Capital Gains Tax Simplified: Part I – Short Term Capital Gains Tax

An important aspect of investment decision making is taxation. Certain type of income/gains may receive favourable tax treatment from the Government. For instance, interest on tax-free bonds is exempt from tax. Similarly, long term capital gain on equity or equity mutual funds is exempt from tax too. A favourable tax regime can thus enhance the attractiveness of an investment.

While investing, you can make two types of gains (short term capital gains or long term capital gains). When it comes to taxation, we need to understand whether a particular sale transaction results in short term or long term capital gains (or losses). This depends on holding period of the asset i.e. period between purchase and sale of the asset. The holding period requirements varies  based on the type of asset.

In this post, I will focus on taxation for short term capital gains. I will cover long term capital gains taxation in a separate post.

Definition of Capital Asset

There is an elaborate definition of what constitutes a capital asset under Section 2 of the Income Tax Act. For instance, agricultural land is not a capital asset. We will not go into such specifics. I will consider those capital assets most of us commonly hold in expectation of capital gains i.e. stocks, equity funds, debt, debt funds, gold and real estate.

Short Term Capital Asset and Long Term Capital Asset

The rule is very simple.

If you hold a capital asset for a period of not more than 36 months, the asset is treated as a short term capital assets. The resulting gain or loss on the sale of such an asset shall be treated as short term capital gain/loss.

If you hold a capital asset for more than 36 months, it is treated as a long term capital asset. The resulting gain or loss on the sale of such an asset shall be treated as long term capital gain/loss.

Are there any exceptions?

Yes, there is an exception.  If the asset under consideration is equity shares, preference shares, units of equity mutual funds, listed securities like debentures and Government Securities, units of UTI or zero coupon bonds, the holding requirement goes down to 12 months.

This means, for assets discussed above, you need to hold the asset for only 12 months before the capital asset is classified as a long term capital asset.

For instance, if you purchased equity shares of Infosys on April 20, 2014 and sold those shares on May 15, 2015, you have held the asset for more than 12 months. Hence, at the time of sale, your equity holding in Infosys was a long term capital asset. Any gains/loss due to sale of such shares shall be treated as long term capital gain/loss.

On the other hand, suppose you had purchased a residential house on April 20, 2014 and sold the house on May 15, 2015. You have held the asset for more than 12 months. However, the relaxation in holding period is not available to real estate transactions. You need to hold real estate asset for more than 36 months for it to be classified as a long term asset. Hence, at the time of sale, the house was still a short term capital asset. Any gain/loss arising due to sale of such property shall be treated as short term capital gain/loss.

Is there any difference in tax treatment of long term and short term capital gains?

Yes, short term capital gains (STCG) are taxed as per investors’ marginal tax rate i.e. the STCG is added to the total income of the investor during the financial year. The investor is taxed as per his/her income tax slab.

Long term capital gains are taxed at lower rates. In this post, I will focus only on short term capital gains taxation. I will discuss long term capital gains taxation in a subsequent post.

Are there any exceptions in short term capital gains tax?

Yes, there is an exception in case of equity shares or equity mutual funds.

As per Section 111A of Income Tax Act, if the asset under consideration is an equity share of a company or units of equity mutual funds, the rate of tax on short term capital gains shall be 15%.

This is subject to the condition that Securities Transaction Tax (STT) has been paid on the sales transaction.

When you trade shares on recognised stock exchanges, the STT is automatically debit by your broker. Even in case of mutual fund transaction, STT payment is taken care of.

Therefore, short term capital gains tax on equity shares and equity mutual funds is 15%.

For the other capital assets, the tax on STCG stays the marginal tax rate of the investor.

What if STT is not paid?

If the STT is not paid, the concessional rate of 15% shall not be applicable. The rate of taxation for such short term capital gains shall be your marginal tax rate (income tax slab). This is possible if you deal in unlisted shares.

I am in the highest tax bracket. Do even I have to pay 15% on short term equity gains?

Yes, the rate of taxation for short term capital gains on equity transactions (under Section 111A) is 15%, irrespective of your income tax slab.

Even if you fall under 10% tax bracket, you need to 15% tax of your short term capital gains on equity or equity funds.

My total taxable income is Rs 1.8 lacs. I have short term equity gains of 60,000.

In such a case, your tax liability shall be Nil.

For capital assets other than equity shares and equity funds, STCG is anyways added to the total income and taxed at marginal rate of income tax. So, in such case, total taxable income will come to Rs 2.4 lacs, which is below the tax exemption limit (Rs 2.5 lacs). Thus, tax liability will be Nil.

The tax exemption limit is Rs 2.5 lacs, Rs. 3 lacs (for senior citizens) and Rs. 5 lacs (for citizens above 80). The exemption limit for NRIs is Rs 2.5 lacs (irrespective of age).

For equity and equity funds, there is a provision under Section 111A under which if your taxable income is below basic tax exemption limit, then short term capital gains shall be reduced by the amount your total income (except short term capital gains on equity/equity funds) falls short of tax exemption limit.

For instance, if you have an income of Rs 1 lac and short term capital gains of Rs 2.75 lacs on equity mutual funds, short term capital gain will be reduced by Rs 1.5 lacs (Rs 2.5 lacs – Rs 1 lac). Thus, you will have to pay 15% tax on only Rs 1.25 lacs (Rs 2.75 lacs – Rs 1.5 lacs).

Please note this relaxation is available only to residents (for capital assets under Section 111A). NRIs can not avail this relaxation. For instance, an NRI has short term capital gains on equity transaction of Rs 1 lac (and no other income), he/she will have to pay 15% tax (Rs 15,000 on gains of Rs 1 lacs).

Cess and surcharge, if applicable have not been considered.

How is Short Term Capital Gain (STCG) Calculated?

Short term capital gains is calculated as

Sales consideration – Expenses incurred in connection with the sales transaction (brokerage, commission etc) – Cost of acquisition of asset – Cost of Improvement of the asset, if any

Consider the following example in case of sale of property. Let’s assume the property was sold before 3 years from date of purchase.

Please note brokerage paid during purchase of the asset shall be included in the cost of acquisition. Stamp duty and registration fees paid should also be adjusted while calculation of STCG. This is applicable for all the capital assets.

For assets other than those under Section 111A, STCG shall be taxed at your marginal rate of income tax. For equity and equity mutual funds (assets under Section 111A), short term capital gains tax shall be 15%.

What if I incur a Short Term Capital Loss?

You do not always make gains in a capital transaction. Losses are an unfortunate reality.

What is the tax treatment of short term capital losses? Do you get to set off short term capital gains against such losses?

Yes, you do. You can set off your short term (or long term) capital gains against such losses. This will help you reduce your tax liability. Please note short term capital loss cannot be set off against income from Salary, House property, business or other sources. Income from House property does not mean gains from sale of residential property. It includes rent from the property and has been defined in Section 23 of the Income Tax Act.

For instance, you made a short term (or long term) capital gain of Rs 50,000 in one transaction (real estate) and a short term capital loss of Rs 20,000 (in equity shares) in another transaction in the same financial year. You will have to pay short term gains tax on only Rs 30,000. Applicable rate of tax shall depend on type of asset. For equity and equity funds, the gains will be taxed at 15%. For other assets, the gains will be taxed at marginal rate of tax (as per income tax slab).

Short term capital losses can be set off against both long term and short term capital gains.

Long term capital losses can be set off against only long term capital gains. For capital assets where long term gains are exempt from tax, no set off against long term capital losses in such assets shall be allowed. For instance, if you incur a long term capital loss (LTCL) on an equity transaction, you will not be allowed to set off this loss against any long term capital gains. This is because long term capital gain on equity transaction is tax-exempt. Recently, a Mumbai tribunal has ruled against this treatment. They allowed adjusted of long term capital losses on equity shares. However, more clarity is awaited on this matter.

What if I do not have short term capital gains to set off these losses?

If you do have such gains in this year, you can carry forward your losses for the next eight years and use to set off those short term/ long term capital gains in the next eight years.

Both long term and short term capital losses can be carried forward for 8 years.

Please note, if you want to carry forward losses, you must file the returns before due date. If you don’t file returns on time, you won’t be able to carry forward losses.

No relief under Section 80C to 80U for STCG under Section 111A

For STCG that are covered under Section 111A (equity and equity funds), there is no relief under Section 80C to 80U.

For example, if you earn STCG of Rs 6 lacs on equity transactions (and no other income) and you invest Rs 1.5 lacs in Public Provident Fund (PPF), you will not get any tax benefit for this investment under Section 80C.  You will get an adjustment under the basic exemption limit though i.e. you will be taxed at 15% for Rs 3.5 lacs (Rs 6 lacs – Rs 2.5 lacs). However, there is no tax benefit of investing in PPF.

You would have got relief if the STCG were other than those under Section 111A. For instance, if the STCG of Rs 6 lacs were on property sale and you had invested Rs 1.5 lacs under Section 80C, you would have got benefit under Section 80C. In that case, you would have to pay tax on only Rs 2 lacs (Rs 6 lacs – Rs 2.5 lacs – Rs 1.5 lacs). The total taxable income is Rs 4.5 lacs (Rs 6 lacs – Rs 1.5 lacs). And adjusting for basic tax exemption limit, you need to pay tax at 10% on the remaining Rs 2 lacs (Rs 4.5 lacs – Rs 2.5 lacs). Please note 10% is only the marginal income tax rate for the investor.

To Sum up

Holding period of capital asset (the period between purchase and sale of asset) is important for classification of an asset as a long term capital asset or a short term capital asset.

If you hold the asset for more than 36 months, the asset is classified as long term capital asset and the resulting gains from sale are treated as long term capital gains. There are a few exceptions such as equity, equity shares etc where holding period requirement is only twelve months (for asset to be qualified as long term capital asset).

If you hold the capital asset for 36 months or less (or 12 month or less as the case may be), the asset is qualified as

For the purpose of tax calculation, short term capital gains can be classified as

1. STCG on assets under Section 111A (to be charged at 15%)
2. STCG on assets not covered under Section 111A (tax to be charged as per income tax slab)

We will discuss the taxation of long term capital gains (LTCG) in a subsequent post.

Additional Reading: You can also refer to Short term capital gains tutorial available on Income Tax website. You can download the tutorial from here.

Disclaimer: I am not a tax expert. This is a simplistic description of income tax laws. The exact rules may have multiple sub-conditions. It is not possible to include all sub-conditions in this short post. You are advised to consult a tax consultant to understand your tax liability better.

Image Credit: Simon Cunningham, 2013. The original image and information about usage rights can be downloaded from Flickr / Lendingmemo

 

Deepesh is a SEBI registered Investment Adviser and Founder, PersonalFinancePlan.in