Capital Gains

[Submitted by Mr. Mohit Agarwal,
CA (Final) student,
Meerut, Uttar Pradesh]

October 1, 2007

A Brief Description of Capital Gains

What is chargeable to tax: Any gain arising on the transfer of a capital asset during the previous year is chargeable to tax under the head 'Capital Gains' under section 45, in the immediately following assessment year, if it is not eligible for exemption under section 54, 54B, 54D, 54EC, 54ED, 54F, 54G, 54GA, and 54H. Incidence of tax on capital gains, however, depends upon whether capital gain is short-term or long-term capital gain.

Short term/long term capital assets:

'Short term capital assets' means a capital assets held by the assessee for not more than 36 months, immediately prior to its date of transfer. In other words, if a capital asset is held by an assessee for more than 36 months, then it is known as 'long term capital' assets. However in the following capital assets such period is taken as 12 months instead of 36 months.

• Equity or preference shares in a company whether listed or not.
• Securities like debentures, Government securities (should be listed on a recognized stock exchange in India).
• Units of UTI or of a mutual fund specified under section 10(23D) whether listed or not.
• Zero coupon bonds whether listed or not.

In the aforesaid cases, an asset, held for not more than 12 months is treated as Short-term capital assets. If the asset is held for more than 12 months immediately prior to its transfer, then it is treated as long-term capital assets.

Why capital assets are divided in short/long-term assets:

The tax incidence under the head 'Capital Gains' depends upon whether the capital gain is short term or long term. If the asset transferred is a short-term capital asset, capital gain will be short-term capital gain. Conversely, long-term capital gain arises on transfer of a long-term capital asset. The classification of long term/short term is important due to the following reasons

• Long-term capital gain is generally taxable at a lower rate.
• The benefit of indexation is available to long term capital gain.
• Exemptions under section 54 are generally available in case of long-term capital gain.

In the case of transfer of a depreciable asset (other than an asset used by a power generating unit eligible for depreciation on straight line basis), capital gain (if any) is taken as short-term capital gain, irrespective of period of holding.

A brief description of capital gains on transfer of shares/securities/units/bonds.

Consequences on transfer of equity shares in a company or units of equity oriented mutual fund:

A. When long term capital gain arises on transfer [SEC. 10(38)]:

When long term capital gain arises on transfer of equity shares in a company or units of equity oriented mutual fund then such capital gain is exempt under section 10(38) if following conditions are satisfied-

• Taxpayer is an individual, HUF, firm or company or any other taxpayer.
• Such capital gain is long term capital gain.
• Such transaction takes place on or after 1 October 2004.
• Such transaction should be chargeable to securities transaction tax.

If above conditions are satisfied then such long term capital gain is exempt from tax from assessment year 2005-06.

However, such long term capital gain exempt under section 10(38) shall be taken into account in computing the book profit and income tax payable under section 115JB (minimum alternate tax)

B. When short term capital gain arises on transfer [SEC. 111A]:

a) When short term capital gain arises on transfer of equity shares in a company or units of equity oriented mutual fund then section 111A is applicable and such short term capital gain is taxable at the rate of 10 per cent (plus surcharge plus education cess) if the following conditions are satisfied.

• Taxpayer is an individual, HUF, firm or company or any other taxpayer.
• Such capital gain is short term capital gain.
• Such transaction takes place on or after 1 October 2004.
• Such transaction should be chargeable to securities transaction tax at the time of transfer.

Provided that in case of an individual or a Hindu undivided family being a resident where the taxable income as reduced by such short term capital gain is less then the exemption limit then such short term capital gain shall be reduced by the amount by which the taxable income as so reduced falls short of the exemption limit.
For example the following shall be taxable.
          [Short term capital gain - (Exemption limit - Taxable income as so reduced)]
Such balance amount of short term capital gain is chargeable to tax.

b) Deduction under chapter VI-A cannot be availed in respect of such short term capital gain included in the total income of the assessee. Deduction under chapter VI-A shall be allowed as if the gross total income as reduced by such short-term capital gain were the gross total income of the assessee.

c) For the above purpose 'equity oriented fund' means a fund, which satisfies the following points:

• The investible funds are invested by way of equity shares in domestic companies to the extent of more than 50% of total proceeds of such fund.
• The fund has been set up under a scheme of a mutual fund specified under section 10(23D).

d) Securities transaction tax is applicable in the case of transfer of equity shares and units of equity oriented mutual fund on or after 1 October 2004. It is applicable only if these assets are transferred in a recognized stock exchange in India or units of equity oriented mutual fund are transferred to the mutual fund. If these assets are transferred without recording the transaction in a recognized stock exchange in India or if units of equity oriented mutual fund are transferred to a person other than the mutual fund, securities transaction tax is not applicable even if the transfer takes place on or after 1 October 2004

Tax On Long Term Capital Gains [SEC. 112]

A. Where the total income of any taxpayer includes any income by way of long term capital gains, then tax is payable on such long term capital gain at a flat rate of 20%. The tax payable on total income shall be aggregate of -

• The amount of income tax payable on total income as so reduced by such long term capital gains at normal rates (assuming the total income as so reduced been his total income; and
• The amount of income tax calculated on such long term capital gain at the rate of 20%.

Provided that in case of an individual or a Hindu undivided family being a resident where the taxable income as reduced by such long term capital gain is less then the exemption limit then such long term capital gain shall be reduced by the amount by which the taxable income as so reduced falls short of the exemption limit.

For example the following shall be taxable.
        [Long term capital gain - (Exemption limit - Taxable income as so reduced)]
Such balance amount of long-term capital gain is chargeable to tax @ 20%.

B. Tax incidence on transfer of listed securities or units or zero coupon bonds: (proviso to section 112):

Where tax payable by any taxpayer in respect of an income arising from the transfer of a long term capital assets, being listed securities or units (units of UTI or a mutual fund whether listed in a recognized stock exchange or not) or zero coupon bond, exceeds 10% of the amount of capital gain before indexation, then such excess shall be ignored while computing the tax payable by the assessee.

For the purpose of this sub-section,

• The listed securities means the securities as defined in section 2(h) of the Securities Contracts (Regulation) Act, 1956 such as shares, stocks, bond, debenture in or of any incorporated company or other body corporate and Govt. securities.
• Unit shall have the meaning assigned to it in clause (b) of Explanation to section 115AB.

C. Deduction under chapter VI-A cannot be availed in respect of long term capital gains included in the total income of the assessee. Where the gross total income of the assessee includes any long term capital gains then Deduction under chapter VI-A shall be allowed as if the gross total income as reduced by long term capital gain were the gross total income of the assessee.

Capital gain on transfer on US64 [SEC. 10(33)]

Any income arising from the transfer of a capital asset being a unit of US64 is not chargeable to tax where the transfer of such assets takes place on or after April 1, 2002. This rule is applicable whether the capital assets (US64) is long term capital assets or short term capital assets.

Cumulative impact of section 10(33), 10(38), 111A, 112:

Income tax rates

(Add surcharge and education cess) 

Capital gain on transfer of bonus shares:

Capital gain on transfer of bonus shares shall be calculated as follows.

Capital gain on transfer of right shares:

Cost of acquisition in different cases is given below:

 *The amount realised by the shareholder by selling his right entitlement will be short-term capital gain (as the cost is taken as nil)

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