Capital Gain Tax – Long Term Capital Gain

Capital Gain

In my previous post on Capital Gain Tax – Short Term Capital Gain   we discussed capital gain tax in detail. We also discussed how short term capital gain tax is calculated. Before going through this post, I would request you to go through my previous post. This post is continuation of previous post Capital Gain Tax – Short Term Capital Gain. In this post we will discuss Long Term Capital Gain and why it is so critical from Income Tax Perspective. Just to recap, If the capital asset is held by an individual for a period more than min Holding Period as specified for each capital asset then Gain / Loss from such capital asset is termed as Long Term Capital Gain. To understand the concept of Long Term Capital Gain, first we will discuss Inflation and Inflation Indexation.

Inflation

As per Wikipedia, Inflation is a sustained increase in the general price level of goods and services in the economy over a period of time. In layman terms, if a particular set of goods and services cost Rs 100 during FY 2013-14 and inflation is 10% then same goods and services will cost Rs 110 in FY 2014-15. In short, Inflation reduces purchasing power of money and eats into your returns. In most of the articles you must have read that Returns should beat Inflation so that Real Returns are positive. Now assume, you invested Rs 100 in FD and post taxation your return is 6.3% therefore after 1 year your 100 Rs will be Rs 106.3. But with 10% inflation, now you need 110 Rs to buy same goods and services therefore your Real Return from Investment is Negative i.e.  Rs 106.3 – Rs 110 = -3.7 Rs or – 3.7%.  If Return on Investment is 10% then your Real Return is Zero as you have just beaten inflation.

Inflation Indexation

Inflation Indexation takes care of Impact of Inflation during the Investment period. In layman terms, Inflation Indexation helps to calculate indexed cost i.e. inflation adjusted purchase price / cost of any capital asset. For every Financial Year, Govt of India declare Cost Inflation Index (CII) value for taxation purpose. Latest cost inflation index is as follows

Cost Inflation Index

With the help of Cost Inflation Index, we can calculate Indexed Cost using following formula

Purchase Price of a Capital Asset  X   Cost Inflation Index Value of FY of Sale

Indexed Cost = ______________________________________________________

Cost Inflation Index Value of FY of Purchase

FY of Purchase: 2010-11

Cost Inflation Index Value of FY of Purchase = 711

FY of Sale: 2014-15

Cost Inflation Index Value of FY of Sale = 1024

40,00,000   X   1024

How Long Term Capital Gain is Calculated?

Long Term Capital Gain can be calculated by subtracting Indexed Cost of a Capital Asset from Sale Price. In above mentioned Example, if you bought a property worth 40 lakhs in Oct, 2010 and sold it for 60 lakhs in Oct, 2014. Since holding period is more than 3 years therefore Long Term Capital Gain will be 60 lakhs – 57.60 lakhs (Indexed Cost) = 2.40 lakh. In case of a property, cost of improvement & cost of transfer can also be included in the cost of acquisition for long term capital gain tax calculation. Long Term Capital Gain from Property is a complex subject, i will discuss it in detail in my future post.

Important points related to Long Term Capital Gain / Loss.

(a) Long Term Capital Loss can only be offset against Long Term Capital Gain.

(b) Long Term Capital Loss from Stocks or Equity Funds cannot offset if Security Transaction Tax is paid (Long Term Capital Gain is Tax Free).

(c) Long Term Capital Loss

cannot be offset against Income.

(d) Long Term Capital Gain can be offset against Short Term Capital Loss.

(e) Any loss from business or profession can be offset against Long Term Capital Gain. Similar to Short Term Capital Gain, Any carry forwarded business losses cannot be set off against long term capital gain.

Long Term Capital Gain Tax Rate

(a) Stocks and Equity Oriented Funds: NIL (Fully Exempted)

(b) Bonds and NCD’s (Non Convertible Debentures): 10% Flat without indexation benefit

(c) Debt Oriented Funds: 20% with indexation benefit

(d) Gold ETF’s and Gold Funds: 20% with indexation benefit

(e) Bullion and Jewellery: 20% with indexation benefit

(f) Real Estate: 20% with indexation benefit

Therefore if Long Term Capital Gain is 2.4 Lakh (as calculated above) with indexation benefit, Tax rate is 20% (irrespective of the tax slab of the investor). Long Term Capital Gain Tax will be 20% of 2.4 Lakh = Rs 48,000.

Imp Point:  Tax rate of Long Term Capital Gain is independent of Tax slab of the investor. Some of my readers who were in 10% income tax slab took indexation benefit but considered tax rate at 10% (individual income tax slab) instead of 20%. With Indexation benefit, Long Term Capital Gain Tax rate is 20%.

If you are an ACTIVE investor in stock market then you might need to pay Long Term Capital Gain Tax as per your Income Tax slab without indexation benefits as Income tax department might treat your stock activity as Business Activity. You will be taxed as per your income tax slab.

Smart Investor

Lastly a smart tip on how to gain maximum from inflation indexation. If you are planning to invest in debt market or real estate for 3 years or more then it is advisable to invest towards the end of Financial Year i.e. during February or March. After 3 years, You can sell your capital asset at the beginning of Financial Year i.e. in April or May to avail indexation benefit of new FY. Through this strategy, you can avail inflation indexation benefit of 4 Financial Years by investing only for slightly more than 3 years. Lets understand with an example.

Assuming, i bough debt mutual funds worth Rs 1 lakh on 20th March, 2012. My minimum holding period of 36 months will be over on 19th March, 2015 and if i sell after this date then any gain will be long term capital gain. I can avail indexation benefit. Now if i wait for 2 more weeks and sell my mutual funds on 5th April, 2015 then Cost inflation index value of FY 2015-16 will be considered instead of FY 2014-15. Average inflation during current FY i.e. 2014-15 is 8% and assuming Cost Inflation Index value of 1105 for FY 2015-16 based on inflation. In short, by deferring my redemption for few days the indexed cost will be high thus my long term capital gain will be less. This strategy works only when Inflation is high.

Indexed Acquisition Cost (Redemption on Mar 20, 2015): Rs 1,30,445

Indexed Acquisition Cost (Redemption on April 05, 2014): Rs 1,40,764

Irrespective of NAV at the time of Redemption, by deferring redemption my long term capital gain will reduce by approx Rs 10,319. If we assume that NAV will remain almost same (NAV of debt mutual fund is not very volatile) then i can save Rs 2063 as Long Term Capital Gain tax with this smart strategy.

This conclude, one of the most interesting topic of Personal Finance / Taxation. Hope you liked the post. You can share this post with your friends and family members through following social media icons. For any query / clarification, Please feel free to leave your comments in following comments section.

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Category: Bank

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