What is Capital Gains Tax: Short Term & Long Term Capital Gains Explained

Taxation in India varies based on the category of income reported. In this regard, taxpayers often face confusion regarding what capital gains are. If you are wondering the same thing, you have come to the right page!

Here is an in-depth look at what capital gains are and how to calculate capital gain taxation.

Capital gains tax or CGT is a tax specifically levied on the profit generated after the transfer of a capital asset. For this to hold true, you would need to transfer the particular capital asset at a price higher than what you paid to buy it.

Therefore, property or capital assets inherited do not qualify for this taxation. In such cases, no transaction occurs, but only a change of hands from one person to another. But when the inheritor transfers the asset, it will attract capital gains.

So, capital gains refer to income that you earn by selling capital assets. Now the question arises as to what capital assets are. As per Section 2(14) of the Income Tax Act, 1961 capital asset includes:

• Any property held by an assessee, irrespective of it being connected with the business or profession of the assessee
• Any securities held by a Foreign Institutional Investor (FII) as an investment as per the regulations under SEBI Act,1992

Capital gains arise when the following conditions are fulfilled:

• There must be a capital asset
• It must be transferred in the previous year
• There must be profit or gains as a result of the transfer

Capital assets can include the following:

• Jewellery
• Lease rights
• Trademarks and patents
• Building
• Land
• Machinery
• House property
• Rights in any Indian company

Now that you know what capital assets are as per Income Tax Act,1961, also make it a point to assess the exclusions.

Here are the capital assets which do not come under capital gains:

• Agricultural land situated in India, owned in rural India as per the provisions.
• Furniture and clothes owned for personal use.
• Consumable items or stocks held for professional or business-related use.
• Special bearer bonds and Specified Gold Bonds.
• Deposit certificates issued under the Gold Monetisation Scheme, 2015.

Now that you have a clear idea of what capital gain is in income tax, you must start understanding the intricacies of taxes on such gains.

Capital gains are divided primarily into two, namely:

• Short-term capital gains
• Long-term capital gains

Before assessing what long-term capital gain and short-term capital gain are, you must understand that the difference is mainly in the amount of time one holds the capital assets before deciding to transfer them.

As per the new capital gains tax rules proposed by Budget 2024, the profits on the transfer of any capital asset owned for more than 24 months is known as long-term capital gains, and the tax on these earnings is called long-term capital gains tax. Earlier this holding period was 36 months.

However, a few assets are considered long-term, even if they are held for 12 months or more. These include:

• Quoted or unquoted Unit Trust of India bonds.
• Securities, such as debentures, bonds, and government securities, which are listed on a recognised Indian stock exchange.
• Equity mutual funds
• Zero-coupon bonds
• Equities or preference shares of a company listed on a recognised Indian stock exchange.

Unlisted shares and immovable property including land and buildings held for more than 24 months will be considered long-term capital assets.

Calculation of long-term capital gains would require you to follow a few simple steps:

• Step 1: Start with the total amount received after capital asset sale.
• Step 2: Deduct the cost of transfer + indexed cost of acquisition + indexed cost of improvement.

Now, to ensure proper calculation, you must know what each of these terms represents.

• Cost of transfer = Expenses incurred for advertising, deals, and legal expenses incurred and wholly and exclusively for the transfer.
• Indexed cost of acquisition = Cost of inflation index (CII) for the year of transfer X acquisition cost/ (CII) for the year of acquisition or FY 2001-02, whichever is later.
• Indexed cost of improvement = Improvement expenses X(CII) for the year of transfer / (CII) for the year of asset improvement.

Profits earned from capital assets that are held for 24 months or for some assets 12 months, are known as short-term capital gains, after the proposed changes by Budget 2024. Thus, if you sell such assets after owning them for more than 12 or 24 months depending on the asset, it would be classified as a long-term capital gain.

The formula for short-term capital gains calculation is the same as that for long-term capital gains. It is as follows:

Short-term capital gain = Full value of consideration – (cost of improvement + cost of acquisition + cost of transfer)