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March 7, 2000

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The ABC of capital gains

Larissa Fernand

How often have you heard that term but never knew what to make out of it? Here are some FAQs to help you come to grips with this issue.

What is capital gains?
Capital gains is nothing but the profit made on selling a capital asset.

What is a capital asset?
Any property held by an assessee (that means an income tax payer). So it can be shares, units of UTI, debentures and land.

However, furniture, personal belongings, agricultural land (subject to certain criteria), Special Bearer Bonds, 1991, Gold Deposit Bonds (1999 scheme), 6.5 per cent Gold Bonds, 7 per cent Gold Bonds, National Defence Gold Bonds issued by the Central Government and raw material held for the purpose of business is not termed as a capital asset. Interestingly, though, from the year 1973-74, jewellery is treated as a capital asset.

How are capital gains treated in the Income Tax Act?
Either as short-term capital gains or long-term capital gains, depending on the number of years it is held.

What is the tax on capital gains?
If cost-inflation indexation is considered, then it is charged at 20 per cent whereas it is 10 per cent if cost-indexation is not considered. NRIs pay capital gains at the rate of 10 per cent.

How is inflation taken into account?
Starting with 1981 - 82 as the base year, the Reserve Bank of India notifies the Cost Inflation Index every year and the income tax department uses this figure in its calculations.

Financial year Cost Inflation index
1981 82 100
1982 83 109
1983 84 116
1984 85 125
1985 86 133
1986 87 140
1987 88 150
1988 89 161
1989 90 172
1990 91 182
1991 92 199
1992 93 233
1993 94 244
1994 95 259
1995 96 281
1996 97 305
1997 98 331
1998 99 351
1999 2000 389

Based on the above figures, how is the cost indexed?

 You bought a home for: Rs 5,00,000
 In the financial year: 1985-86
 You sold it for: Rs 15,00,000
 In the financial year: 1995-96
 Cost inflation index:
1995-96 index   281    
---------------------------- = --------- = 2.11278
1985-86 index   133    
 Indexed cost: Rs 5,00,000 x 2.11278 = Rs 10,56,390
 Long-term capital gains: Rs 15,00,000 Rs 10,56,390 = Rs 4,43,610

So if I sold it before the stipulated holding period, I don't get the indexed benefit?
Correct. And to make it more clear, lets work with some figures.

   Long-term capital gains  Short-term capital gains
 You bought a home for  Rs 5,00,000  Rs 5,00,000
 In the financial year  1985-86  1993-94
 You sold it for  Rs 15,00,000  Rs 15,00,000
 In the financial year  1995-96  1995-96
 You repaired the house for  Rs 5,000  Rs 5,000
 In the year  1990-91  1994-95
 Expenses on transfer  Rs 5,000  Rs 5,000
 Capital gains  Rs 4,30,890.25  Rs 9,90,000

How long should I hold the asset to avail of long-term capital gains?
Equity, preference shares and units of Unit Trust of India (whether they are quoted or not), debentures or government securities (listed on a stock exchange), units of mutual funds specified under section 10(23D) (whether quoted or not), have a holding period of just 12 months. For all other assets, like property and diamonds, the holding period is a minimum of three years.

If you sell it before this time frame you will have to pay short-term capital gains.

Is there any way I can avoid paying capital gains tax?
The budget of 2000 - 2001 abolished section 54EA and EB, which were available for claiming exemption on capital gains. A new section 54 EC was introduced, instead. Under this, investments qualifying for exemption are bonds issued by the National Highway Authority of India (NHAI) and the National Bank for Agriculture and Rural Development.

Are there any transactions that do not come under capital gains?
Yes, certain transactions are not considered as transfer and hence not considered as capital gains. They are:

  • distribution of assets to shareholders on liquidation
  • distribution of assets to members of HUF on total/ partial partition
  • transfer on account of a Will/ irrevocable trust/ gift
  • transfer by holding company to subsidiary and vice versa
  • transfer on account of amalgamation
  • transfer on account of demerger
  • transfer of agricultural land in India
  • transfer of artifacts to National Museum, National Art Gallery or the government
  • transfer of bonds into shares of the company
  • transfer of membership to stock exchange by assessee to company in lieu of shares of
  • that company (done before December 31, 1998)

If I sell my car, do I have to pay capital gains?
No. The sale of a car is exempt from capital gains tax since it is a personal item.

What about an insurance claim?
No. The payment of an insurance claim is not an amount being paid for taking over an assets. So it is not subject to capital gains.

If I lend my shares, they get returned with other distinctive numbers. What is the law on that?
Here again, lending shares with specific distinctive numbers and receiving them back with other distinctive numbers does not result in a transfer. So here too it is not subject to capital gains tax.

What if I make a capital loss instead of a gain?
Any capital loss suffered (short-term and long-term) is available for set off against short-term or long-term capital gains. Any unadjusted loss can be carried forward for a period of eight subsequent assessment years.

Also see

Capital Gains Calculator

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