As this column appears exactly one day before the last date for filing tax returns, my dilemma was to choose from the vast maze of Indian tax laws a single topic that would be most useful to taxpayers at this juncture.
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A quick office poll saw capital gains win hands down. Therefore, the following is a snapshot of our capital gains tax structure encompassing the various rules and rates applicable to different assets.
Basically, capital gains tax is applicable on capital assets such as property, gold, shares, units, bonds debentures, etc. Depending upon your period of holding, these capital assets may be classified as long-term or short-term.
Short-term assets are those that are held for three years or less. By corollary, assets held for over three years will be termed as long-term. Note the above rule carefully. A capital asset has to be held for over three years to be deemed long-term. For example, if you sell a property after exactly three years of owning it, it would still be termed as a short-term asset. It has to be owned for over three years (even one day more) to be designated as long-term.
In the case of shares, debentures, units of mutual funds and deep discount bonds, the period of holding to qualify as long-term assets is reduced to over 12 months instead of the above mentioned three years. The equity share, units and bonds neednt be listed or quoted. Only debentures have to be necessarily listed in order to qualify for the 12-month period.
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Starting with FY 1981-82 as the base year, the RBI notifies the Cost Inflation Index (CII) every year. Indexed cost is arrived at by multiplying the cost with the ratio of CII for the year of sale and year of purchase, respectively. Indexation essentially adjusts cost for inflation, thereby reducing the amount of capital gains.
For example, say a property that was purchased in April 1992 for Rs 10 lakh is sold in March 2008 for Rs 50 lakh. Now, in this case, the capital gain would normally have been Rs 40 lakh (Rs 50 lakh - Rs 10 lakh). However, this would be unfair to the taxpayer since the value of the rupee in 1992 was not the same as it is today. Hence, the cost would be suitably inflated as per the indices for the specified year. The CII for 92-93 was 223 and that for 2007-08 was 551.
Therefore, the indexed cost in the above example would work out to Rs 24.7 lakh (Rs 10 lakh x 551 223). The resultant capital gain of Rs 25.3 lakh is much lower than the non-indexed Rs 40 lakh.
Long-term capital gain tax rate is 20% after reducing the indexed cost. However, only in the case of listed securities, units and zero-coupon bonds does the taxpayer have the option of choosing to pay 10% after reducing the non-indexed cost from the sale price, if the same works out to be lower. For other assets, such as property or gold, the 10% option isnt available, long-term tax is payable only at 20% after indexation.
Short-term capital gains tax on listed shares and units is 10% (subsequently increased to 15% by the Finance Act 2008). On other assets, short-term gains is simply added to the other income and taxed at slab rates applicable to the taxpayer.
Saving capital gains tax
Tax on short-term capital gains cannot be specifically saved. In other words, short-term capital gain is necessarily taxable. On the other hand, depending upon the asset, long-term capital gains tax may be saved by making certain investments. For example, long-term gains from sale of a residential house may be saved by investing the capital gain amount in another residential property, either one year before or within two years of date of sale.
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Long-term gains on assets other than a residential house may be saved by investing the net sale consideration (and not the capital gain), in another residential property again one year before or within two years from date of sale. If only a part of the consideration is used to buy the new property, proportionate deduction will be available.
Lastly, tax on all long-term capital gain (whether from residential property or otherwise) may be saved by investing the capital gain amount in bonds under sec 54EC. Today, NHAI and REC issue such bonds. The maximum amount investible is Rs 50 lakh in any one financial year.