By Homi Mistry, Mousami Nagarsenkar and Hiral Tanna
Capital gain is the profit that arises on sale of a capital asset as defined in the Income Tax Act. It can be short term or long term, depending on the type of asset and the time period for which the capital asset is held. The general rule is that an asset qualifies to be a long-term capital asset if it is held for more than 36 months and short term otherwise. However, specific rules apply for certain assets. For example, equity shares or units of an equity-oriented mutual fund are considered to be long-term capital assets if held for more than 12 months, whereas immovable property qualifies to be a long-term capital asset if it is held for more than 24 months.
If you are considering selling a capital asset, you should be mindful of these rules since the tax that you pay on the capital gains can vary significantly based on whether it is a short-term asset or a long-term asset. While short-term capital gains are generally taxed at applicable tax slab rates (which may be as high as 35.535%), the Act provides for long term capital gains to be taxed at a lower rate of 20% (10% in certain cases) plus applicable surcharge and cess. Moreover, when a long-term capital asset is sold, the cost of acquisition of the asset is generally allowed to be adjusted upward to account for inflation, thus reducing the capital gains tax that you pay. Further, the Act also provides for avenues to claim tax exemptions for long-term capital gains, some of which have been discussed below.
Investment in a new residential house
Exemption is provided under section 54 of the Act for long-term capital gain arising on sale of a residential house property, provided the capital gain is invested in a new residential house property. If only a part of the capital gain is invested in a new residential house property, exemption would be restricted proportionately. To illustrate, if Ram purchased a house property in April 2013 for Rs 1 crore and sells it for Rs 3.5 crore in May 2017, his cost of Rs 1 crore will be indexed to Rs 1.24 crore and the full capital gains of Rs 2.26 crore would be exempt from tax for Ram if he invests the entire capital gain in a new residential house.
Section 54F of the Act provides for exemption for long-term capital gains on the sale of any capital asset other than a residential house. Here the requirement is that the total sale proceeds (net of any selling expenses) should be invested in a residential house property. In case the net sale proceeds are not entirely invested, exemption in proportion to the investment made is available (exemption = cost of new house * capital gains after indexation / net sale proceeds). This exemption is available only if an individual does not own more than one house property at the time of buying the new residential house property.
For claiming exemption under both the aforesaid sections, the investment should be in a house property situated in India and if it is not possible to buy a residential house immediately, the net sale proceeds / capital gains can be parked in a special bank account under the capital gains account scheme by the due date for filing the tax return, to claim the exemption. Withdrawals can be made from such account as stipulated. Further, the new residential house property must be purchased either one year before the sale or two years after the sale of the original property or it should be constructed within three years from the sale of property /asset. It is also important to keep in mind that there are timelines before which the new house property cannot be sold.
Investment in specified securities
There are other options as well, if buying a residential house property is not on your radar. In accordance with section 54EC of the Act, capital gains arising from sale of any long-term capital asset (including a residential house property) would be exempt if the gains are invested in specified bonds within a period of six months from the date of sale of the asset. Specified bonds include bonds issued by National Highways Authority of India, Rural Electrification Corporation of India. However, the maximum limit of investment in these bonds is Rs 50 lakh even if the investment is spread over two tax years.
Thus, a number of tax concessions and exemptions are available in respect of the sale of a long-term capital asset which are not available in the case of a short-term capital asset. As selling of a capital asset such as a house property involves a large sum of money, it is imperative that one makes the best use of the tax provisions pertaining to capital gains.
(Homi Mistry is Partner, Mousami Nagarsenkar is Director and Hiral Tanna is Manager with Deloitte Haskins & Sells LLP. The views expressed are personal)