Capital gains occur when you sell an asset for an amount higher than the purchase amount of the respective asset. Depending on the duration to which the asset was owned (holding period), it will be classified as capital gains – long-term and short-term, and will be taxed accordingly. This article explores types of capital gains and attempts to provide a better understanding of capital gain tax on shares.
This article covers:
- What is capital gain tax on shares?
- What are the components of the capital gain tax on shares?
- How is capital gain tax on shares calculated?
- What does capital gain tax on shares denote?
What is capital gain tax on shares?
There are two types of capital gains on shares – long-term and short-term, taxed under the Income Tax Act. Let’s look at both in detail.
Long-term capital gains (LTCG) taxes on shares
Long term capital gain taxes on shares apply on the profit made from selling stocks or redeeming equity mutual fund units after holding them for more than 12 mths from the date of acquisition.
The Finance Act, 2018, introduced a new Section 112A to the Income Tax Act with effect from the assessment year 2019-2020. As per this amendment, any capital gains arising out of sale or transfer of equity shares or mutual fund units or unit of a business trust, shall be taxed at a flat 10% of the gains exceeding Rs 1 lakh in the financial year.
Short-term capital gains (STCG) tax
The other kind of capital gain under the umbrella of capital gain tax is short term capital gains. The short term denotes a holding period for less than 12 mth. The holding period decides the distinction between long term or short term. For shares, if the duration is less than 12 mth, it falls under short term investments. Shares traded within one year of its purchase attract tax at the rate of 15% on the short-term gains.
Note that surcharges and cess are applicable separately on your capital gains on shares.
What are the components of the capital gain tax on shares?
Capital, in simple terms, denotes assets – an investment that leads to gains over time. Shares are also an investment. There are a few important components of the capital gain taxes on shares under the Income Tax Act of India. Those components are:
Equity-based mutual funds units
Equity-based mutual funds mean the mutual funds that are dominated by equity in the weightage of the portfolio. At least 65% of the portfolio is invested in the equity segment in an equity-oriented mutual fund. In this case, the mutual funds are subject to long term capital gain tax, provided that you have held the mutual fund units for more than 12 mth, and short term capital gains tax, if your holding was for a period less than 12 mth.
Securities listed on a stock exchange
Listed shares are subject to capital gains tax. The shares listed on BSE or NSE that are held longer than 12 mths are liable for long-term capital gains tax when you sell them and make a profit from the transaction. Shorter term capital gains tax apply should you make a gain from your near-term investment, selling out within 1 yr of investment.
Preference shares fall under the ambit of capital gains tax on shares. If you sell preference shares after holding them for more than 12 mth, you are liable to pay long term capital gains taxes.
As there is a capital gain tax on shares, there is similarly a capital loss that can be set off. Another provision is to carry forward your capital loss. In accordance with the Income Tax Act, you can carry forward the capital loss for eight assessment years.
How is capital gain tax on shares calculated?
The calculation of capital gains taxes starts with understanding a few important terms. Following are the most terms one should accustom themselves to.
- Sale value: A capital asset’s sale value refers to the amount of money that is received upon its sale.
- Cost of acquisition: It is the amount you paid while you purchased the capital asset.
- Expenditure related to transfer of shares: This can be brokerage fees and other charges which are paid in the process of the sale of the shares.
- Indexation: With indexation, the time value of money is estimated accounting for inflationary pressures.
- Holding period: The period to which an assessee holds the investment is considered the holding period. It begins on the day of asset acquisition and ends on the day preceding the date of transfer of ownership.
Computation of capital gains on shares
Capital gains on shares = Sale value – Indexed cost of acquisition of an asset – Indexed cost of asset improvement – expenditure related to transfer of shares
The tax is levied on the capital gain calculated using the above formula.
Long-term capital gains tax on shares: Under Section 10 (38), on a capital gain made which is more than the limit set by the Income Tax Department – Rs 1 lakh – a simple rate of 10% is charged as long term capital gains on shares. In case of long term capital gains on equity and equity-oriented securities, the benefit of indexation is not available.
Short-term capital gains tax on shares: The same section provides for short term capital gains tax to be levied at 15% on gains made through sale of equity shares. Indexation benefit is not available here either.
What does capital gain tax on shares denote?
Shares are classified as capital assets as you invest your capital on the purchase of shares. The purpose of investing in shares or any asset is to secure a certain amount sometime in the future in addition to the amount you anticipate will be your profit. The profit earned on selling your shares calls for tax. It signifies the Capital Gain tax on shares.
If the holding is within 12 mth, it is a short-term gain, and 15% tax is charged on such gain. Whereas, if the holding exceeds 12 mth, the income is termed long-term capital gains, and 10% tax is charged on such gains.
Investors must be aware of the capital gain tax on shares before investing in shares. The tax rate applicable as long term capital gain taxes on shares is lower as compared to the short-term gains tax on shares. This adds to the bucket of benefits that investors stand to claim from staying invested for the longer term. Over a period of more than 12 mth, we can expect the short-term volatility to settle and the price of the shares to increase too, resulting in overall profitability for the investors in the long run.
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