What is Long Term Capital Gain Tax?

What is Long Term Capital Gain

For understanding long term capital gain, first we need to know what actually capital asset and capital gain are.

The term capital asset refers to any property or jewelry or antique ornaments which are owned by any person (in case of tax: assessee), irrespective of the fact that whether it is connected to his business/profession or not.

For any Foreign Institutional Investor or FII, holding up of securities in accordance with SEBI’s Act of 1992, would always count under capital asset.

Capital assets do not include consumables (like clothing, regular furniture, etc.) or any materials or stock held for trading in usual business activities.

Capital gain is referred as an increase in the value of a capital asset that gives it a greater worth than the purchase price. The gain is not recognized until the asset is sold. A capital gain is of two sorts, i.e,  short-term (usually 36 months or less) or long-term (more than 36 months).  Upon realization, both these gains have to be reflected on the income tax returns. 

In this article, we would understand long term capital gains and how it is reflected in the Income Tax.

LONG TERM CAPITAL GAIN 

A long-term capital gain refers to a gain from an investment kept for longer than 12 months-36 months before it was sold. The sum of an asset sale that counts toward a capital gain is the difference between the sale value and the purchase value, or merely, the sum of money the investor gained when he sold the asset.

Long term Capital gains, if the assets such as shares and securities, are held by the assessee for a period above 12 months or 36 months in the case of other assets. Also, a few mutual funds will now be qualified for treatment as long term capital assets if they are held for a period exceeding 12 months.

Long term Capital gains are calculated by deducting from the full value of consideration for the transfer of a capital asset the following: 

– Expenditure linked exclusively with the transfer.

– Indexed cost of acquisition of the asset ,as well as,

– Indexed cost of improvement, if any, of that asset. In the case of shares, expenditure in line with the transfer includes the stock broker’s commission, but the salary of an employee is not deducted in calculating capital gains though the employee may have helped in the transfer of the shares.

The Cost of attainment, in these cases contains the price-paid, cost of share transfer stamps, postage fee for sending the shares for transfer to the transfer-agents of the company etc.

Indexed cost of acquisition means a sum which stands for the cost of acquisition the equal part as Cost Inflation Index for the year in which the asset is transferred bears to the Cost Inflation Index for the initial year in which the asset was held by the assessee.

BREAKING IT DOWN: 

When taxpayers file their returns with the Internal Revenue Service (IRS) or Income Tax Department, they report the gross total of their long-term capital gains earned in the tax year. For example, if someone has a long-term gain of $60,000 and a long-term loss of $40,000 in a calendar year, he reports $20,000 in terms of capital gain.

The major factor regarding capital gains is the tax on them. Tax on capital gains directly affects investment decisions.

For Instance, LTCG is taxed at a beneficial rate of 20%, plus a cess of 3%, subject to completion of certain conditions. Other than the concessional rate of taxes available on the sale of capital assets, there are also certain exemptions provided under the Income tax law for capital gains arising from the sale of long-term capital asset.

What is Indexation while calculating Long Term Capital Gains Tax?

Indexation refers to a process of adjusting the cost of an asset to counter any inflation based rise that may cause reduction in the value of the asset. Indexation is the task of the Government or the concerned tax department. It usually depends on these few factors:

  • The Year when the asset was acquired and its respective cost inflation index
  • Year of transfer and its cost inflation index.

Only LTCG can enjoy the benefit of indexation.

Hence, a generalized formula for Indexation is:

(Cost of acquisition × Cost inflation index of the year of transfer of the capital asset)/ Cost inflation index of the year of acquisition

After inclusion of indexation, the maths for calculation of LTCG can be understood as under:

Particulars Currency
Full value of consideration (i.e., Sales consideration of asset) 10,10,000
Less: Expenditure incurred wholly and exclusively in connection with transfer of capital asset (brokerage) 10,000
Net sale consideration 10,00,000
Less: Indexed cost of acquisition (*) 1,96,875
Less: Indexed cost of improvement, if any Nil
Long-Term Capital Gains 8,03,125

EXEMPTIONS FROM LONG TERM CAPITAL GAINS 

  •  Section 54 

Long term capital gain is exempt for an individual or HUF (Hindu Undivided Family) on the sale of a residential house property, if such gains (not the whole consideration) is used to purchase or construct another residential house.

  •  Section 54F 

It is exempt for an individual/HUF where it is realized on the sale of any capital asset, other than a residential house, if the net consideration is invested in the purchase or construction of a residential house

  • Section 54EA: If any long term capital asset is transferred before 1.4.2000 and out of the consideration, investment in state bonds/debentures/shares is made within 6 months of the date of transfer, then exemption from capital gains is available as figured in Section 54F.
  • Section 54EB, Section 54EC AND Section 54ED (Read separately)

The exempt sum is calculated by multiplying the capital gain with the number arrived by dividing the amount invested with the net sale consideration. Though LTCG is required to be invested as per the timelines mentioned in the Income Tax law (two/ three years from the date of transfer), it is likely that such investment may not be made before the due date of filing of return.

Long Term Capital Gain v/s Short Term Capital Gain

An inquisitive person would always ask for the prime difference between long term and short term capital and why the need to have these two arises? As per The Department of Income Taxes, it can be attributed to the different rate of tax over short term and long term realization. Further, indexation can be applied to only LTCG based gains.

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