Introduction to Capital Gains and Their Classification

Capital gains are the profits derived from selling or transferring capital assets, which can be either tangible or intangible, such as shares, bonds, real estate, and vehicles. The classification of these gains is based on the holding period of the assets, which is crucial for tax purposes.

Types of Capital Assets

Capital assets are primarily divided into two categories based on their holding periods:

• Short-Term Capital Assets: Held for a period equal to or less than a designated threshold, these assets typically incur different tax rates compared to long-term assets.
• Long-Term Capital Assets: Assets held beyond the designated threshold, with the period varying across property types and securities. Financial securities listed in markets usually become long-term assets if held beyond 12 months, affecting their tax treatment on sale.

Taxability of Long-Term Capital Gain (LTCG) on Shares

The taxation of long-term capital gains (LTCG) on shares in India has seen major changes, notably in 2018. While short-term capital gains (STCG) continue to be taxed at distinct rates, the amendments to LTCG rules align with contemporary tax strategies.

Historical Context and Changes in Taxation

Previously, under Section 10(38) of the Income Tax Act, 1961, gains from equity shares and equity-oriented mutual funds were exempt from tax, a provision initiated to attract Foreign Institutional Investors (FIIs). The 2018 budget repealed this exemption by introducing Section 112A, redefining the tax treatment for LTCG on certain assets such as equity shares, units of equity-oriented mutual funds, and business trusts under specific conditions.

Current Tax Rates and Provisions for LTCG

Section 112A stipulates that LTCG on shares and equity-oriented mutual funds are taxed at 12.5% if the total exceeds ₹1.25 lakh in a financial year, along with applicable surcharges and cess. For other securities not covered under Section 112A, different tax rates apply:
- Listed Shares and Mutual Funds: Taxed at 12.5% if Securities Transaction Tax (STT) is paid.
- Bonds and Debentures: Also at 12.5% if STT is unpaid.
- Debt-Oriented Mutual Funds: Usually taxed at higher rates.

Exemptions on Long-Term Capital Gains

Section 54F enables long-term capital gains exemptions upon meeting conditions such as reinvesting the net amount from asset sales into residential properties, now up to two instead of one (post-Budget 2019), within specific timelines. Unused amounts influence the proportionality of exemption. The exemption formula is:
Exemption = (Capital Gains * Cost of New House) / Net Consideration. If the new property is sold within three years, the exemption is nullified, rendering the gains taxable.

Grandfathering Provision

To smoothen the tax transition, the 'grandfathering' provision was implemented, allowing advantages from previous regulations for investments made before policy change. Under Section 112A, grandfathering protects:
- Pre-January 31, 2018 transactions
- Pre-April 1, 2018 sales
- Transactions post these dates undergo new tax rules.

Calculation of Long-Term Capital Gain with Grandfathering

For grandfathered assets, the acquisition cost is crucially determined by comparing the original cost with the Fair Market Value (FMV) of January 31, 2018. Example: If shares bought at ₹15,000 were sold for ₹20,000, with a January 31, 2018 FMV of ₹18,000, the cost is the higher of actual cost or FMV. Thus, the LTCG is assessed as ₹20,000 - ₹18,000 = ₹2,000.

Handling Long-Term Capital Loss

A long-term capital loss occurs when the acquisition cost eclipses the sale price. Such losses can offset long-term capital gains of the same assessment year and can be carried forward for up to eight years to offset future gains.

Conclusion

Understanding long-term capital gains tax implications on shares is vital for financial planning. Changes in tax laws, including grandfathering and exemptions under Section 54F, offer strategic tax management avenues. Staying updated on tax rates, exemptions, and computations helps investors make informed decisions and optimize tax effectiveness.