A taxpayer is required to pay tax on income under different heads of income under the Income Tax Act, 1961. Of the 5 heads of income, one very important head of income is “Capital Gains.” Under this head of income, income tax is payable by a taxpayer on the gains made by him on the transfer of a capital asset during a particular financial year. Since this tax is applicable only in relation to a capital asset, the meaning of the expression “capital asset” assumes a very special significance. Under Section 2(14) of the IT Act normally, a capital asset means property of any kind held by an assessee, whether or not connected with his or her business or profession, but does not include stock-in-trade and personal effects meant for personal use by the assessee or members of his or her family. Some types otrural agricultural land are also outside the definition of capital asset.
There are two types of capital gains, namely, long-term capital gain and short-term capital gain, depending on whether the gain is in relation to the transfer of a long-term capital asset or a short-term capital asset. The distinction between long-term capital gain and short-term capital gain assumes special significance because short-term capital gains are liable to income tax like any other income, and at the same rates as any other income is. Generally speaking, no deduction or exemption is available in respect of a short-term capital gain, whereas, long-term capital gains are subject to various deductions and exemptions. Let’s find out.
Long-Term and Short-Term Capita! Gains
A long-term capital gain means capital gain arising from the transfer of a long-term capital asset. A long-term capital asset means a capital asset, which is not a short-term capital asset. Generally speaking, a capital asset held by an assessee for more than three years, i.e. 36 months, is a long-term capital asset. There are exceptions in the case of shares, units, debentures and securities traded on the stock exchange in respect of which a holding period of only 12 months is sufficient for it to be classified as a long-term capital asset. As noted earlier, it is certain tax deductions and exemptions available only in regard to long-term capital gains.
Exemption of Long-Term Capita’ Gains on Shares, etc.
Under the provisions of Section 10(38) of the Income Tax Act, any income arising from the transfer of a long-term capital asset, being equity shares as also units of equity oriented mutual funds would be exempted from the purview of long-term capital gains. This exemption is available only in respect of transactions relating to the sale of equity shares or units of equity oriented mutual funds entered into on or after 1.10.2004, and which are subject to securities transaction tax. Thus, if a person sells shares of a listed company directly to a friend without routing the transaction through a stock broker and stock exchange, then the benefit of tax-exemption of long-term capital gain would not be available on the sale of such equity shares. As regards short-term capital gain on the sale of equities and units of equity oriented funds, there is a lower rate of tax, namely 15% only as against the normal rate of 20% payable on taxable long-term capital gains as in the case of other types of capital assets.
Cost Inflation Index
Under the provisions of Section 48 of the IT Act, a deduction is allowed in computing the taxable capital gain in respect of the cost of acquisi
tion. However, where the capital asset is
acquired prior to 1.4.1981, then the market value of the asset as on 1.4.1981
can be substituted for its cost of acquisition. As regards any acquisition on
or after 1.4.1981, the cost of acquisition of the capital asset is increased by
the application of the Cost Inflation index. The indexed cost of acquisition
means the amount which bears to the cost of acquisition, the same proportion as
the Cost Inflation Index for the year in which the asset is transferred bears
to the Cost Inflation index for the first year for which the asset was held by
the assessed or for the year beginning on 1.4.1981, whichever is later. The
Cost inflation Index for the initial base year 1981-82 is 100 and the Cost
Inflation Index notified for the financial year 2011- 2012 is 785. Thus,
the indexed cost of acquisition of an asset purchased in the year 1981-82 for ` 10,00,000 for the
F.Y. 2011-12 would be deemed to be:
` 10,00,000 x 785
----------------- = ` 78,50,000
100
100
which would be available for deduction from the sale price of an asset for the purposes of computing the taxable capital gain. Thus, if a plot of land acquired in the financial year 1981-82 for ` 10 lakh is sold for ` 80 lakh, then the taxable long-term capital gain would be calculated by deducting ` 78.50 lakh from ` 75 lakh, i.e. only ` 2,15,000 would be considered as the taxable long-term captal gain in respect of that plot of land. Even such capital gain can be made fully exempt as per the provisions described below.
Exemption of Long-Term Capital Gain of a Residential House
One of the important exemptions regarding long-term capital gains relates to a residential house property as per Section 54 of the IT Act. Thus, it is provided that if an assessee, being an individual or a Hindu Undivided Family transfers, his or its residential house, or part thereof, and makes a long-term capital gain and the entire long-term capital gain is invested in the purchase of a residential house property within one year in anticipation of the transfer or within two years of the transfer of his first residential house, or if the new residential house property is constructed within three years of the transfer of the first house and the entire long-term capital gain only is invested in the acquisition of such residential house property, then the entire long-term capital gain in respect of the transfer of the first residential house property would be fully exempt from tax. Where only part of the taxable long-term capital gain is so utilized, then proportionate exemption would be available. There are certain procedural conditions regarding the utilisation of the amount to be kept in a capital gains scheme account in a bank if the money is not fully utilised within the time limit.
Exemption of Long-Term Capita’ Gains Regarding Any Other Asset
Another very important exemption which can be enjoyed by an individual or a Hindu Undivided Family is in respect of long-term capital gains in respect of any capital asset, other than a residential house property, under Section 54F of the IT Act. Thus, it is provided that where the assessee had a long-term capital gain on the transfer of any other capital asset, such as shares, a plot of land, commercial house property, jewellery, etc., then he can secure complete income tax exemption on the long-term capital gain in respect of the sale of the capital asset if the entire net sale proceeds thereof are invested in the acquisition of a residential house either by purchase or by construction within the same period of one, two or three years as in the above case. This exemption is available only when the assessee does not own more than one residential house as on date of the transfer of the capital asset concerned. Lockin period for the new residential house is three years during which it should not be sold or transferred, otherwise the entire long-term capital gain would become taxable.
Exemption on Long-Term Capital Gain on Investment in Capital Gain Bonds
Under the provisions of Section 54EC, a complete exemption is available in respect of the long-term capital gain from any asset provided the net capital gain is invested in six months after the date of transfer of the capital asset in any of the two types of bonds issued by the Rural Electrification Corporation Ltd. or the National Highway Authority of India tip to a maximum sum of ` 50 lakh.
No Capital Gains Tax on Transfer of Residential Property if Invested in Manufacturing Small or Medium Enterprise (SME)
As per the Finance Act, 2012 a new Section 54GB has been added in the Income-tax Act which provides relief from re-investment of sale consideration in the equity of a new start-up SME company in the manufacturing sector which is utilized by the company for the purchase of new plant and machinery. Some of the important conditions to avail this benefit are as under:
(i) The amount of net consideration is used by
the individual of HIJF before the due date of furnishing of return of income
under subsection (1) of Section 139, for subscription in equity shares in the
SME company in which he holds more than 50% share capital or more than 50%
voting rights.
(ii) The amount of subscription as share capital
is to be utilized by the SME company for the purchase of new plant and
machinery within a period of one year from the date of subscription in the
equity shares.
(iii) If the amount of net consideration subscribed
as equity shares in the SME company is not utilized by the SME Company for the
purchase of plant and machinery before the due date of filing of return by the
individual or HUF, the unutilized amount shall be deposited under a deposit
scheme to be prescribed in this behalf.
(iv) Suitable safeguards so as to restrict the
transfer of the shares of the company and of the plant and machinery for a
period of 5 years are proposed to be provided to prevent diversion of these
funds. Further, capital gains would be subject to taxation in case any of the
conditions are violated.
The tax benefit would be available in case of investments made on or before 31.3.2017. The above mentioned tax benefits are applicable only in respect of long-term capital gains arising on sale of a residential property, namely a house and not a plot of land.
Other Aspects of Capital Gains
If there is a loss under the head “Capital Gains”, then the loss is to be computed as loss in respect of short-term capital asset and loss in respect of long-term capital asset, respectively. It has to be remembered clearly that short-term capital loss can be set off or adjusted against long-term capital gain, but not vice-versa. Similarly, any unadjusted short-term capital loss can be carried forward for eight years to be set off against long-term capital gains or short-term capital gains. However, long-term capital loss can be carried forward for eight years to be set off only against long-term capital gains. Besides, there are certain exemptions available in respect of capital gains regarding agricultural land, merger and demerger, etc. which looking to the nature of this tip, are not described here.