Capital Gains Tax: Meaning, Types Long Term and Short Term Gains

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 represent, and it also answers your question ‘What is Capital Gains Tax?’

Capital Gains arise when the following conditions are fulfilled:

1. There must be a capital asset

2. It must be transferred in the previous year

3. There must be profit or gains as a result of the transfer

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

Simply speaking, 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.

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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.

Capital gains are divided primarily into two, namely –

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

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

In most instances, profits on the transfer of any capital asset owned for more than 36 months is known as long-term capital gains. Taxes on these earnings are known as long-term capital gains tax.

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 building held for more than 24 months will be considered as 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. Read on –

• 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

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Profits earned from capital assets that are held for 36 months or less are known as short-term capital gains. However, there are some exceptions to this segregation. For example,  in the case of land, building, or house property, this span has been reduced to 24 months only. Thus, if you sell such assets after owning them for more than 24 months, 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)