Capital Gain
Capital gain refers to the profit realised when a capital asset is sold at a price higher than its purchase price. It represents the increase in the value of an investment or asset over time and is a key component of investment income. Capital gains can arise from the sale of assets such as stocks, bonds, real estate, mutual funds, jewellery, or business assets. The gain becomes taxable only when the asset is sold — until then, it is considered an unrealised gain.
Capital gains play a significant role in personal and corporate finance, influencing investment behaviour, taxation, and overall wealth management strategies.
Nature and Concept
A capital gain occurs when the selling price of a capital asset exceeds its cost of acquisition (including any improvement costs and transfer expenses). The difference between the two amounts constitutes the capital gain. Conversely, if the selling price is lower than the cost of acquisition, it results in a capital loss.
Formula: Capital Gain = Full Value of Consideration – (Cost of Acquisition + Cost of Improvement + Transfer Expenses)
For example, if an investor buys shares for ₹1,00,000 and later sells them for ₹1,50,000, the capital gain is ₹50,000.
Types of Capital Gains
Capital gains are classified based on the holding period of the asset. The classification varies slightly between asset categories such as securities, real estate, and other capital assets.
1. Short-Term Capital Gain (STCG)
A short-term capital gain arises when an asset is sold within a short holding period from the date of purchase.
Typical classifications in India:
- For equity shares and equity-oriented mutual funds: held for less than 12 months.
- For real estate, gold, debt mutual funds, and other assets: held for less than 36 months.
Short-term gains are usually taxed at higher rates since they represent short-duration speculative or trading profits.
2. Long-Term Capital Gain (LTCG)
A long-term capital gain arises when the asset is held for a longer duration before being sold.
Typical classifications:
- For equity shares and equity-oriented mutual funds: held for more than 12 months.
- For real estate, debt mutual funds, and other capital assets: held for more than 36 months.
Long-term gains generally enjoy lower tax rates or exemptions, as they encourage long-term investment and economic stability.
Examples of Capital Assets
Capital assets include both tangible and intangible property held for investment or personal use. Examples include:
- Land and buildings.
- Shares, bonds, and debentures.
- Units of mutual funds.
- Jewellery, art, and collectibles.
- Patents, trademarks, and goodwill.
Assets such as stock-in-trade, personal vehicles, and agricultural land in rural areas are usually excluded from the definition of capital assets for tax purposes.
Computation of Capital Gains
The computation of capital gains typically follows these steps:
- Determine the Full Value of Consideration: The total amount received or receivable from the sale of the asset.
- Deduct the Cost of Acquisition: The original purchase price or, in some cases, the indexed cost (adjusted for inflation).
- Deduct the Cost of Improvement: Any capital expenditure incurred to enhance the value of the asset.
- Deduct Transfer Expenses: Costs directly associated with the sale, such as brokerage, legal fees, and commission.
For Long-Term Capital Gains, the indexed cost of acquisition is used to adjust the purchase price according to inflation using the Cost Inflation Index (CII).
Indexed Cost = Original Cost × (CII in year of sale ÷ CII in year of purchase)
This method ensures that only the real (inflation-adjusted) appreciation in value is taxed.
Taxation of Capital Gains
Capital gains are taxable under the Income Tax Act of most jurisdictions, including India, and are categorised separately from regular income.
In India:
-
Short-Term Capital Gains (STCG):
- For listed equity shares and equity-oriented funds (subject to Securities Transaction Tax): taxed at 15%.
- For other assets: added to total income and taxed as per applicable income tax slab rates.
-
Long-Term Capital Gains (LTCG):
- For listed equity shares and equity-oriented funds: taxed at 10% on gains exceeding ₹1,00,000 (without indexation).
- For real estate and other assets: taxed at 20% after indexation benefits.
Exemptions:
Various sections of the Income Tax Act provide exemptions from capital gains tax if the proceeds are reinvested in specified assets.
- Section 54: Exemption on sale of residential property if reinvested in another house.
- Section 54EC: Investment in specified bonds (e.g., NHAI or REC) within six months of sale.
- Section 54F: Exemption on sale of other assets if proceeds are used to purchase a residential house.
Capital Gains in the Context of Investments
Capital gains are central to investment performance analysis. They form part of the total return on an investment, along with dividends or interest income.
For instance:
- In stocks, capital gains arise from selling shares at higher prices.
- In real estate, appreciation in property value leads to capital gains.
- In mutual funds, gains arise when fund units are redeemed at a higher Net Asset Value (NAV).
Investors often adopt strategies such as tax harvesting (selling loss-making assets to offset gains) to minimise tax liability.
Capital Gain vs Revenue Gain
| Basis | Capital Gain | Revenue Gain |
|---|---|---|
| Nature | Arises from sale of capital assets | Arises from normal business operations |
| Frequency | Occasional or one-time | Regular and recurring |
| Tax Treatment | Taxed under capital gains head | Taxed as business or professional income |
| Examples | Sale of land, shares, or bonds | Profit from sale of goods or services |
This distinction ensures that profits from long-term asset appreciation are treated differently from ordinary business income.
Importance of Capital Gains
- Wealth Creation: Encourages investment in appreciating assets such as stocks and property.
- Economic Growth: Channelises funds into productive sectors by rewarding long-term investment.
- Government Revenue: Capital gains tax is a significant source of public revenue.
- Portfolio Diversification: Helps investors balance risk and return through strategic asset allocation.
- Inflation Hedge: Long-term capital assets often appreciate faster than inflation, protecting purchasing power.
Capital Loss and Set-Off
A capital loss occurs when an asset is sold at a price lower than its purchase cost.
- Short-Term Capital Loss (STCL) can be set off against both short-term and long-term capital gains.
- Long-Term Capital Loss (LTCL) can be set off only against long-term capital gains.Unadjusted losses can be carried forward for up to eight assessment years for future set-off.
Illustrative Example
An investor buys a plot of land in 2010 for ₹10,00,000 and sells it in 2024 for ₹40,00,000. The Cost Inflation Index (CII) for 2010 is 167 and for 2024 is 348.
Indexed Cost of Acquisition = 10,00,000 × (348 ÷ 167) = ₹20,84,000Long-Term Capital Gain = 40,00,000 – 20,84,000 = ₹19,16,000
Taxable LTCG = ₹19,16,000 × 20% = ₹3,83,200 (before exemptions).
Global Perspective
In most countries, capital gains taxation serves both revenue and policy purposes:
- The United States taxes long-term gains at preferential rates (0%, 15%, or 20%) depending on income level.
- The United Kingdom imposes a Capital Gains Tax (CGT) on profits above a defined annual exemption.
- Singapore and Hong Kong do not levy capital gains tax, encouraging investment inflows.
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