The primary goal of investing in any asset is to generate a profit by selling it after its value appreciates. However, these profits are not always tax-free. The Income Tax Act specifies the capital assets that are taxable, as well as the applicable tax rates. Investing in assets like cryptocurrencies, stocks, real estate, or mutual funds can generate capital gains, which are subject to taxation. It is crucial for investors to understand how capital gains tax is calculated to make informed financial decisions. In this blog, I will explain the basics of capital gain tax calculation on a recurring investment in India.

What is a Recurring Investment?

A recurring investment is a systematic approach to investing where an individual regularly invests a fixed amount at consistent intervals, such as monthly or quarterly, in a specific financial instrument or asset. Mutual Funds are one such example of recurring investment. This strategy enables investors to accumulate wealth over time while balancing out the cost of purchases. The profits generated from these recurring investments fall under the category of capital gains according to the Income Tax regulations, and the applicable tax is determined based on the holding period, which can be classified as either long-term or short-term capital gains.

Types of Capital Gains

Capital gains tax can be classified into two categories: short-term capital gains tax and long-term capital gains tax. The classification depends on the holding period of the capital asset being sold.

• Short-term capital gains tax: For land, property, and similar assets, if sold before 24 months from the date of purchase, it is considered a short-term capital gain. For equity, bonds, gold, and mutual funds, if sold before 12 months from the date of purchase, it is classified as a short-term capital gain. For debt-oriented assets like bonds and mutual funds, if sold before 36 months from the date of purchase, it is categorized as a short-term capital gain.
• Long-term capital gains tax: For land, property, and similar assets, if sold after 24 months from the date of purchase, it is considered a long-term capital gain. For equity, bonds, gold, and mutual funds, if sold after 12 months from the date of purchase, it is classified as a long-term capital gain. For debt-oriented assets like bonds and mutual funds, if sold after 36 months from the date of purchase, it is categorized as a long-term capital gain.

Criteria for Inherited Securities: In cases where the asset is acquired through a gift, will, succession, or inheritance, the period for which the asset was held by the previous owner is also taken into account to determine whether it is a short-term or long-term capital asset.

Capital gains tax rates as per asset class

The tax rates for capital gains differ based on the asset class. Here are the applicable rates:

1. Long-term capital gains tax: For assets other than equity-oriented fund units or equity shares, the tax rate is 20%. For the sale of equity-oriented fund units or equity shares, a tax rate of 10% is applicable on gains exceeding ₹1,00,000.
2. Short-term capital gains tax: When securities transaction tax is not applicable, the short-term capital gains tax is added to the individual's income tax slab. When securities transaction tax is applicable, the tax rate is 15%.

TERMINOLOGY

Before we go into the details of the calculations, let us understand a few terms used for the calculation:

Capital Assets

Capital assets include land, house, property, building, trademarks, vehicles, leasehold rights, machinery, patents, and jewellery. 

Full Value Consideration

The consideration to be received or received by the seller as a result of the transfer of the capital asset is known as the full value consideration. Capital gains tax applies in the year of transfer, even if the seller receives no consideration in that year.

Cost of Acquisition

The cost of acquisition is the sum the seller paid to acquire the capital asset in the first place.

Cost of Improvement

An expense incurred by the seller for making any alteration or additions to the capital asset is known as the cost of the improvement. 

Indexation

It is a method of adjusting the purchasing price of an asset to reflect the effects of inflation so that the capital gain on the assets is taxed fairly.

Inflation Index

The inflation index is a measure of the rate of inflation, which is used to adjust the purchase price of an asset for capital gain tax purposes.

How to calculate capital gains tax?

Capital gains tax is calculated differently for different periods on different capital asset classes.

• Start with the full value of consideration.
• Deduct the indexed cost of acquisition + indexed cost of transfer + indexed cost of improvement.

Let us define the terms used in the above formula:

• Indexed cost of acquisition = (cost of acquisition x by the cost of inflation index of the acquisition year)/(cost of inflation index of the transfer year)
• Indexed cost of transfer = (brokerage paid for arranging the deal, legal and other expenses x cost of inflation index of the improvement year)/(cost of inflation index of the transfer year)
• Indexed cost of the improvement = (cost of improvement x cost of inflation index of the improvement year)/(cost of inflation index of the transfer year)
• Long-term Capital Gains Tax = (Full Value Consideration) - (indexed cost of acquisition) + (transfer) + (indexed cost of improvement)

Short-Term Capital Gains Tax

• Start with the full value of consideration.
• Deduct the cost of acquisition + cost of transfer + cost of improvement.
• The final amount will be short-term capital gain.
• Short-term capital gain = full value consideration - (cost of acquisition + cost of transfer + cost of improvement).

What are the different tax rates for different asset types?

• The long-term capital gains on stocks and equity mutual funds are taxed at 10%. 
• If the gains on the sale of listed securities exceed ₹1 lakh, the short-term gains are taxed at 15 per cent. 
• The short-term capital gains debt mutual funds are added to the taxpayer's income. They are taxed according to the individual's income tax slab. 
• The long-term capital gains on debt mutual funds are taxable at 20% with indexation and 10 % without indexation.
   

Let us look at each of these assets and their taxes in detail: 

Capital gains tax on bonds

A capital gain bond is a type of bond where you can invest within six months of selling your asset.

You can invest in specific bonds like the National Highway Authority of India and Rural Electrification Limited and get tax exemption under Section 54EC of the Income Tax Act. 

Capital gains, in this case, cannot be redeemed before three years. The individual can earn a guaranteed rate of interest on the bond. During a financial year, one can invest up to a maximum of ₹50,00,000 in capital gain bonds. This benefit is only available for long-term capital bonds.

Capital gains tax on house property

The following expenses are deducted from the total sale price:

• Commission or brokerage paid for securing the purchaser.
• Stamp paper cost.
• Expenses related to travel along with the transfer.
• The place of property inheritance, expenses incurred concerning the process associated with the inheritance and the will, gaining the certificate of succession, in some cases, the cost of the executor is also applicable.
  

Capital gains taxes on the sale of shares

The following expenses are deductible:

• Commission of brokers related to the sold shares.
• Securities transaction tax (STT) is not allowed as a deductible expense.
  

What are the things to be careful about while calculating capital gains tax?

Capital gains tax comes into play during exit, not entry

You probably have a broad idea about the capital gains tax on investment. However, you may choose to consider it in detail at a later stage. This is because the capital gains tax comes into play only when you exit the investment. You do not pay any capital gains tax when you enter an investment. 

Enter an investment with an exit strategy and time horizon

Entering an investment without considering an exit strategy and time horizon is like doing only half of the homework. Having a clear exit strategy and time horizon frame is important. After knowing all the capital gains tax implications, you can ask yourself: 

• Does the investment still match my investment goal? 
• Does it still match my risk appetite (capacity to take risks)? 
• Am I comfortable entering the investment knowing fully well when and how much capital gains tax I will have to pay when I exit?
  

Conclusion

Understanding the basics of capital gains tax calculation on recurring investments is essential for investors in India. By comprehending the classification of capital gains as either short-term or long-term, based on the holding period of the asset, investors can determine the applicable tax rates. The tax rates for long-term capital gains range from 10% to 20%, depending on the asset class. In comparison, short-term capital gains are added to the individual's income tax slab or taxed at a fixed rate of 15% when securities transaction tax is not applicable.

To calculate capital gains tax, investors need to consider factors such as the full value consideration, cost of acquisition, cost of improvement, and indexed costs. It is crucial to be cautious while calculating capital gains tax, considering expenses that can be deducted and being aware that tax is applicable only upon exiting the investment. Having a clear exit strategy and time horizon can help investors make informed decisions while considering the implications of capital gains tax on their investments.

byAstik Dubey

Astik is a law student diving deep into indirect Tax and business law. With a flair for business writing and a special interest in crypto taxation, he turns complexity into captivating articles. Join his enlightening blog, where law and business intersect.

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