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5 Mins
Thu Jun 08 2023
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.
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.
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.
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.
The tax rates for capital gains differ based on the asset class. Here are the applicable rates:
Before we go into the details of the calculations, let us understand a few terms used for the calculation:
Capital assets include land, house, property, building, trademarks, vehicles, leasehold rights, machinery, patents, and jewellery.
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.
The cost of acquisition is the sum the seller paid to acquire the capital asset in the first place.
An expense incurred by the seller for making any alteration or additions to the capital asset is known as the cost of the improvement.
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.
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.
Capital gains tax is calculated differently for different periods on different capital asset classes.
Let us define the terms used in the above formula:
Short-Term Capital Gains Tax
Let us look at each of these assets and their taxes in detail:
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.
The following expenses are deducted from the total sale price:
The following expenses are deductible:
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.
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:
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.