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Capital Gain Tax, Key and Indexation, Key Changes in Budget 2024

The Union Government is facing a backlash over changes to the long-term capital gains tax regime announced in the Budget, including critiques from MPs within the National Democratic Alliance (NDA).

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  • The new LTCG regime proposed in the Union Budget for 2024-25 does away with the indexation benefit available for calculation of LTCG on property, gold, and other unlisted assets, while reducing the LTCG tax rate to 12.5% from 20%.
  • According to the government, the new LTCG tax regime, even without the benefit of indexation, would be beneficial in the vast majority of cases in the property sector.

Investors often focus on the returns from their investments, but understanding the tax implications of those returns is equally important. Capital gain tax, which applies to the profit earned from the sale of assets, comes in two forms: long-term capital gain tax and short-term capital gain tax. Additionally, the concept of indexation plays a crucial role in minimizing tax liability.

What is Capital Gain Tax?

Capital gain tax is levied on the profit earned from the sale of capital assets such as real estate, stocks, bonds, and mutual funds. It is defined as profits accumulated from the sale of any capital asset. Example of capital assets; Land, buildings, house property, vehicles, patents, trademarks, leasehold rights, machinery, and jewellery.

The tax is categorized into two types based on the holding period of the asset:

  1. Long-Term Capital Gain Tax (LTCG): This applies to assets held for more than a specified period, typically one year for financial assets and two to three years for real estate. The LTCG tax rate is generally lower than the short-term rate to encourage long-term investments.
  2. Short-Term Capital Gain Tax (STCG): This applies to assets sold within a shorter holding period, usually less than one year for financial assets and less than two to three years for real estate. The STCG tax rate is higher and often aligns with the individual’s income tax slab.

Long-Term Capital Gain Tax

Long-term capital gain tax is imposed on profits from the sale of assets held for a long period. The holding period required to qualify as a long-term asset varies by the type of asset:

  • Equity Shares and Mutual Funds: Held for more than 12 months.
  • Real Estate: Held for more than 24 to 36 months.
  • Debt Funds and Other Assets: Held for more than 36 months.

LTCG Tax Rates

In many jurisdictions, the LTCG tax rate is lower than the STCG rate to promote long-term investments. For instance, in India, the long-term capital gains on the sale of listed equity shares and equity-oriented mutual funds are taxed at 10% if the gains exceed Rs 1 lakh. However, the 2024 Union Budget increased this rate to 12.5% while raising the exemption limit to Rs 1.25 lakh.

Short-Term Capital Gain Tax

Short-term capital gain tax is applied to profits from the sale of assets held for a shorter duration. The holding period to qualify as a short-term asset is generally:

  • Equity Shares and Mutual Funds: Held for less than 12 months.
  • Real Estate: Held for less than 24 to 36 months.
  • Debt Funds and Other Assets: Held for less than 36 months.

STCG Tax Rates

STCG is typically taxed at a higher rate compared to LTCG. For example, in India, short-term capital gains on the sale of equity shares and equity-oriented mutual funds are taxed at 15%. The 2024 Union Budget raised the STCG tax rate on certain financial assets to 20%.

Budget 2024: Key Changes in Capital Gain Tax

The Union Budget 2024, presented by Finance Minister Nirmala Sitharaman, introduced significant changes to the capital gain tax regime in India. These changes impact both long-term and short-term capital gains, with adjustments aimed at increasing government revenue while offering some relief to taxpayers through increased exemption limits. Here’s a detailed look at the changes and their implications.

Long-Term Capital Gain Tax (LTCG)

Rate Increase

One of the most notable changes in the 2024 budget is the hike in the long-term capital gain tax rate from 10% to 12.5%. This increase applies to all financial and non-financial assets. Despite the rate hike, there is a positive development for taxpayers: the exemption limit for long-term capital gains has been increased from Rs 1 lakh to Rs 1.25 lakh.

Exemption Limit

Under the previous provisions, long-term capital gains up to Rs 1 lakh were exempt from tax. This threshold has now been raised to Rs 1.25 lakh, meaning that investors can earn up to this amount from long-term capital gains without incurring any tax liability. This adjustment helps to offset the impact of the rate increase, providing some relief to taxpayers.

Calculation Example

To understand the practical impact of these changes, let’s consider an example. Suppose an investor has long-term capital gains amounting to Rs 2 lakh.

  • Under the old regime, with a 10% tax rate and a Rs 1 lakh exemption:
    • Taxable gain = Rs 2,00,000 – Rs 1,00,000 = Rs 1,00,000
    • Tax = 10% of Rs 1,00,000 = Rs 10,000
    • Adding 4% cess, the total tax = Rs 10,400
  • Under the new regime, with a 12.5% tax rate and a Rs 1.25 lakh exemption:
    • Taxable gain = Rs 2,00,000 – Rs 1,25,000 = Rs 75,000
    • Tax = 12.5% of Rs 75,000 = Rs 9,375
    • Adding 4% cess, the total tax = Rs 9,750

This example shows a reduction in the overall tax paid, demonstrating how the increased exemption limit can lead to tax savings despite the higher tax rate.

Short-Term Capital Gain Tax (STCG)

Rate Increase

The Budget 2024 also increased the short-term capital gain tax rate for certain financial assets to 20%. Previously, short-term capital gains on equity shares and equity-oriented mutual funds were taxed at 15%. This change aims to boost government revenue from the taxation of short-term profits.

Impact on Investors

Investors who frequently trade financial assets may find this rate increase significant, as it directly affects the profitability of short-term investments. The higher STCG tax rate encourages investors to hold their investments longer to benefit from the lower LTCG tax rates and higher exemption limits.

What is Indexation?

  • Indexation is the process of adjusting the original purchase price of an asset or investment in order to neutralise the impact of inflation on it.
  • It involves revising upward the cost of the acquisition of an asset based on the inflation over the period for which it was held.
  • Inflation reduces the value of money over time, and therefore, when an asset is sold or investment is redeemed, indexation helps in arriving at the cost of acquisition with the impact of inflation over the holding period factored in.

Indexation Benefit: Key Points

  • Purpose: Indexation adjusts the purchase price of an asset for inflation, reducing taxable capital gains.
  • Calculation: It involves multiplying the original purchase price by the ratio of the Cost Inflation Index (CII) for the year of sale to the CII for the year of purchase.
  • Impact on Tax: By increasing the cost basis of an asset, indexation lowers the capital gain, thus reducing the tax liability.
  • Applicable Assets: Mainly benefits long-term investments in real estate, bonds, and certain mutual funds.
  • CII Values: The Cost Inflation Index is released annually by the government and used for adjusting the purchase price.
  • Real Gain Measurement: Indexation helps measure the real gain by accounting for inflation, providing a fairer tax assessment.
  • Recent Changes: With the 2024 Budget, while the LTCG tax rate increased to 12.5%, the exemption limit was raised to Rs 1.25 lakh, making indexation even more beneficial.
  • Example: If you bought an asset for Rs 50 lakhs in 2010 and sold it for Rs 1 crore in 2024, indexation adjusts the cost so that the gain taxed is lower compared to a non-indexed calculation.

Conclusion

Understanding capital gain tax, particularly the differences between long-term and short-term capital gain tax, is essential for effective financial planning. Utilizing the indexation benefit can help investors minimize their tax liability on long-term investments, making it a valuable tool for maximizing returns. As tax laws and rates change, staying informed and seeking professional advice is crucial to optimize your investment strategy and comply with current regulations.

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Capital Gain Tax FAQs

How much capital gain is tax free?

Budget 2024 has increased the limit of exemption of capital gains on listed equity and equity oriented mutual funds to Rs 1.25 lakh per annum from the existing Rs 1 lakh.

How is capital gain tax calculated?

To calculate capital gains, subtract the cost of acquisition and sale expenditures from the sale price. If capital gains exceed Rs. 1 lakh in a fiscal year, apply a 10% tax rate (plus surcharge and cess) on the excess profits. There is no tax duty on gains that are less than Rs. 1 lakh.

What is the income tax rule for capital gain?

Under the recent Budget 2024, the exemption limit for capital gains has been raised to Rs 1.25 lakh annually, a significant increase from the earlier limit of Rs 1 lakh per year. This move is designed to provide greater relief to taxpayers and promote economic growth.

How to avoid capital gain tax on property?

One of the best way to save on capital gains tax incurred from selling a property for profit is by reinvesting all the proceeds availed from the sale in another property within a certain time frame. The proceeds can be reinvested only in a residential property and not a commercial property.

What is the period of holding for capital gains?

The 36-month holding period has been removed. The holding period for all listed securities is 12 months.

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Piyush
Piyush
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Greetings! I'm Piyush, a content writer at StudyIQ. I specialize in creating enlightening content focused on UPSC and State PSC exams. Let's embark on a journey of discovery, where we unravel the intricacies of these exams and transform aspirations into triumphant achievements together!