Understanding the Significance of the Capital Gain Index in Taxation

When you sell an asset, such as real estate, stocks, or bonds, and earn a profit, this profit is known as capital gain. However, due to inflation, the value of money decreases over time, meaning that the purchasing power of a fixed amount of money declines. To account for this, the Cost Inflation Index (CII) is used to adjust the purchase price of an asset, ensuring that long-term capital gains reflect the true profit after considering inflation.

The Capital Gain Index is an essential tool that helps determine the adjusted cost of acquiring an asset when calculating capital gains tax. By using indexation, taxpayers can reduce the impact of inflation on their taxable income, thereby lowering the tax burden on long-term capital gains.

Types of Capital Gains

Capital gains are the profits earned from selling an asset, such as real estate, stocks, mutual funds, gold, or bonds. The taxation of capital gains depends on how long the asset is held before selling. Based on this holding period, capital gains are classified into two types:

1. Short-Term Capital Gain (STCG)

A short-term capital gain occurs when an asset is sold within a short period after purchase. The holding period for STCG varies based on the type of asset:

• For equity shares and equity-oriented mutual funds: The gain is considered a short-term capital gain if sold within one year of purchase.
• If real estate, bonds, and other assets: If sold within 24 months of purchase, they are considered short-term capital gains.

Tax on Short-Term Capital Gains:

• For equity shares and equity-oriented mutual funds: A flat 15% tax is applicable on STCG if securities transaction tax (STT) is paid.
• For other assets (real estate, gold, debt funds, etc.): The gain is added to the seller’s total income and taxed according to the individual’s income tax slab. The tax rate could range from 5% to 30%, depending on the person’s income.

2. Long-Term Capital Gain (LTCG)

A long-term capital gain arises when an asset is held longer before selling. The holding period required for LTCG classification varies:

• For equity shares and equity-oriented mutual funds: Gains from the sale of shares held for more than one year are considered LTCG.
• For real estate, gold, bonds, and other assets: If held for more than two years before selling, the profit is classified as a long-term capital gain.

Tax on Long-Term Capital Gains:

• Equity shares and equity-oriented mutual funds can receive LTCG up to Rs. 1 lakh per year tax-free. Any gain exceeding this limit is taxed at 10% without indexation.
• After applying the indexation benefit, LTCG is taxed at 20% tax.

What is Indexation?

Indexation is a method used to adjust the original purchase price of an asset to account for inflation. Since the value of money decreases over time due to inflation, the government provides this benefit to ensure that taxpayers do not pay tax on the portion of capital gains that arises due to inflation.

Without indexation, a seller would have to pay tax on the difference between the purchase and selling prices, even though rising prices over time account for a significant part of this increase. Indexation ensures that taxpayers do not pay tax on the portion of capital gains that arise due to inflation, providing a sense of reassurance.

How Does Indexation Work?

• The government releases a Cost Inflation Index (CII) every year, which reflects the inflation rate for that year.
• The purchase price of an asset is multiplied by the CII factor to adjust it for inflation.
• The result is the inflation-adjusted purchase price, which calculates the taxable capital gain.

How to Calculate Capital Gain Using the Capital Gain Index?

To calculate the indexed cost of an asset, use the formula:

Indexed Cost of Acquisition = (Purchase Price x CII in Sale Year) / CII in Purchase Year

Example Calculation:

• Seth bought a property in 2004 for ₹50,000.
• He sold it in 2018 for ₹90,000.
• The CII in 2004-05 was 113.
• The CII in 2018-19 was 280.

Indexed Cost of Acquisition = (50,000 x 280) / 113 = ₹123,894

Now, the taxable capital gain is:

Capital Gain = Sale Price – Indexed Cost of Acquisition

= 90,000 – 123,894 = (-33,894)

Since there is no gain, there is no tax liability.

Capital Gain Index Table

Below is the Capital Gain Index Table (CII) used for capital gain calculation:

Source

Capital Gains Tax Calculation

• Short-Term Capital Gains Tax (STCG): Added to your income and taxed as per your tax slab.
• Long-Term Capital Gains Tax (LTCG): Taxed at 20% after indexation benefits.

Capital Gains Calculator

You can use an online capital gains calculator to compute your tax. Enter the following details:

1. The sale price of the asset
2. Purchase price of the asset
3. Date of purchase
4. Date of sale
5. Type of investment (real estate, stocks, bonds, etc.)

The calculator will provide:

• Indexed purchase cost
• Capital gain after indexation
• Taxable amount
• Tax to be paid

Exemptions from Capital Gains Tax

The Income Tax Act provides exemptions for capital gains tax under certain sections:

• Section 54: Exemption on capital gains from selling a house if the amount is reinvested in another residential property.
• Section 54F: Exemption on selling any asset if the proceeds are used to buy a house.
• Section 54EC: Exemption if capital gains are invested in specific bonds like NHAI or REC bonds.

Conclusion

Understanding capital gain index, indexation, and capital gains tax is essential for investors and taxpayers. Using indexation, you can reduce tax liability on long-term investments and make informed financial decisions. Keeping track of the Capital Gain Index Table helps you compute the indexed acquisition cost and accurately calculate capital gains tax. Always consider tax-saving options under various exemptions to reduce tax burdens on profits from long-term asset sales.

Frequently Asked Questions

1. How do I calculate capital gains tax on mutual funds?

• Long-term capital gains tax on equity mutual funds is 10% (for gains above ₹1,00,000 in India).
• Short-term capital gains tax is 15%.
• Debt mutual funds are taxed at 20% with indexation.

2. Are long-term capital gains considered taxable income?

If the total long-term capital gain does not exceed the taxable income threshold, it may not be taxable. However, if it exceeds the threshold, tax is applicable.

3. How are Recurring Deposits (RDs) taxed?

RDs do not get tax exemptions under Section 80C. The interest earned is taxed as per your tax slab. A 10% TDS is deducted if PAN details are provided or 20% if PAN details are unavailable.