Capital Gains Tax

Capital Gains Tax (CGT) is a direct tax levied on the profit or gain arising from the sale or transfer of a capital asset. It represents the difference between the sale consideration (selling price) and the cost of acquisition (purchase price) of the asset. In India, the capital gains tax is governed by the provisions of the Income Tax Act, 1961, and applies to individuals, Hindu Undivided Families (HUFs), firms, and companies.
The tax is an important component of the Indian taxation system, as it ensures that income generated from asset appreciation contributes to public revenue, alongside income earned from regular employment or business activities.

Concept of Capital Gain

A capital gain arises when a taxpayer sells a capital asset—such as land, building, shares, mutual funds, or bonds—at a price higher than its purchase cost.
Capital Gain=Sale Consideration−(Cost of Acquisition+Cost of Improvement+Transfer Expenses)\text{Capital Gain} = \text{Sale Consideration} – (\text{Cost of Acquisition} + \text{Cost of Improvement} + \text{Transfer Expenses})Capital Gain=Sale Consideration−(Cost of Acquisition+Cost of Improvement+Transfer Expenses)
If the result is positive, it is taxable as capital gain; if negative, it is termed a capital loss, which can be set off or carried forward according to income tax provisions.

Definition of Capital Asset

Under Section 2(14) of the Income Tax Act, a capital asset includes:

• Property of any kind held by a person, whether or not connected with business or profession.
• Examples: land, buildings, machinery, shares, securities, mutual funds, trademarks, and patents.

Exclusions:

• Stock-in-trade or raw materials used in business.
• Personal movable property such as clothing, furniture, or vehicles (except jewellery, art, or antiques).
• Agricultural land in rural areas (as specified under the Act).

Classification of Capital Gains

Capital gains are categorised based on the holding period of the asset before sale:

1. Short-Term Capital Gains (STCG):
   • Assets held for a short period before transfer.
   • The holding period threshold varies by asset type (detailed below).
2. Long-Term Capital Gains (LTCG):
   • Assets held for a longer period before sale.
   • Enjoy preferential tax rates and indexation benefits to adjust for inflation.

Holding Period Criteria

Tax Rates on Capital Gains

The rate of tax depends on the nature and duration of the asset held:

1. Short-Term Capital Gains (STCG):
   • Equity-oriented assets (Section 111A): Taxed at 15% if securities transaction tax (STT) has been paid.
   • Other assets: Taxed as per the normal income tax slab rates applicable to the taxpayer.
2. Long-Term Capital Gains (LTCG):
   • Listed equity shares and equity mutual funds (Section 112A):
     • Taxed at 10% on gains exceeding ₹1 lakh per financial year (without indexation).
   • Other long-term assets (Section 112):
     • Taxed at 20% with indexation benefit (adjustment for inflation based on the Cost Inflation Index).

Indexation Benefit

Indexation adjusts the purchase cost of a long-term capital asset for inflation, thereby reducing taxable gains.
Indexed Cost of Acquisition=Cost of Acquisition×CII (Year of Sale)CII (Year of Purchase)\text{Indexed Cost of Acquisition} = \text{Cost of Acquisition} \times \frac{\text{CII (Year of Sale)}}{\text{CII (Year of Purchase)}}Indexed Cost of Acquisition=Cost of Acquisition×CII (Year of Purchase)CII (Year of Sale)​
Where CII stands for Cost Inflation Index, notified annually by the Central Board of Direct Taxes (CBDT).
This benefit is not available for equity-oriented investments taxed under Section 112A.

Exemptions under Capital Gains

To encourage reinvestment and asset development, the Income Tax Act provides several exemptions on capital gains:

1. Section 54:
   • Exemption on sale of a residential property if the gain is reinvested in another residential house within prescribed time limits (1 year before or 2 years after sale, or 3 years if under construction).
2. Section 54EC:
   • Exemption on gains from sale of land or building if invested in specified bonds (NHAI or REC) within 6 months, up to ₹50 lakh.
3. Section 54F:
   • Exemption on sale of any asset other than a house, if proceeds are invested in a residential property.
4. Section 54B:
   • Exemption for capital gains on sale of agricultural land, provided the proceeds are used to purchase another agricultural land.
5. Section 10(38) (withdrawn from FY 2018–19):
   • Earlier exempted long-term capital gains on listed equity shares; now replaced by Section 112A imposing 10% LTCG tax.

Set-Off and Carry Forward of Capital Losses

Losses from capital assets can be adjusted as follows:

• Short-Term Capital Loss (STCL): Can be set off against both STCG and LTCG.
• Long-Term Capital Loss (LTCL): Can be set off only against LTCG.
• Unabsorbed Capital Losses: Can be carried forward for 8 assessment years, provided the return is filed within due date.

Illustrative Example

Suppose an individual purchased a plot of land in 2010–11 for ₹5,00,000 and sold it in 2023–24 for ₹20,00,000.The Cost Inflation Index (CII) for 2010–11 = 167, and for 2023–24 = 348.
Indexed Cost of Acquisition=5,00,000×348167=10,42,514\text{Indexed Cost of Acquisition} = 5,00,000 \times \frac{348}{167} = 10,42,514Indexed Cost of Acquisition=5,00,000×167348​=10,42,514 Long-Term Capital Gain=20,00,000−10,42,514=9,57,486\text{Long-Term Capital Gain} = 20,00,000 – 10,42,514 = 9,57,486Long-Term Capital Gain=20,00,000−10,42,514=9,57,486
Tax @ 20% = ₹1,91,497 (before exemptions, if applicable).

Capital Gains Tax on Different Assets

(Note: Post-April 2023, debt mutual funds are treated as short-term capital assets, irrespective of holding period, under new taxation rules.)

International Perspective

Globally, capital gains taxation is a common fiscal instrument, but rates and structures vary:

• United States: Long-term gains taxed at lower rates (0%, 15%, or 20%) depending on income.
• United Kingdom: Separate rates for individuals and corporates, with exemptions for small investors.
• Singapore & Hong Kong: No capital gains tax, making them investment-friendly jurisdictions.

India’s approach balances revenue mobilisation with investment incentives through exemptions and indexation benefits.

Importance of Capital Gains Tax

1. Revenue Generation:
   • Significant source of direct tax revenue for the government.
2. Economic Equity:
   • Ensures that profits from asset appreciation contribute to national income.
3. Encouragement of Productive Reinvestment:
   • Exemptions promote reinvestment in housing, infrastructure, and bonds.
4. Regulation of Speculative Activities:
   • Discourages short-term speculative trading in real estate and securities.
5. Fiscal Stability:
   • Provides a stable and progressive component of tax policy.

Challenges and Criticisms

• Complexity: Multiple holding periods, exemptions, and rates make compliance difficult.
• Inflation Effect: Despite indexation, taxation of nominal rather than real gains can distort equity.
• Disincentive for Investment: High rates may discourage long-term investment in capital markets.
• Tax Avoidance: Difficulties in monitoring property and offshore transactions lead to evasion.
• Frequent Amendments: Constant changes in provisions create uncertainty for investors.
  Capital Gains Tax (CGT) is a direct tax levied on the profit or gain arising from the sale or transfer of a capital asset. It represents the difference between the sale consideration (selling price) and the cost of acquisition (purchase price) of the asset. In India, the capital gains tax is governed by the provisions of the Income Tax Act, 1961, and applies to individuals, Hindu Undivided Families (HUFs), firms, and companies.
  The tax is an important component of the Indian taxation system, as it ensures that income generated from asset appreciation contributes to public revenue, alongside income earned from regular employment or business activities.

  Concept of Capital Gain

  A capital gain arises when a taxpayer sells a capital asset—such as land, building, shares, mutual funds, or bonds—at a price higher than its purchase cost.
  Capital Gain=Sale Consideration−(Cost of Acquisition+Cost of Improvement+Transfer Expenses)\text{Capital Gain} = \text{Sale Consideration} – (\text{Cost of Acquisition} + \text{Cost of Improvement} + \text{Transfer Expenses})Capital Gain=Sale Consideration−(Cost of Acquisition+Cost of Improvement+Transfer Expenses)
  If the result is positive, it is taxable as capital gain; if negative, it is termed a capital loss, which can be set off or carried forward according to income tax provisions.

  Definition of Capital Asset

  Under Section 2(14) of the Income Tax Act, a capital asset includes:

  • Property of any kind held by a person, whether or not connected with business or profession.
  • Examples: land, buildings, machinery, shares, securities, mutual funds, trademarks, and patents.

  Exclusions:

  • Stock-in-trade or raw materials used in business.
  • Personal movable property such as clothing, furniture, or vehicles (except jewellery, art, or antiques).
  • Agricultural land in rural areas (as specified under the Act).

  Classification of Capital Gains

  Capital gains are categorised based on the holding period of the asset before sale:

  1. Short-Term Capital Gains (STCG):
     • Assets held for a short period before transfer.
     • The holding period threshold varies by asset type (detailed below).
  2. Long-Term Capital Gains (LTCG):
     • Assets held for a longer period before sale.
     • Enjoy preferential tax rates and indexation benefits to adjust for inflation.

  Holding Period Criteria

  Type of Asset	Short-Term	Long-Term
  Immovable property (land/building)	≤ 24 months	> 24 months
  Listed equity shares / equity-oriented mutual funds	≤ 12 months	> 12 months
  Debt mutual funds / unlisted shares	≤ 36 months	> 36 months
  Other capital assets (jewellery, bonds, etc.)	≤ 36 months	> 36 months

  Tax Rates on Capital Gains

  The rate of tax depends on the nature and duration of the asset held:

  1. Short-Term Capital Gains (STCG):
     • Equity-oriented assets (Section 111A): Taxed at 15% if securities transaction tax (STT) has been paid.
     • Other assets: Taxed as per the normal income tax slab rates applicable to the taxpayer.
  2. Long-Term Capital Gains (LTCG):
     • Listed equity shares and equity mutual funds (Section 112A):
       • Taxed at 10% on gains exceeding ₹1 lakh per financial year (without indexation).
     • Other long-term assets (Section 112):
       • Taxed at 20% with indexation benefit (adjustment for inflation based on the Cost Inflation Index).

  Indexation Benefit

  Indexation adjusts the purchase cost of a long-term capital asset for inflation, thereby reducing taxable gains.
  Indexed Cost of Acquisition=Cost of Acquisition×CII (Year of Sale)CII (Year of Purchase)\text{Indexed Cost of Acquisition} = \text{Cost of Acquisition} \times \frac{\text{CII (Year of Sale)}}{\text{CII (Year of Purchase)}}Indexed Cost of Acquisition=Cost of Acquisition×CII (Year of Purchase)CII (Year of Sale)​
  Where CII stands for Cost Inflation Index, notified annually by the Central Board of Direct Taxes (CBDT).
  This benefit is not available for equity-oriented investments taxed under Section 112A.

  Exemptions under Capital Gains

  To encourage reinvestment and asset development, the Income Tax Act provides several exemptions on capital gains:

  1. Section 54:
     • Exemption on sale of a residential property if the gain is reinvested in another residential house within prescribed time limits (1 year before or 2 years after sale, or 3 years if under construction).
  2. Section 54EC:
     • Exemption on gains from sale of land or building if invested in specified bonds (NHAI or REC) within 6 months, up to ₹50 lakh.
  3. Section 54F:
     • Exemption on sale of any asset other than a house, if proceeds are invested in a residential property.
  4. Section 54B:
     • Exemption for capital gains on sale of agricultural land, provided the proceeds are used to purchase another agricultural land.
  5. Section 10(38) (withdrawn from FY 2018–19):
     • Earlier exempted long-term capital gains on listed equity shares; now replaced by Section 112A imposing 10% LTCG tax.

  Set-Off and Carry Forward of Capital Losses

  Losses from capital assets can be adjusted as follows:

  • Short-Term Capital Loss (STCL): Can be set off against both STCG and LTCG.
  • Long-Term Capital Loss (LTCL): Can be set off only against LTCG.
  • Unabsorbed Capital Losses: Can be carried forward for 8 assessment years, provided the return is filed within due date.

  Illustrative Example

  Suppose an individual purchased a plot of land in 2010–11 for ₹5,00,000 and sold it in 2023–24 for ₹20,00,000.The Cost Inflation Index (CII) for 2010–11 = 167, and for 2023–24 = 348.
  Indexed Cost of Acquisition=5,00,000×348167=10,42,514\text{Indexed Cost of Acquisition} = 5,00,000 \times \frac{348}{167} = 10,42,514Indexed Cost of Acquisition=5,00,000×167348​=10,42,514 Long-Term Capital Gain=20,00,000−10,42,514=9,57,486\text{Long-Term Capital Gain} = 20,00,000 – 10,42,514 = 9,57,486Long-Term Capital Gain=20,00,000−10,42,514=9,57,486
  Tax @ 20% = ₹1,91,497 (before exemptions, if applicable).

  Capital Gains Tax on Different Assets

  Type of Asset	STCG Tax Rate	LTCG Tax Rate	Indexation
  Listed Shares / Equity Mutual Funds	15% (Sec. 111A)	10% beyond ₹1 lakh (Sec. 112A)	No
  Debt Mutual Funds / Bonds	Normal slab	20%	Yes
  Immovable Property	Normal slab	20%	Yes
  Gold / Jewellery	Normal slab	20%	Yes
  Unlisted Shares	Normal slab	20%	Yes

  (Note: Post-April 2023, debt mutual funds are treated as short-term capital assets, irrespective of holding period, under new taxation rules.)

  International Perspective

  Globally, capital gains taxation is a common fiscal instrument, but rates and structures vary:

  • United States: Long-term gains taxed at lower rates (0%, 15%, or 20%) depending on income.
  • United Kingdom: Separate rates for individuals and corporates, with exemptions for small investors.
  • Singapore & Hong Kong: No capital gains tax, making them investment-friendly jurisdictions.

  India’s approach balances revenue mobilisation with investment incentives through exemptions and indexation benefits.

  Importance of Capital Gains Tax

  1. Revenue Generation:
     • Significant source of direct tax revenue for the government.
  2. Economic Equity:
     • Ensures that profits from asset appreciation contribute to national income.
  3. Encouragement of Productive Reinvestment:
     • Exemptions promote reinvestment in housing, infrastructure, and bonds.
  4. Regulation of Speculative Activities:
     • Discourages short-term speculative trading in real estate and securities.
  5. Fiscal Stability:
     • Provides a stable and progressive component of tax policy.

  Challenges and Criticisms

  • Complexity: Multiple holding periods, exemptions, and rates make compliance difficult.
  • Inflation Effect: Despite indexation, taxation of nominal rather than real gains can distort equity.
  • Disincentive for Investment: High rates may discourage long-term investment in capital markets.
  • Tax Avoidance: Difficulties in monitoring property and offshore transactions lead to evasion.
  • Frequent Amendments: Constant changes in provisions create uncertainty for investors.