Capital Gain is a head of income under Income Tax Act, which charges a rate when assets are sold. Not all assets are taxed under this head when sold as the rule clearly states it must be a Capital Asset. Hence to understand how capital gains may affect you, it is vital to understand a few important definitions. Only Capital assets are liable to tax under the head capital gains. A Capital asset is any asset which isn’t used as stock in a business. E.g. If a goldsmith owns gold which he uses to make jewelry and sell in his shop, such gold would be stock and hence not liable to capital gains. However when all of us who are not goldsmiths own gold, it would be considered a capital asset and would hence be liable to capital gains.
Income tax act has been very stringent to define transfer in the law. Under the act transfer need not merely mean sale of said asset. It could also income the insurance compensation received when an asset is destroyed, compulsory acquisition by the government is also considered as transfer and will come under capital gains tax. A special feature under this act that specifically applies to people who carry on some form of business is the term deemed transfer. When a person starts a business and converts his assets held as capital assets into stock in trade, in such a situation too, the conversion would be considered transfer of capital asset.
Capital gains are categories into two types based on period of holding of assets as well as whether or not such assets are shares. A Capital asset held for a period beyond 36 months is considered Long Term capital asset and if lesser than such period is a short term capital asset. However when it comes to equity shares, the period of holding for segregating short term and long term is reduced to 12 months. Hence there are actually four categories under which capital gain can be charged.
Capital gain taxation has introduced the concept of indexation. This is applicable in case of long term capital gains, where the cost of acquisition of the asset is adjusted with an index to provide a current cost. An indexation value is published for every year and the asset is indexed to the year of tax from the date of purchase of such asset. However, short term capital gains do not have to apply such a principal.
Capital gains have a series of deductions under section 54. These deductions are mainly focused on sale and purchase of Residential House or Agriculture Land. Three Important deductions available are:
- Sec 54- When a residential property is sold, if a new residential property is purchased 1 year before or 2 years after such sale or if a house is constructed within three years of sale, the amount of capital gains invested in new house is exempt from tax.
- Sec 54 EC– When a residential property is sold, if gains is invested in NHAI or REC bonds, such amount invested up to amount of capital gain subject to a maximum of 50 lakhs is exempt. The investment must remain invested for a minimum period of 3 years.
- Sec 54 F– On sale of any asset other than residential house, an exemption is available if such gain is invested in a residential house 1 year before or within 2 years after sale. In case of construction, it must begin construction within 3 years of sale.