Five minutes to understanding Capital Gains Tax

Capital gains tax is the payout that makes you scale down your happiness from making a killing on the stock market. While it scares some, it...

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Capital gains tax is the payout that makes you scale down your happiness from making a killing on the stock market. While it scares some, it remains ignored by the others. Both attitudes need change and the best way to deal with a demon is to unmask it.

What is a capital gain?
A ‘capital gain’ is made when the price at which you sell an asset is higher than the price at which you had bought the same asset in the past. An asset can be any property owned by a person like real estate, equity, bonds or mutual funds.

However, furniture, personal belongings, agricultural land (subject to certain conditions), certain gold schemes issued by the Central Government and raw material held for the purpose of business is not termed as a capital asset. Jewellery is treated as a capital asset but selling a car is not. When you make a profit from selling such an asset, you need to share your good fortune with the Government by paying a tax on the profit. This is called a capital gains tax. We will only deal with capital gains on financial instruments like equity and debt products here.

How many types of capital gain taxes are there?
The quantum of capital gains tax is linked to your holding period. There are two defined holding periods for tax purposes:

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• Short term: If you hold the asset for a period less than one year, you pay what is called a short term capital gains tax. For you, this tax is equal to your income tax rate. If you are in the 30 per cent tax bracket, and have sold shares bought for Rs 1 lakh, for Rs 1.5 lakh, then your profit is Rs 50,000. You will now pay 30 per cent of Rs 50,000 or Rs 15,000 as short term capital gains tax, if you make this gain within one year.

• Long term: If you hold the asset for more than one year, you pay a lower rate of tax, called the long term capital gains tax. This is just 10 per cent of the profit, if you do not inflation index the buy price. If you inflation adjust (index) it, then your tax rate is 20 per cent of the profit. In the Budget of 2003-04, long term capital gains on all listed shares was removed for a period of one year. So, if you bought shares after April 2003 and hold on for a year, you pay no tax on your gains. This may get reviewed in the next budget, so make the most of it.

How can I minimise this tax?
First, start recording the dates of purchase and check this before you sell. Currently the difference between short term and long term tax is between paying no tax and paying upto one third of your gain. So make sure you don’t get caught with short term tax through ignorance. Second, you can offset capital losses against capital gains. Third, the reinvestment option of mutual funds are able to get around the capital gains tax problem since dividends are tax free currently.