Capital gains refer to profit earned on transfer of a capital asset.
A transfer includes sale, relinquishment, exchange, renouncement, extinguishment, compulsory acquisition, etc. However, under provisions of income tax, there are certain transfers which are not taxable like transfers in the form of gifts, will, settlement, transfer at the time of conversion of constitutions, etc. although on fulfillment of prescribed conditions.
Having known what a transfer is, let us see what a capital asset is. Few common examples of capital assets are shares of companies, real estate, jewellery, etc. A capital asset includes a large basket of products; hence it would be easier to understand what is not a capital asset. A capital asset excludes stock in trade, movable items for personal use (excluding jewellery, archaeological and art work), agricultural land and gold bearer bonds (although not in existence).
Now on understanding what a capital asset is, let us understand the types of capital assets which are namely, Long Term Capital Assets and Short Term Capital Assets. Long term capital asset means a capital asset held by an assessee for more than 36 months except for some assets like equity shares, units of mutual funds, listed securities, etc. wherein the time period shrinks to 12 months. It is pertinent to note that if an asset is held for exactly 36 or 12 months, as the case may be, it shall be considered as a Short Term Capital Asset. Gains arising on sale of Long Term Capital Asset and Short Term Capital Asset shall be Long Term Capital Gains (LTCG) and Short Term Capital Gains (STCG) respectively.
On understanding what are the types of assets and the types of capital gains, we shall proceed to understand the rate at which they are taxed. The STCG on which Securities Transaction Tax (STT) is paid is taxed at 15% and at normal slab rates in other cases. LTCG on sale of listed securities is exempt from tax whereas in other cases, it is taxable at the rate of 20%.
We shall now logically proceed towards computation of capital gains.
Short Term Capital Gains is basically the difference between the purchase price and sale price. Long term Capital Gains is typically the difference between the sale price and the purchase price adjusted for inflation. It is pertinent to note that, selling expenses incurred on sale of capital asset and cost of improvement (adjusted for inflation in case of LTCG) can also be deducted from the sale price.
Now moving on to the topic of every tax payers liking, EXEMPTIONS. Exemptions to capital gains tax is allowed under the provisions of income tax, if the amount of capital gains is invested in another house property, in specified bonds, etc. with fulfilment of stipulated conditions.
Capital gains is one of the important tool for income tax department to initiate the litigation proceedings, hence, it becomes paramount important to understand the provisions of capital gains with utmost clarity.