Understanding Short Term Capital Gain Tax

Holding capital assets as an investment has been a widespread practice for some time now. There is no doubt that capital assets are quite profitable investments. People keep buying and selling them to acquire that difference between the buying and selling price.

This spread has a financial term, called Capital Gains. And like any other gains, these capital gains also have tax rates attached to them that need to be paid. It's a cost of enjoying the gains.

But don't worry, the tax rates are not that scary, and it differs between Long-Term Capital Gain (LTCG) and Short-Term Capital Gains (STCG). In this blog, the focus will be on the Short-Term Capital Gain Tax.

What are Capital Assets?

Let's begin with the basics; understanding what capital assets are. In technical terms, capital assets are assets that are expected to provide value for an extended period and have a useful life longer than 1 year. Simply speaking, it is an asset that is costlier than your general day to day costs and is helpful for a long period.

Capital Assets include securities, precious metals, property, bonds, and real estate. Within capital assets, there are two types:

Long-Term Capital Assets	Held for more than 12 months and for tax purposes before the transfer, it should be held for more than 36 months.
Short-Term Capital Assets	For tax reasons, assets should be held by the taxpayer for 36 months or less before transfer (with exception of immovable properties). Equities are referred to as short term capital assets if held for 12 months or less.

Capital Gains

The term itself is self-explanatory; the gain or loss incurred from the sale of the capital asset are capital gains. The gain generated is treated as an income; therefore, it will be charged taxes under the Income Tax Act 1961. And the gain will be liable for tax on the same year the transfer of the asset was made. Just like the capital asset, its gains are also categorized into two parts:

1. Long-Term Capital Gains

2. Short-Term Capital Gains

What is Short-Term Capital Gain?

Coming to the MVP of the blog, Short-Term Capital Gains are the profits generated from the transfer (sale) of the asset which is held for the required period for it to be categorized as Short-Term Asset. And the tax imposed on such gains generated from these assets, differ based on the effects it has.

Before addressing the tax part of the short term capital gain tax, it is important to figure out how to calculate short-term capital gains. Let's first see the format and then apply it in an actual situation.

Particulars	Amount
Sale proceeds from the transfer of asset	XXX
LESS: deduct costs incurred for the transfer (brokerage, commission, transportation, etc.)	(XXX)
Net proceeds from the sale	XXX
LESS: cost of acquisition	(XXX)
LESS: deduct the cost of maintenance and improvement of the asset	(XXX)
Total Short-Term Capital Gain	XXX

Quick illustration

Mrs. Saxena is an office worker with regular salaries. She bought an immovable property in August 2017 worth Rs. 15,00,000, and decided to sell it in July 2018. The sale proceeds were equal to Rs. 15,70,000. The expenses incurred during the transfer of the property were Rs. 13,500.

Now, since Mrs. Saxena held the property from August 2017 to July 2018 and it accounts for 11 months, the gain generated from the asset will be considered a short-term capital gain.

Particulars	Amount (in Rs.)
Sale proceeds from the transfer of asset	15,70,000
LESS: deduct costs incurred for the transfer	(13,500)
Net proceeds from the sale	15,56,500
LESS: cost of acquisition	(15,00,000)
LESS: deduct the cost of maintenance and improvement of the asset	-
Total Short-Term Capital Gain	56,500

What is Short Term Capital Gain Tax?

Till now we understood all the terms included in "Short Term Capital Gain Tax", now it's time to understand how the tax part works in this.

Remember that the tax liability on short-term capital gains differs among each other. The basis of this difference is stated below:

1. Short-Term Capital Gains covered under the Income Tax Act Section 111A.

2. Short-Term Capital Gains that are not covered under the Income Tax Act Section 111A.

STCG under Income Tax Act Section 111A

The capital assets listed below if held by the taxpayer for 1 year or less, fall under the short-term capital assets:

1. Gains from stocks, both equity and preference, of companies who are listed on stock exchanges such as BSE or NSE.

2. Zero-coupon bonds, both quoted and unquoted.

3. Gains from UTI mutual funds, both quoted and unquoted.

4. Other securities such as debentures, bonds, government securities, which are also listed on stock exchanges of India.

STCG not covered under Income Tax Act Section 111A

1. Gains are generated from the transfer of short-term assets like immovable property, precious metals (gold, silver), etc.

2. STCG generated out of the sale of shares other than equity shares.

3. Gains are generated from government securities, bonds, and debentures.

4. Gains from the sale of equity shares that are not listed in any stock exchanges.

5. Gains from debt-oriented mutual funds.

Tax implications

The implication of tax on short-term capital gains:

Tax on short-term capital gains	When applicability of securities transaction tax.	15%
Tax on short-term capital gains	When there is no applicability of securities transaction tax.	The gain will be added to the taxpayer's income and then taxed based on their income tax slab.

Quick illustration

Mr. Gupta, an office worker with an annual salary of Rs. 9,50,000. In August 2018, he purchased 10,000 equity shares at Rs. 100 per share and later sold them in February 2019 at Rs. 140 per share with a brokerage fee of Re.1/share.

The shares were listed in NSE and Mr. Gupta paid securities transaction tax for them.

First, the capital gain needs to be calculated:

Particulars	Amount (in Rs.)
Sale proceeds from the transfer of asset	14,00,000
LESS: deduct costs incurred for the transfer(brokerage fee)	(10,000)
Net proceeds from the sale	13,90,000
LESS: cost of acquisition	(10,00,000)
LESS: deduct the cost of maintenance and improvement of the asset	-
Total Short-Term Capital Gain	3,90,000

Now for the tax liability:

Particulars	Amount (in Rs.)
Salary	6,50,000
Short-term capital gain	3,90,000
Gross total income	10,40,000
LESS: Deductions under Section 80C to Section 80U	-
Taxable income	10,40,000
Tax liable on the income	1,88,500**
ADD: Health and education cess (at 4%)	7,540*
Total taxable income	1,96,040

**total tax= (6,50,000x20%) + (3,90,000x15%) = 1,30,000 + 58,500 = 1,88,500

*Health and education cess= 1,88,500x4% = 7,540

STCG tax on inheritance

When a property is inherited, STCG is not liable because there is a transfer of ownership and no sale of the asset. But if the capital asset is sold after the transfer, then the tax is liable. The previous and current ownership period will be counted for the duration.

Setting of losses

In case of a loss incurred during the sale of the short-term capital asset, the loss can be set off with the gain generated from the sale of some other short-term capital asset. The loss cannot be cleared off with some other type of income. 

The Bottom Line

It is always important to understand the tax part related to any investment. Without proper prior knowledge on tax, people may face problems later with the tax assessment. Many times people are also able to take advantage of tax-exempts if they know their taxes well.

Similarly understanding the short-term capital gain tax will help when you go for investment options in short-term capital assets.