Understanding the Basics and Tax Efficient Strategies TAXCONCEPT

Capital gain tax meaning, the tax that is levied on capital gains is termed as capital gain tax. Such taxes are levied when an asset is transferred between owners.

Though all capital gains are liable for taxation, the tax approach for long-term gains tend to differ from that of short-term gain. Taxpaying individuals can use tax-efficient financial strategies to reduce the burden of their capital gains taxes.

Here is an example of how it works –

Mr. B purchased a house for Rs. 50 Lakh in July 2004. The full value of consideration in the financial year of 2016-2017 stood at Rs. 1.8 Crore. The said property was held for over 36 months and was, therefore, deemed as a long-term capital asset.

After taking into consideration the inflation, the cost price was adjusted, and the indexed cost of acquisition was also taken into account.

The adjusted cost of the property was then settled at Rs. 1.17 Crore, which means Mr. B accrued a net capital gain worth Rs. 63 Lakh. After a long-term capital gains tax rate of 20% was levied on the net capital gain, the tax liability that was to be paid by Mr. B arrived at a total of Rs. 12,97,800.

Types of Capital Gains Taxation

There are two types of capital gains –

1) Short-term Capital Gain Tax

Any asset that is held for less than 36 months is termed as a short-term asset. In the case of immovable properties, the duration is 24 months. The profits generated through the sale of such an asset would be treated as short-term capital gain and would be taxed accordingly.

2) Long-term Capital Gain Tax

Any asset that is held for over 36 months is termed as a long-term asset. The profits generated through the sale of such an asset would be treated as long-term capital gain and would attract tax accordingly.

Assets like preference shares, equities, UTI units, securities, equity-based Mutual Funds and zero-coupon bonds are also considered as long-term capital asset if they are held for over a year.

Regulations on Short-Term Gains and Long-Term Gains Taxation

Under Section 80C of Income Tax Act –

The short-term capital gains would attract a tax at the rate of 15% of the investor decides to sell it within a year.

A long-term Mutual Funds capital gains tax would be charged 10% on profits exceeding Rs. 1 Lakh generated through equity-oriented funds and shares.

The table below shows how the short-term and long-term capital gains taxation in India is calculated.

For long-term capital gains –

Treatment of Equity and Debt Mutual Funds Capital Gains Tax 

Any gains accrued on the sale of equity funds and debt Mutual Funds are treated differently.

Check the tables below to find out the differences in their calculation –

Type of Funds On or before 1 April 2023
Short-Term Gains Long-Term Gains
Debt Funds At tax slab rates of the individual 10% without indexation or 20% with indexation, whichever is lower
Equity Funds 15% 10% over and above Rs 1 lakh without indexation
Type of Funds Effective 1 April 2023
Short-Term Gains Long-Term Gains
Debt Funds At tax slab rates of the individual At tax slab rates of the individual
Equity Funds 15% 10% over and above Rs 1 lakh without indexation

Exemption on Capital Gains Tax in India

Individuals can lower the burden of such taxes by availing of the tax benefits offered by the Income Tax Act of India. Such benefits can be availed when proceeds from the sale of one asset are reinvested into another asset.

Here are a few exemptions that individuals can avail to lower their burden of capital gains tax in India. 

States exemptions on gains incurred through the sale of an existing residential property and reinvesting the proceeds to purchase another residential property.

As per the budget, individuals would be able to avail an exemption on their long-term capital gains amassed through the sale of a residential property.

They can do so by investing the sale proceeds into a maximum of two residential properties. In this case, capital gains accumulated should not be more than Rs. 2 Crore.

If the cost of the new property is lower than that of the sold unit, the deduction would be liable to attract taxes per the Income Tax Act of India. But such an exemption can be availed only once by a tax-paying individual.

States exemptions on gains incurred through the sale of any asset besides a residential property.

Individuals can avail of this benefit when capital gains have been accrued through the sale of a long-term asset that is not a residential property.

To avail of such an exemption, individuals have to reinvest their sale consideration (inclusive of capital gains) to purchase a new property. Such a purchase should be made 12 months before the sale or at least 24 months post-sale.

States exemptions on gains incurred through sale of an existing residential property and reinvesting its proceeds in particular bonds.

Individuals can avail exemptions under the said Section when they reinvest the proceeds earned through the sale of the first property into specific bonds within six months.

The funds invested in such bonds can be redeemed only after 60 months.

States exemptions on capital gains incurred through the transfer of land for agricultural purposes.

Individuals can avail of exemption under the said section on the short-term or long-term capital gains accrued through the transfer of agricultural lands. The transfer of property has to be 24 months before the sale of the said asset. The exempted amount must be reinvested to purchase a new asset within 36 months from the date of such transfer.

Additionally, the property that is to be bought with the proceeds should not be sold within 36 months of acquisition.

There are several conditions which must be fulfilled to avail these capital gains tax benefits. Individuals must find out which tax benefit is applicable to them and whether they fulfil the pre-required conditions before applying as well. Being aware of such exemptions and how they function under different situations would help individuals reap the best returns.

However, individuals above the age of 60 years and with a minimum annual income of Rs. 3 Lakh are exempted from capital gains tax on their long-term capital gains.

Capital Gains Tax Strategies to Reduce the Tax Burden

The reason why every tax-paying individual wants to reduce the burden of capital gains tax is that they tend to erode a big portion of their capital earnings.

Individuals have the option to reduce their tax liability by adopting the following strategies.

One of the simplest strategies to reduce the tax burden is by holding on to the assets for a longer period.

Individuals can reduce their tax liability to a significant extent by holding onto their assets for over 12 months before selling. The fact that the capital gain tax on long-term capital gains is lower than that of short-term capital gains will act in their favour.

Individuals can reduce their liability of capital gains tax on the property by reinvesting the profits into a new asset within a stipulated time. Individuals need to be careful about the terms and conditions that are associated with such a strategic investment option to maximise their benefits and minimise the tax burden.

Individuals can further lower their tax liability on their capital gains by reinvesting them for constructing a new property or investing them into capital gain bonds.

As a strategic move to reduce the capital gains tax, individuals can park their earnings into a capital gains account. This strategy can be adopted at times when they fail to invest in a new residential property within the stipulated time to save on their tax liability.

Besides these, several tax-saving strategies can be adopted by individuals to lower their capital gains tax in India.

Having a thorough knowledge of such taxes, their exemptions and associated terms and conditions come in handy while availing of a tax exemption on capital gains.

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