Tax on short-term capital gains cannot be saved

With February coming to an end, it is as good a time as any to start planning your tax return.

The trick is to start early and take the necessary actions step by step. Tax planning is at all times a process and not a one time, sporadic exercise. This week’s column comprehensively examines the vast maze that our capital gains tax structure is - it is hoped that the following snapshot of capital gains tax encompassing the various rules and rates applicable to different assets would help the reader in the upcoming tax return preparation process.

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 that are 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, say you sell property exactly after three years of owning it, the property 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.

Now, 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 shares, units and bonds needn’t be listed or quoted. Only debentures have to be necessarily listed in order to qualify for the 12 month period.

Indexation
Starting with financial year (FY) 81-82 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 Rs10 lakh is sold in February 2011 for Rs75 lakh. Now, in this case, the capital gain would normally have been Rs65 lakh (Rs75 lakh - Rs10 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 FY 92-93 was 223 and that for FY 10-11 is 711. Therefore, the indexed cost in the above example would work out to Rs31.9 lakh (Rs 10 lakh x 711 / 223). The resultant capital gain of Rs43.1 lakh is much lower than the non-indexed Rs65 lakh.

Tax rates
Long-term capital gain tax rate is 20% after reducing indexed cost. However, only in the case of listed securities, units and zero coupon bonds, the taxpayer has 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 isn’t available, long-term tax is payable only at 20% after indexation.

Short-term capital gains tax on listed shares and units is 15%. On other assets, the short-term gains are 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 gain 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. 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 gains (whether from residential property or otherwise) may be saved by investing the capital gain amount in bonds under Sec 54EC. Currently, NHAI and REC issue such bonds. The maximum amount investible is Rs50 lakh in any one financial year.