Long Term Capital Gains (LTCG) Tax

Long Term Capital Gains (LTCG) Tax refers to the tax imposed on profits earned from the sale of a capital asset held for a specific minimum period, classified as a long-term holding. It is a critical component of the taxation framework in many countries, including India and the United Kingdom, designed to differentiate between short-term and long-term investments. The concept promotes long-term investment behaviour and discourages speculative trading by offering different tax treatment for assets held over longer durations.

Definition and Concept

A capital gain arises when an individual or entity sells a capital asset—such as property, shares, bonds, or mutual fund units—at a price higher than its purchase cost. The classification of the gain as long-term depends on the period for which the asset is held before sale. When this holding period exceeds the prescribed threshold, the resulting gain is treated as a long-term capital gain, subject to LTCG tax.
The holding period varies according to asset type. For instance:

• In India, equity shares and equity-oriented mutual funds are considered long-term if held for more than 12 months, while immovable property such as land or buildings is deemed long-term if held for more than 24 months.
• In the United Kingdom, there is no specific holding period; instead, all gains from the sale of capital assets fall under Capital Gains Tax (CGT), with certain exemptions or reliefs available for long-term investments.

Calculation of Long Term Capital Gains

The computation of LTCG typically involves deducting the indexed cost of acquisition and cost of improvement from the sale consideration, thereby adjusting for inflation over the holding period. The formula generally applied is:
LTCG = Full value of consideration – (Indexed cost of acquisition + Indexed cost of improvement + Expenses incurred wholly and exclusively in connection with transfer).
The concept of indexation is particularly significant in India, where the Cost Inflation Index (CII) is used to account for inflationary effects. This adjustment ensures that only the real gains, not nominal ones caused by inflation, are taxed.
For example, if an investor purchased property in 2010 for ₹40 lakh and sold it in 2024 for ₹1 crore, the indexed cost (after applying inflation adjustment) may rise to around ₹70 lakh. The LTCG, therefore, would be ₹30 lakh, on which tax is levied as per applicable rates.

Applicable Tax Rates

Tax rates on LTCG vary between countries and depend on asset class and taxpayer status.

• India:
  • For listed equity shares and equity-oriented mutual funds, LTCG exceeding ₹1 lakh in a financial year is taxed at 10% without indexation.
  • For other assets like property, gold, or debt mutual funds, LTCG is taxed at 20% with indexation benefits.
  • Non-resident investors are subject to special provisions depending on the Double Taxation Avoidance Agreement (DTAA) between countries.
• United Kingdom:
  • Individuals pay Capital Gains Tax on profits exceeding the Annual Exempt Amount (£3,000 for 2024–25).
  • Basic rate taxpayers pay 10% (or 18% on residential property gains), while higher-rate taxpayers pay 20% (or 24% for residential property).
  • Certain exemptions apply, such as Private Residence Relief for one’s main home and Entrepreneurs’ Relief (now called Business Asset Disposal Relief) for business owners, offering a reduced 10% rate.

Exemptions and Deductions

Several exemptions are provided under different legal frameworks to encourage reinvestment and economic growth.
In India, exemptions are available under specific sections of the Income Tax Act, 1961:

• Section 54: Exemption for individuals or Hindu Undivided Families (HUFs) when LTCG from sale of residential property is reinvested in another residential property within prescribed timelines.
• Section 54EC: Exemption when capital gains are invested in specified bonds issued by the National Highways Authority of India (NHAI) or Rural Electrification Corporation (REC), subject to a cap of ₹50 lakh.
• Section 54F: Exemption for capital gains arising from the sale of any long-term asset other than a house, provided the proceeds are invested in residential property.

In the UK, exemptions and reliefs include:

• Private Residence Relief for one’s primary home.
• Business Asset Disposal Relief, encouraging entrepreneurial investment.
• Investor Relief, offering a lower tax rate for shares held in unlisted trading companies for at least three years.

Implications for Investors and the Economy

The structure of LTCG taxation plays a vital role in shaping investment patterns. Lower tax rates on long-term gains incentivise investors to hold assets for extended periods, contributing to market stability. They also encourage productive capital allocation towards infrastructure, real estate, and equity markets.
However, the imposition of LTCG tax can also impact investor sentiment. For instance, India’s reintroduction of LTCG tax on equities in 2018 initially led to market volatility as investors adjusted to the new regime. Despite such short-term reactions, economists generally view LTCG tax as a fair mechanism that broadens the tax base and ensures equitable revenue distribution.

Criticism and Challenges

Critics argue that LTCG tax may discourage investment by reducing net returns, particularly for small investors. Frequent changes in tax rates or exemption thresholds can also create uncertainty in financial planning. Furthermore, complexities in indexation and compliance requirements often make the system cumbersome.
In the UK context, debates persist over aligning CGT rates with income tax rates, with proponents arguing for equity in taxation and opponents warning of reduced investment activity. The interaction between capital gains tax and inheritance tax also raises issues of double taxation in certain scenarios.

Significance and Future Outlook

LTCG taxation remains a cornerstone of fiscal policy, balancing revenue generation with investment promotion. Governments continually adjust its structure to suit evolving economic goals. With the growth of digital assets and alternative investments, such as cryptocurrencies, tax authorities worldwide are expanding LTCG frameworks to include new asset classes.
In India, proposals for rationalising capital gains taxation and simplifying the holding period classifications are under consideration to improve compliance and transparency. Similarly, in the UK, policy discussions focus on streamlining reliefs and closing loopholes to prevent tax avoidance.