indexed cost of acquisition, then compute the LTCG and the tax. 

For example, if you sold equity mutual fund units for ₹5 lakhs and the indexed cost of acquisition is ₹3 lakhs, your LTCG will be ₹2 lakhs, and the tax burden will be 10% of the amount that exceeds ₹1 lakh, in this case, ₹10,000. 

For other assets, such as real estate, the long-term capital gains tax rate is 20%, but with an indexation advantage. This means that the asset's purchase price is adjusted for inflation when determining the tax rate. 

Like a marathon runner, the long-term investor reaps the rewards of their dedicated efforts as the power of compounding works its magic. Taxation of these rewards is inevitable, but with the right knowledge, you can ensure that you get the most benefits from your investments. With the right strategy and a clear understanding of the taxation system, investors can ensure that their earnings are maximised.

Assets

LTCG Tax Rate

Equity Mutual Funds, Stocks

10%

Gold, Debt Funds, Miscellaneous Assets, Land, Flats, Real Estate

20%

Taxes are something like a toll gate. One has to pay to enter the safe haven of wealth. The long-term capital gain tax rate is no different. It is calculated at 20% plus the applicable surcharge and cess. 

But, there are some golden tickets that allow individuals to pay at the rate of 10%, like when you sell listed securities of more than ₹1,00,000. It is like a rare gemstone in the treasure box of taxes. 

Similarly, returns earned by selling securities listed on a recognised stock exchange in India, zero-coupon bonds, and any Mutual Funds or UTI (Unit Trust of India) that were sold on or before 10th July 2014 also qualify for this concessional rate.

Exemptions on Long-Term Capital Gains Tax

Investing in the stock market is similar to going on an adventure. As an investor, you are a daring explorer eager to venture into the unknown in search of financial success.
When you succeed in the stock market, you are rewarded with profits. Some of these gains come with the benefit of being tax-free, as per the Indian Tax Law. This is due to the exemptions available to investors under Sections 54, 54B, 54D, 54F, and 10(38) of the Income Tax Act of 1961. 

1. Section 54 allows capital gains to be tax-free if the gains are reinvested in another asset. This gives investors a chance to reinvest their hard-earned profits and grow their portfolio further. 

2. Section 54B allows tax exemption on the sale of agricultural land, provided the sale proceeds are used to buy another agricultural property. This exemption is meant to give farmers relief when shifting the location of their land.

3. Section 54D provides tax exemption for capital gains arising from the sale of an industrial property, provided the proceeds are used to purchase an industrial land/building within three years of the sale. This gives investors the chance to upgrade their businesses without worrying about the tax implications.

4. Section 54F allows tax exemption on capital gains if the proceeds are used to purchase a residential house. This allows investors to use their profits to purchase a home of their own.
The Indian Tax Law has created these exemptions to encourage investment in the stock market. These exemptions give investors a chance to grow their wealth without any fear of taxation. 

So, if you're an investor looking for a chance to explore the world of stocks and reap the rewards of your hard work, make sure you take advantage of the tax exemptions available to you. So, in conclusion, long-term capital gains are like the delicious dessert of the investment world - they're sweeter, more satisfying, and can teach us valuable lessons about patience and long-term thinking.

Short-Term Capital Gains Tax

When it comes to understanding the taxability of short-term capital gains, it is important to know that there are different time frames applicable for different types of assets. For example, if the asset is a house, land or building, then it is considered to be a short-term asset if it is held for less than 24 months. However, if the asset is equity shares or units of an equity mutual fund, then it is considered to be a short-term asset if it is held for less than 12 months.

So, when it comes to capital gains, the investor must be aware of the applicable time frames for different types of assets and plan out their investments accordingly. They also need to be mindful of short-term capital gains tax implications while making investment decisions. 

Computation of STCG

Let's understand the calculation of STCG with an example - 

Value released from sale

₹10,00,000

Less: Expenditure incurred wholly and exclusively in connection with the transfer of capital assets (e.g., brokerage, commission, etc.)

(₹50,000)

= Net Sale Consideration

₹9,50,000

Less: Cost of acquisition

(₹7,00,000)

Less: Cost of improvement

(₹50,000)

Short-Term Capital Gains

₹2,00,000

Short-term capital gains are categorised in order to determine the applicable tax rate.

Short-term capital gains covered under section 111A: Section 111A of the Income Tax Act provides for a flat rate of 15% taxation with indexation benefit on short-term capital gains, on the transfer of listed securities, units of equity-oriented mutual funds and units of business trust.

Short-term capital gains other than those covered under section 111A: Short-term capital gains arising on transfer of assets other than those specified under section 111A of the Income Tax Act are taxed at the slab rate of the taxpayer. The slab rate is determined according to the taxpayer's annual income. 

For example, if the annual taxable income of an individual is ₹10 lakhs, then the slab rate applicable to the individual is 20%. Therefore, the short-term capital gains of ₹2 lakhs will be taxed at a rate of 20%.

Taxation of STCG Under Section 111A of the Income Tax Act

Section 111A of the Income Tax Act deals with the taxation of Short-Term Capital Gains (STCG). STCG refers to the profits made from the sale of any asset held for a period of less than 12 or 24 months, based on the asset class. In India, STCG is taxed at a flat rate of 15%, which is much lower than the normal income tax rate. 

Under Section 111A, units of equity-oriented mutual funds held for less than 12 months are covered and taxed as STCG. Mutual funds are investment vehicles which allow investors to pool their money and invest in different types of securities, such as stocks and bonds.

However, there are some instances which are not covered under Section 111A. These include gains from the sale of unlisted shares, gains from the sale of land and building, and gains from the sale of gold bonds. All of these are taxed at the income slab rate, which can be higher or lower than the flat 15% rate applicable to STCG. 

To better understand this, consider the case of an Indian investor who invests in an equity-oriented mutual fund. When the investor sells his units in the mutual fund within 12 months, he is liable to pay STCG tax at a rate of 15%. 

On the other hand, if he buys a piece of land and sells it within 36 months, he will have to pay the normal income tax rate applicable to him, which could be much higher than 15%.

Thus, it is important to keep in mind the differences between the instances covered and not covered under Section 111A of the IT Act, so as to make the most of the tax benefits available.

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

Tax Type

Condition

Tax Applicable

Long-term capital gains tax

Except on the sale of equity-oriented fund units/ equity shares

20%

Long-term capital gains tax

On the sale of equity-oriented fund units/ equity shares

10% over and above ₹1,00,000

Short-Term capital gains tax

When securities transaction tax is not applicable

The STCGT is added to the ITR of the taxpayer

and the individual is taxed as per his income tax slab

Short-Term capital gains tax

When securities transaction tax is applicable

15%

Exemption on Short-Term Capital Gains: 

Understanding the tax implications of short-term capital gains on shares is essential for making informed investment decisions. Unfortunately, short-term capital gains derived from shares are not exempt from taxation. However, there are certain income thresholds which, if met, would enable individuals to be exempted from paying taxes on short-term capital gains on shares.

For instance, resident individuals who are 80 years or above of age with an annual income of up to ₹5 lakh, those who are 60 years or above but below 80 years with an annual income of ₹3 Lakh, or those who are below 60 years of age with an annual income of ₹2.5 Lakh, can enjoy tax exemption on short-term capital gains on shares. 

Similarly, Hindu Undivided Families (HUF) with an annual income of ₹2.5 Lakh are also eligible for this exemption.

It is significant to note that only resident individuals and HUF have the benefit of adjusting their exemption limit against Section 111A-covered short-term capital gains. However, they are only able to do so after successfully adjusting their other sources of income.

Knowing these exemptions can be helpful in managing your tax liability as an investor. It is crucial to stay up-to-date with the latest tax regulations and to consult with a tax expert to make informed investment decisions that are aligned with your financial goals. By understanding the tax implications of short-term capital gains on shares, investors can optimise their investment returns and avoid unnecessary tax liabilities.

The Bottom Line

"Capital gains tax is not something to be feared, but something to be understood. By taking the time to learn about it, investors can make informed decisions that can help them grow their wealth and achieve their financial goals." - John Paulson, American businessman and investor.

To summarise, knowing the ins and outs of capital gains tax is an important part of being a savvy investor. It's like having a map to help you navigate the complicated world of investments and taxes and make informed decisions that align with your financial goals.

You can optimise your investment returns and reduce your tax liability by understanding the exemptions, rates, and timelines associated with capital gains tax. Consider it similar to packing your suitcase with all of the necessary tools and equipment before embarking on an exciting adventure.

So, whether you're a seasoned investor or just getting started, remember that understanding capital gains tax is critical to making informed investment decisions and reaching your financial objectives. You can turn what may appear to be a daunting task into a rewarding and exciting journey towards financial success by approaching it with a positive attitude and a willingness to learn.

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Shivam Vallecha

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Shivam is a PGPM student at ICFAI Business School Pune. He participates actively in social activities and believes that people should be the change rather than just seeking it. The majority of his time is spent reading, but he also enjoys binge watching. His belief is that people must dream big and work hard in order to grow each day and achieve their dreams. 

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