There are two broad asset classes — physical assets like gold, real estate etc, and financial assets like equity, debt, mutual funds and others, which are intangible in nature. People invest across asset classes based on their risk appetite and return expectations. Gains made through investments in these assets are called capital gains. Capital gains made from these investments are subjected to differing levels of taxation in India. Since the tax liability on profits impacts overall returns, it is essential to analyse this aspect before committing funds to any asset class.
Capital gains can be classified as either short-term capital gains (STCG) or long-term capital gains (LTCG). The taxability is the difference between these two types of gains. Moreover, the rates of capital gains are different for different assets in India.
If assets are held on for more than three years, the gains accruing from them are treated as long-term capital gains. If these are held for less than three years, any gain is treated as short-term capital gain. One exception to this is equity shares, where the holding period is one year or more. So, if one holds listed equity shares for more than one year, gains made on these are treated as long-term capital gains. LTCG on listed equity shares are exempted from taxes. Tax is levied on STCG on listed shares at the rate of 15%.
In debt funds, both short and long-term capital gains are taxed. The short-term capital gain on debt mutual fund is added to the income and taxed as per the individual’s income tax slab and the long-term capital gains on debt mutual funds are taxed at 20% with indexation and 10% without indexation. The long-term gain arising from the sale of a capital asset is exempt under Section 54 and 54F if invested in purchase or construction of a house property subject to certain conditions. Also, as per Section 54EC, one can claim tax relief by investing the capital gains earned from long-term capital assets in bonds issued by government agencies like the National Highways Authority of India and Rural Electrification Corporation.
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Agricultural land in rural areas in India is not considered a capital asset and therefore, no capital gains will be applicable on its sale. One should take into account the taxability and rate of taxation on a particular asset before making investments in any asset class. One should look at post-tax returns rather than pre-tax returns. As of now, capital gains tax rates on equity shares are attractive, which lead to relatively better returns.
Dipen Shah, senior vice-president and head, PCG Research, Kotak Securities