Earned Capital Gains? Calculate Your Tax Liability

Written by Amit Agarwal on Aug 21, 2010

The method for calculating capital gain and tax thereon as envisaged in the Income tax Act is no doubt, complex and requires expert help in interpretation and understanding. The Act prescribes certain rules and procedures which are simplified here:

1.    Long-term capital gain is calculated by subtracting indexed cost of purchase and expenses on sale from the sale proceeds. RBI releases cost inflation index (CII) for every year, taking 1981-82 as base year. The CII for financial year 2007-08 is 551.

Indexed cost of purchase = (Cost of purchase x CII for the year in which asset is transferred) / CII for the year in which asset is acquired

2.    Since October 2004, Securities transaction tax (STT) is applied on all stock market transactions. So long term capital gain is completely exempt from tax on shares or securities or mutual funds on which STT has been deducted and paid. In case of other shares and securities, person has an option either to index costs to inflation and pay 20% of indexed gains, or pay 10% of non indexed gains.

3.    In case of all other long term capital gains, indexation benefit is available and tax rate is 20%.

4.    Similarly, short-term capital gain realised from the sale of shares and mutual funds through a recognised stock exchange and subject to STT will be taxed @ 10%. In all other cases, it is part of gross total income and normal tax rate is applicable.

5.    Deduction u/s 80C cannot be claimed on the long-term capital gains chargeable @10% or 20% and short-term capital gains chargeable @10%.

6.    Section 111A specifically prescribes the method of taxing income of an individual or a Hindu Undivided Family, when there is both short-term capital gain taxable @10% and other income. It provides that if the total income reduced by the short-term capital gain is less than the maximum amount not chargeable to tax then, the unexhausted portion of the basic exemption will be reduced from the short-term capital gains in computing the tax payable.

7.    Similarly, Sec. 112(1) prescribes that where the tax liability arises in the case of resident individual or HUF only because of the inclusion of long-term capital gain in the total income (i.e. if income other than long-term capital gain is less than the amount of exemption limit), tax shall be levied @ flat rate of 20% (plus surcharge) on the excess over the minimum exemption limit.   The following examples will help in better understanding of the above tax provisions:

Example A:The assessee has following incomes:Long-term capital gain from sale of jewellery Rs.20,000 taxable @20%Short-term capital gain on sale of land Rs.15,000Other Incomes Rs.85,000In the above case, the total income excluding long-term capital gain comes to Rs.1,00,000 which is equal to the basic exemption limit. Hence, this income will be tax-free. However, long-term capital gain of Rs.20,000 will suffer tax @20%. Example B:The assessee has following incomes:Long-term capital gain Rs.20,000Short-term capital gain Rs.15,000 taxable @10%Other Incomes Rs.85,000

Herein, long-term and short-term gains will constitute a separate block and will not be included in other incomes of Rs.85,000. This requires application of Section 111A and 112(1). Other incomes of Rs.85,000 falls short of basic exemption limit of Rs.1,00,000 by Rs.15,000. Hence, there is an option to subtract Rs.15,000 either from long-term or short-term gain. Subtracting Rs.15,000 from short-term gain will result in tax liability of Rs.4,000 (20,000@20%). Subtracting Rs.15,000 from long-term gain will result in tax-liability of Rs.2,500 (20,000-15,000 @20% + 15,000 @10%). Thus, subtracting from long-term gain will result in maximum tax benefit.

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