How to soften the capital gains tax blow

How often have you seen your gains vanish into the taxman's pocket? Here's how to do better tax planning.

The country's capital markets have not only delivered phenomenal returns over the last few years but also succeeded in catching global investors' attention. This signals the maturity of the markets.

Factors such as greater transparency, good governance and enhanced liquidity have all contributed to our markets being ranked among the world's top 10. All this leads to gains.

But how often have you encashed paper profit by selling capital assets that have appreciated considerably, only to find your gains disappear into the taxman's pocket because you have paid little or no attention to tax-planning?

Well, with the right tax tactics, you can maximise your gains from such transactions. But first, get acquainted with some 'capital gains' jargon.

'Capital gains' tax is really a misnomer. It would have been more appropriate to call it the 'capital formation' tax. It is a tax penalty imposed on productivity, investment and capital accumulation.

When you sell any asset you own - house, land, shares, mutual fund units, gold, debentures, bonds - and make a profit on the sale, it is considered a capital gain. The tax you pay on this profit is called capital gains tax. If you make a loss (you sell at a lower price than you bought it), you incur a capital loss.

Types of capital gains

A capital gain is classified as short-term or long-term depending on how long you have held the asset.

Short-term capital gain: If you sell your asset within 36 months from the date of purchase (12 months for shares or mutual funds).

Long-term capital gain: If you sell the asset after 36 months from the date of purchase (12 months for shares or mutual funds).

Taxation

Short-term capital gain tax in case of property: A short-term capital gain is added to your total income. You will be taxed depending on which tax bracket you fall under.

Long-term capital gain tax in case of property: Tax on a long-term capital gain (other than shares and mutual fund units) is more complicated because inflation is taken into account. The inflation factor makes it better for the tax-payer as it reduces the capital gain
amount and, hence, the amount he ends up paying as tax.

Difference of sale of stock from any other asset: Capital gains arising from transfer of shares or securities are different from those of other assets, in two respects - the period of holding and the rate of tax.

STT (securities transaction tax - introduced in the Chapter VII of the Finance Act [No.2] Act, 2004) plays a major role in determining the short-term profit in case of equities and equity-linked products. STT provides for a levy of a transaction tax on the value of certain transactions.

These transactions include the purchase and sale of equity shares in a company, purchase and sale of units of an equity growth fund, sale of units of an equity growth fund to a mutual fund and sale of a derivative. The transaction tax will be payable on all transactions that have taken effect from October 1, 2004. Surcharge: Nil, Education cess: Nil

From the above discussion, it is now clear that long-term capital gains, shall be exempt from tax under Section 10(38). STT, paid for purchase and sale of the specified securities, will not be available as a deduction. No deduction for the STT is incurred for purchase or sale of the specified securities.

Rebate, under Section 88E, is available in respect of Securities Transaction Tax from Assessment year 2005-06.

Rates of tax

Short-term capital gains: If the transaction has suffered STT, the rate of tax is 10 per cent. If the transaction has not suffered STT, you will be taxed at the normal rate depending on which tax bracket you fall under.

For example, STCG on stock (STT suffered): Sale consideration is Rs 20,000 and cost is Rs 12,000. Since the gain is short term in nature there is no indexation. The gain is Rs 8,000.

The transaction has suffered STT, hence the capital gains tax is Rs 8,000*10 per cent = Rs 800. If the transaction has not suffered STT, the tax is Rs 8,000*30 per cent = Rs 2,400. This is based on the assumption that you are in the highest tax bracket.

Long-term capital gains: If the transaction has suffered STT, LTCG is exempt from tax, if the transaction has not suffered STT, the rate of tax is 20 per cent.

Further, where tax is applicable on LTCG, the assesse has two options - one, he/she can calculate the capital gains using indexed cost of acquisition and two, he/she can choose not to take the benefit of indexation.

The implementation of the short-term or long-term capital gains in the country's capital markets should be closely monitored for the best and most effective results, in terms of tax payment. One should not evade or avoid tax, so plan accordingly.