Tax Treatment of Long Term Capital Gains

What is a Long-Term Capital Gain?

Section 45 of the Income Tax Act, 1961, states the long-term capital gain definition as the profit or gain arising from the transfer of an asset of a capital nature will constitute the income of the year in which the transfer took place, and the same will be chargeable to income tax under the head 'Capital Gains. In the LTCG meaning, a capital asset is any property held by the individual- whether or not connected with his business or profession. It also includes the securities held per SEBI regulations by foreign institutional investors. 

What Qualifies as Long-Term Capital Gains? 

Section 2 (29A) states that a capital asset held for more than 36 months immediately preceding the date of its transfer is a long-term capital asset. However, there are certain exceptions to the long term capital gain meaning.

For example, the period of holding unlisted shares and immovable property will be 24 months and not 36 months, and that of a Zero-Coupon Bond will be more than 12 months. Generally, the period ranges from 1-3 years. 

The following fall within the purview of the long-term tax regime:

● Equity Shared in a company listed on a recognized stock exchange 
● Unit of an equity-oriented fund
● Unit of a business trust

Earlier, Long term capital gains on shares and securities on which securities transaction tax was paid were tax-free. This exemption was stated in Section 10(38) of the Income Tax Act, which was later removed in 2018. From FY 2018-19, Section 112A of the Income-tax Act levies a tax on LTCG at 10% on the sale of equity shares, equity-oriented mutual funds, and units of business trust exceeding 1 lakh for the respective financial year.

How Long-Term Capital Gains are Calculated?

Section 48 of the Income Tax Act lays down the Mode of Computation of Tax on LTCG. The income chargeable under the category of Capital Gains is computed by deducting the following from the total value of the consideration that is received or accrued owing to the transfer of the capital asset:

1. Expenditure incurred in connection with such transfer
2. Cost of Acquisition
3. Cost of Improvement

Note that no deduction is allowed in respect of the STT. The section further allows an increment in the cost of Acquisition and cost of the improvement by the cost inflation index (CII). Subsequently, these gave us the indexed Cost of Acquisition and Cost of Improvement.

Let us explain these terms mentioned above for a better understanding.

Value of Consideration: Payment received or received by the seller due to the transfer of the capital asset. Note that even if the consideration is received after the year in which the transfer of the capital asset took place, the tax will be chargeable in the year it accrues.

Cost of Acquisition: This refers to the value paid by the seller at the time of buying or acquiring the capital asset. 

Cost of Improvement: The capital expenditure incurred in the seller's additions or modifications to the asset. 

Cost Inflation Index: 75% of average rise in the urban consumer price index (CPI) as notified by the Central Government.

Tax on Long-Term Capital Gains    

The long-term capital gains tax on equity shares and equity-oriented funds over and above Rs 1 lakh is 10%. This category includes LTCG earned by selling securities of more than Rs 1 Lakh under Section 112A of the Income Tax Act of India, as well as returns from zero coupon bonds, UTI, or Mutual Funds sold on or before July 10, 2014.

The rate of LTCG tax is 20% for other capital assets. A surcharge and cess are also levied on the abovementioned rates. Certain exemptions are allowed to ease the burden of taxes under particular conditions.

Exemptions on LTGC Tax 

The Income Tax Act allows for the following exemptions in the case of LTCG:

1. Investment in Capital Gains Account Scheme (CGAS): If the gain arising from the sale of a capital asset is invested in a CGAS, it is exempt from tax.

2. Mutual Funds Investments help for longer than 1 year: Some asset management companies may offer tax-free returns for mutual funds investments if held for longer than one year.

3. Reinvestment of proceeds from the sale of property: If the gains from a property are reinvested in another one within 1 or 2 years from the time the deal was effected, then the gains are exempt from tax. However, the exemption is inapplicable in cases where the property was sold or transferred within three years of purchase.

What are long-term capital gains on equity-oriented funds? 

Equity-oriented funds invest at least 65% of the assets in equity or equity-related instruments. The long-term capital gains on equity-oriented funds refer to the profits arising from the sale of listed equity shares from April 1, 2018.

The holding period in the case of listed equity funds is 12 months or more from its purchase date.

 Earlier, these were subject to STT only as opposed to short-term capital gains that attracted a tax rate of 15%. The motive behind keeping the LTCG on equity-oriented funds tax-free was to have more investors participate in the equity market.

Post the 2018 Union budget amendment, equity-oriented funds are now taxable at 10% if the gains are more significant than 1 Lakh, along with surcharge and cess. However, Indexation is not applicable in LTCG on equity-oriented funds.

How to calculate long-term capital gains on equity-oriented funds with examples 

To illustrate how long-term capital gain tax is calculated for equity-oriented funds, let us consider an example. Suppose you invest Rs 2,00,000 in an equity fund in July 2017 and the NAV be Rs 20 (i.e., 10,000 units). Suppose you redeemed all of the units of the equity-oriented fund on September 2020 at a NAV of Rs. 40.

As per the conditions laid down in the Income-tax Act of India, you are liable to pay a tax on the gains you receive chargeable under 'Capital Gains. Since the period you helped these units were more than a year, this capital gain will be considered long-term; therefore, a 10% tax will be applicable on the gains above Rs 1 Lakh.

Sale consideration (10,000units @Rs 40) = Rs 4,00,000

Less: Cost of Acquisition (10,000 units@ Rs 20) = Rs 2,00,000

Long-term Capital Gain= Sale Consideration- Cost of Acquisition

                                           = Rs 4,00,000-Rs 2,00,000

                                           = Rs 2,00,000

LTCG above Rs 1 Lakh in a FY= Rs 1,00,000*10%= Rs 10,000

How to Save LTCG on Equity-Oriented Funds 

Any capital loss incurred on the sale of equity-oriented funds can be offset against the capital gains from these funds. It is important to note that profits and losses of a similar nature can be set off against each other alone.

For instance, a long-term capital loss can be offset against a long-term capital gain alone. If this cannot be done during the same financial year, the losses can be carried forward and adjusted against the gains in the next eight years.

The income tax return (ITR) needs to be filed for each of these years, even if no income is earned during that financial year (FY).
 

LTCG on Equity Linked Savings Scheme (ELSS)

An Equity Linked Savings Scheme or ELSS is an investment scheme similar to mutual funds in which an investor's fund is invested across different sectors and industries.

It is a tax-saving investment scheme that enjoys tax exemption under Section 80C of the Income Tax Act, 1861. The minimum period for remaining invested in an ELSS investment is 36 months. A 10% tax applies to ELSS investments over Rs 1 Lakh profits.
 

LTCG Tax on ELSS With Example 

Consider that you invested Rs 4,00,000 in an ELSS in October 2017 and redeemed this entire investment in June 2021 at Rs 7,00,000. The LTCG will be calculated as follows:

Full Value of Consideration= Rs 7,00,000

Less: Cost of Acquisition= Rs 4,00,000

LTCG= Full Value of Consideration- Cost of Acquisition

         = Rs 7,00,000- Rs 4,00,000

         = Rs 3,00,000

Tax is applicable only on the LTCG earned more than Rs 1 Lakh annually. Therefore, the taxable amount for LTCG will be Rs 2,00,000 (Rs 3,00,000-Rs 1,00,000) and the LTCG tax will be Rs 20,000 (10%*Rs 2,00,000)

A capital asset sold before the expiration of 1-3 years will not qualify for LTCG, and the tax rates applicable for short-term capital gains will be helpful in this condition. The surcharge on Long-term Capital Gains is capped at 15% following the 2022 budget. 

Conclusion

This blog discussed the long term capital gain definition, how to calculate LTCG, the examples of the same, among other aspects. To sum up, long term capital gain can be understood as the profit or loss which results from the sale of an investment that has been in possession of an organization or an individual for more than a year, at the time. These can include examples such as properties, houses, land, etc.