The profits arising from the sale of a ‘capital asset’ are known as a capital gains. This gain is subject to income tax in the financial year in which the capital asset is transferred. How Can Tax Planning Capital Gains be done?
Minimizing Tax on Capital Gains
No capital gains tax is applicable when an asset has been inherited by an assessee as there is no ‘sale’ but merely a transfer. However if such asset is sold by the assessee, capital gains tax will apply even though one has spent an money to acquire it. In that case, capital gains will be computed based on the cost to the erstwhile owner, indexed to the year of purchase.
In case the property has been inherited, the cost paid to the original owner will be treated as the cost of acquisition for the purpose of computing capital gains. If the property has been acquired before 1.4. 1981, the cost of acquisition will be the cost incurred by the original owner or the fair market value of the property, whichever is more.
Assets which are considered as capital assets:
The Income Tax Act has enlisted some assets that are considered as capital assets. Property such as land, building, house, cars, machinery, jewellery, etc. are considered as capital assets.
Rights in relation to a company, including rights of management or control, are also considered as capital assets.
Assets which are not considered as capital assets:
The following assets are not considered as capital assets:
1. Any raw material held for a business;
2. Personal belongings like clothes, furniture, etc.
3. Agricultural land in a rural area;
4. Gold Bonds or National Defense Gold Bonds issued by the Central Government.
What is long-term capital asset?
A capital asset that is held for not more than 36 months is a long-term capital asset. For example, a house which is held for more than 36 months is known as a long-term capital asset. Debt Funds when held for more than 36 months are also long-term assets.
Rate of tax on long-term capital gain:
Long-term capital gain is charged to income tax at the rate of 20% along with surcharge.
Calculation of long-term capital gains:
To calculate long-term capital gains, from the full value of consideration, one should deduct the following:
1. Expenses incurred for such transfer;
2. Indexed cost of acquisition;
3. Cost of improvement;
The remaining amount is long-term capital gain.
Section 54EC for Tax Planning Capital Gains:
Section 54EC of Income Tax Act, 1961 provides the opportunity to the assessees to save tax on capital gain arising from transfer of long term capital asset upon fulfillment of some conditions.
Circumstances under which such deduction is available:
The deduction under section 54EC will be available subject to the following conditions:
1. The property transferred should be a long term capital asset;
2. There must be a long term capital gain;
3. The asset is transferred by the assessee after 1.04.2000;
4. The assessee has invested the capital gain in the long term specified asset within a period of six months of such transfer.
What are Specified Assets?
Specified assets are the bonds issued by National Bank for Agriculture and Rural Development or by the National Highways Authority of India or those issued by Rural Electrification Corporation Ltd. which can be redeemed after a period of 3 years. Now-a-days National Housing Bank has also been included in the list for deduction under section 54EC.
The cost of long-term specified assets taken into account for exemption under section 54EC shall not be entitled for deduction with reference to such cost under section 80C. As such investment made in bonds under section is not eligible for deduction under section 80C of the Act.
Amount of deduction: The capital gain is exempt under section 54EC only up to that extent it is invested by the assessee in the long term assets which are specified within six months from the date of transfer.
Illustration – If a long term capital gain arises amounting to Rs. 15 lakh and bonds under section 54EC are purchased amounting Rs. 13 lakh, capital gain of Rs. 13 lakh will only be exempted as per section 54EC and the remaining amount of Rs. 2 lakh will be taxed.
Limit of investment for Tax Planning on Capital Gains:
On and from 1.4.2007, the investment made in the long term specified capital assets in any financial year should not be more than Rs. 50, 00,000. Thus investment in bonds in a year can be made up to Rs. 50 lakhs.
Judicial decisions -in How much time to invest Capital Gains:
The ITAT Jaipur in the case of Assistant Commissioner of Income Tax, Circle-2, Ajmer vs. Shri Raj Kumar Jain and Sons (HUF) 2012, has held that an investment within 6 months is investment for that particular financial year in which transfer took place and said period should not include any part of a subsequent financial year.
Read Further- Computation of Capital Gains after Indexation