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Home » Taxation » Capital Gains Tax

What is the Capital Gains Tax?


Profits or gains arising from the transfer of a capital asset made in a previous year is taxable as capital gains under the head "Capital Gains". The important ingredients for capital gains are, therefore, existence of a capital asset, transfer of such capital asset and profits or gains that arise from such transfer.

Capital asset

Capital asset means property of any kind except the following :

a) Stock-in-trade, consumable stores or raw-materials held for the purpose of business or profession.

b) Personal effects like wearing apparel, furniture, motor vehicles etc., held for personal use of the tax payer or any member of his family. However, jewellery, even if it is for personal use, is a capital asset.

c) Agricultural land in India other than the following:

  • Land situated in any area within the jurisdiction of muni-cipality, municipal corporation, notified area committee, town area committee, town committee, or a cantonment board which has a population of not less than 10,000 according to the figures published before the first day of the previous year based on the last preceding census.
  • Land situated in any area around the above referred bodies upto a distance of 8 kilometers from the local limits of such bodies as notified by the Central Government (Please see Annexure 'A' for the notification).

For the Assessment Year 2008-09

Dividends that are distributed attract a tax of 15 per cent. Short term capital gains attract a tax of 10 per cent under Section 111A. There is merit in equating the rates and hence increased the rate of tax on short term capital gains under Section 111A and Section 115AD to 15 per cent. This encourages investors to stay invested for a longer term.

STT paid will be treated like any other deductible expenditure against business income. Further, the levy of STT, in the case of options, is to be only on the option premium where the option is not exercised, and the liability to be on the seller. In a case where the option is exercised, the levy is to be on the settlement price and the liability will be on the buyer. There will be no change in the present rates.

Commodities Transaction Tax (CTT) introduced on the same lines as STT on options and futures.

For the Assessment Year 2007-08

The undermentioned assets is brought under the scope of capital assets and has been excluded from the scope of personal effects:

  • Archeological collections
  • Paintings
  • Drawings
  • Sculptures
  • Any work of art

Ceiling prescribed for investment in Long-Term Specified Bonds (LTSB) for claiming the exemption of long-term capital gains:

  • All the capital gains arising from transfer of any long-term capital assets is exempt if such gains are invested in Long-Term Specified Bonds. From April 1, 2007, ceiling of Rs 5 million has been stipulated for investments in such bonds made during any financial year.
  • Notifying of such bonds in Official Gazette is dispensed. Bond issued by NHAI or by REC on or after 01.04.07 & redeemable after three years will be LTSB. Bond issued between 01.04.06 & 31.03.07 will be deemed to be LTSB.

  Short-term Capital gains tax Long-term capital gains tax
Sale transactions of securities which attracts STT:- 10% NIL
Sale transaction of securities not attracting STT:-    
Individuals (resident and non-residents) Progressive slab rates 20% with indexation;

10% without indexation (for units/ zero bonds)
Partnerships (resident and non-resident) 30%
Individuals (resident and non-residents) 30%
Overseas financial organisations specified in section 115AB 40% (corporate)
30% (non-corporate)
10%
FIIs 30% 10%
Other Foreign companies 40% 20% with indexation;

10% without indexation (for units/ zero coupon bonds)
Local authority 30%
Co-operative society Progressive slab rates

A capital gain is income derived from the sale of an investment. A capital investment can be a home, a farm, a ranch, a family business, or a work of art, for instance. In most years slightly less than half of taxable capital gains are realized on the sale of corporate stock. The capital gain is the difference between the money received from selling the asset and the price paid for it.

"Capital gains" tax is really a misnomer. It would be more appropriate to call it the "capital formation" tax. It is a tax penalty imposed on productivity, investment, and capital accumulation.

The capital gains tax is different from almost all other forms of taxation in that it is a voluntary tax. Since the tax is paid only when an asset is sold, taxpayers can legally avoid payment by holding on to their assets--a phenomenon known as the "lock-in effect."

There are many unfairnesses imbedded in the current tax treatment of capital gains. One is that capital gains are not indexed for inflation: the seller pays tax not only on the real gain in purchasing power but also on the illusory gain attributable to inflation. The inflation penalty is one reason that, historically, capital gains have been taxed at lower rates than ordinary income. In fact, "most capital gains were not gains of real purchasing power at all, but simply represented the maintenance of principal in an inflationary world."

Another unfairness of the tax is that individuals are permitted to deduct only a portion of the capital losses that they incur, whereas they must pay taxes on all of the gains. That introduces an unfriendly bias in the tax code against risk taking. When taxpayers undertake risky investments, the government taxes fully any gain that they realize if the investment has a positive return. But the government allows only partial tax deduction if the venture goes sour and results in a loss.

There is one other large inequity of the capital gains tax. It represents a form of double taxation on capital formation. This is how economists Victor Canto and Harvey Hirschorn explain the situation:

A government can choose to tax either the value of an asset or its yield, but it should not tax both. Capital gains are literally the appreciation in the value of an existing asset. Any appreciation reflects merely an increase in the after-tax rateof return on the asset. The taxes implicit in the asset's after-tax earnings are already fully reflected in the asset's price or change in price. Any additional tax is strictly double taxation.

Take, for example, the capital gains tax paid on a pharmaceutical stock. The value of that stock is based on the discounted present value of all of the future proceeds of the company. If the company is expected to earn Rs.100,000 a year for the next 20 years, the sales price of the stock will reflect those returns. The "gain" that the seller realizes from the sale of the stock will reflect those future returns and thus the seller will pay capital gains tax on the future stream of income. But the company's future Rs.100,000 annual returns will also be taxed when they are earned. So the Rs.100,000 in profits is taxed twice--when the owners sell their shares of stock and when the company actually earns the income. That is why many tax analysts argue that the most equitable rate of tax on capital gains is zero.


Related Resources:

Computation of Capital Gains

Why Does Capital Matter?

How Do Capital Gains Taxes Affect Workers?

Advantages & Disadvantages Of Capital Gains Tax Cut

The Lock-In Effect

Myths & Facts Of Capital Gains Tax Cut



Keywords:

taxation, direct taxation, indirect taxation, tax planing, tax, capital, capital gains, gains, gains tax, capital gains tax, agricultural land in india, long term capital assets

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