Long Term and Short Term Capital Gains

Capital Gains is an often heard term in the Indian income tax world. Here is a preliminary article on what the terminology means and what Long term and short term capital gains are.

Capital gains arises only when a capital asset is transferred. So if the asset transferred is not a capital asset, it will not be covered under the head capital gains.

Profits or gains arising in the previous year in which the transfer took place shall be considered as income of the previous year and chargeable to income tax under the head “Capital Gains” and the concept of indexation shall apply, if applicable.

What is a capital asset ?

A capital asset is any property held by the income tax assessee but does not include :

1. personal effects like jewellery, drawings and paintings.
2. any item held for a person’s business or profession (such items are called stock in trade). These will be taxed under the head “profits and gains of business or profession”.
3. agricultural land in India, which is not urban. This is agricultural land which is outside of 8 kilometers of a municipality and population is less than 10,000. Agricultural land mean any land from which agricultural income is derived.

Capital asset is of two types :

(a) Short term capital asset

This is an asset that is held for not more than 36 months immediately preceding the date of its transfer. However, if the following assets are held for 12 months, they will qualify as well :

1. Equity or preference shares held in a company
2. Any other security listed on a recognized stock exchange of India
3. Units of Unit Trust of India
4. Units of specific Mutual Funds
5. Zero coupon bonds

(b) Long term capital asset

This is an asset that is held for more than 36 months or 12 months as the case may be.

Transfer is defined as the sale of the asset, giving up of rights on the asset, forceful takeover by law or maturity of the asset to name a few. Many transactions are not considered as transfer, for example, transfer of a capital asset under a will.

Long Term and Short Term Capital Gains

Any profits or gains arising from the transfer of a capital asset effected in the previous year shall be chargeable to income-tax under the head ‘Capital Gains’.

Since capital assets are of two types, there will be two types of capital gains – Long Term and Short Term Capital Gains

• Short term capital gains (STCG) – capital gains arising on transfer of short term asset.
• Long term capital gains (LTCG) – capital gains arising on transfer of long term asset.

Examples of assets are apartments, land, shares, mutual funds, gold among many others.

You can infer from the information above, that stocks and units of equity diversified mutual funds qualify for LTCG if held for more than a year.

Similarly, if real estate is held for 3 years, it qualifies for LTCG. If sold before 3 years, it qualifies for STCG.

In order to tax capital gains, the following conditions must have been met :

• The assessee must have owned a capital asset.
• The assessee must have transfered the capital asset in the previous year. So it is not necessary that the property should have been a capital asset on the date of acquisition (date when asset was acquired by the investor) of the asset by the assessee.
• There must have been profit or gains as a result of such transfer.

Computation of capital gains

To compute STCG, the Full Value of Consideration is reduced by the (1) expenditure incurred in the transfer of the asset, (2) the cost of acquisition, (3) the cost of improvement (if any) and (4) exemptions available.

An example of expenditure incurred in the transfer of the asset could be agent’s commission on sale of a property.

Computation of STCG
Full Value of Consideration		–
Less	(1) Expenditure incurred in such a transfer	–
	(2) Cost of acquisition	–
	(3) Cost of improvement	–
	(4) Exemptions available, if any	–
Taxable STCG		–

In case of  LTCG, the formula changes a bit to incorporate the indexed cost of acquisition and improvement. The concept of indexation is covered in another article, the link of which is given later.

Computation of LTCG
Full Value of Consideration		–
Less	(1) Expenditure incurred in such a transfer	–
	(2) Indexed Cost of acquisition	–
	(3) Indexed Cost of improvement	–
	(4) Exemptions available, if any	–
Taxable LTCG		–

Full Value of Consideration is the amount of money which the transferor receives and is not always the market value of the asset which is being transferred.

Note that there are certain exemptions available under Section 54/54B/54D/54EC/54F/54G/54G which can reduce the tax outgo on capital gains. The capital gains arrived after the above calculation is called taxable capital gains.

Example

If an investor has bought stocks worth Rs 50,000/- on January 1st 2006 and sold them for Rs 75,000/- on January 1st 2010, then will this qualify as STCG or LTCG ?

The capital asset has been held for more than one year (01/01/2010 – 01/0/2006 = 4 years),  so this is a long term asset and so gains arising from it qualify as LTCG.  Note that we have compared with 1 year and not 3 years as the asset in question is stocks.

What would have been the case if the stocks were sold on December 1st 2006 ?

In this case, the capital asset has been held for  less than one year (01/12/2006 – 01/01/2006 is < 1 year), and so the asset is a short term asset. In this case, the investor incurs STCG.

Since capital gains is almost always linked with the concept of indexation, make sure you hop over to read about cost inflation index and indexation as well.

We will see the tax liability calculations in future lessons.