Capital Gain Tax, Key and Indexation, Key Changes in Budget 2024

The Union Government is facing a backlash over changes to the long-term capital gains tax regime announced in the Budget, including critiques from MPs within the National Democratic Alliance (NDA).

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• The new LTCG regime proposed in the Union Budget for 2024-25 does away with the indexation benefit available for calculation of LTCG on property, gold, and other unlisted assets, while reducing the LTCG tax rate to 12.5% from 20%.
• According to the government, the new LTCG tax regime, even without the benefit of indexation, would be beneficial in the vast majority of cases in the property sector.

Investors often focus on the returns from their investments, but understanding the tax implications of those returns is equally important. Capital gain tax, which applies to the profit earned from the sale of assets, comes in two forms: long-term capital gain tax and short-term capital gain tax. Additionally, the concept of indexation plays a crucial role in minimizing tax liability.

What is Capital Gain Tax?

Capital gain tax is levied on the profit earned from the sale of capital assets such as real estate, stocks, bonds, and mutual funds. It is defined as profits accumulated from the sale of any capital asset. Example of capital assets; Land, buildings, house property, vehicles, patents, trademarks, leasehold rights, machinery, and jewellery.

The tax is categorized into two types based on the holding period of the asset:

1. Long-Term Capital Gain Tax (LTCG): This applies to assets held for more than a specified period, typically one year for financial assets and two to three years for real estate. The LTCG tax rate is generally lower than the short-term rate to encourage long-term investments.
2. Short-Term Capital Gain Tax (STCG): This applies to assets sold within a shorter holding period, usually less than one year for financial assets and less than two to three years for real estate. The STCG tax rate is higher and often aligns with the individual’s income tax slab.

Long-Term Capital Gain Tax

Long-term capital gain tax is imposed on profits from the sale of assets held for a long period. The holding period required to qualify as a long-term asset varies by the type of asset:

• Equity Shares and Mutual Funds: Held for more than 12 months.
• Real Estate: Held for more than 24 to 36 months.
• Debt Funds and Other Assets: Held for more than 36 months.

LTCG Tax Rates

In many jurisdictions, the LTCG tax rate is lower than the STCG rate to promote long-term investments. For instance, in India, the long-term capital gains on the sale of listed equity shares and equity-oriented mutual funds are taxed at 10% if the gains exceed Rs 1 lakh. However, the 2024 Union Budget increased this rate to 12.5% while raising the exemption limit to Rs 1.25 lakh.

Short-Term Capital Gain Tax

Short-term capital gain tax is applied to profits from the sale of assets held for a shorter duration. The holding period to qualify as a short-term asset is generally:

• Equity Shares and Mutual Funds: Held for less than 12 months.
• Real Estate: Held for less than 24 to 36 months.
• Debt Funds and Other Assets: Held for less than 36 months.

STCG Tax Rates

STCG is typically taxed at a higher rate compared to LTCG. For example, in India, short-term capital gains on the sale of equity shares and equity-oriented mutual funds are taxed at 15%. The 2024 Union Budget raised the STCG tax rate on certain financial assets to 20%.

Budget 2024: Key Changes in Capital Gain Tax

The Union Budget 2024, presented by Finance Minister Nirmala Sitharaman, introduced significant changes to the capital gain tax regime in India. These changes impact both long-term and short-term capital gains, with adjustments aimed at increasing government revenue while offering some relief to taxpayers through increased exemption limits. Here’s a detailed look at the changes and their implications.

Long-Term Capital Gain Tax (LTCG)

Rate Increase

One of the most notable changes in the 2024 budget is the hike in the long-term capital gain tax rate from 10% to 12.5%. This increase applies to all financial and non-financial assets. Despite the rate hike, there is a positive development for taxpayers: the exemption limit for long-term capital gains has been increased from Rs 1 lakh to Rs 1.25 lakh.

Exemption Limit

Under the previous provisions, long-term capital gains up to Rs 1 lakh were exempt from tax. This threshold has now been raised to Rs 1.25 lakh, meaning that investors can earn up to this amount from long-term capital gains without incurring any tax liability. This adjustment helps to offset the impact of the rate increase, providing some relief to taxpayers.

Calculation Example

To understand the practical impact of these changes, let’s consider an example. Suppose an investor has long-term capital gains amounting to Rs 2 lakh.

• Under the old regime, with a 10% tax rate and a Rs 1 lakh exemption:
  • Taxable gain = Rs 2,00,000 – Rs 1,00,000 = Rs 1,00,000
  • Tax = 10% of Rs 1,00,000 = Rs 10,000
  • Adding 4% cess, the total tax = Rs 10,400
• Under the new regime, with a 12.5% tax rate and a Rs 1.25 lakh exemption:
  • Taxable gain = Rs 2,00,000 – Rs 1,25,000 = Rs 75,000
  • Tax = 12.5% of Rs 75,000 = Rs 9,375
  • Adding 4% cess, the total tax = Rs 9,750

This example shows a reduction in the overall tax paid, demonstrating how the increased exemption limit can lead to tax savings despite the higher tax rate.

Short-Term Capital Gain Tax (STCG)

Rate Increase

The Budget 2024 also increased the short-term capital gain tax rate for certain financial assets to 20%. Previously, short-term capital gains on equity shares and equity-oriented mutual funds were taxed at 15%. This change aims to boost government revenue from the taxation of short-term profits.

Impact on Investors

Investors who frequently trade financial assets may find this rate increase significant, as it directly affects the profitability of short-term investments. The higher STCG tax rate encourages investors to hold their investments longer to benefit from the lower LTCG tax rates and higher exemption limits.

What is Indexation?

• Indexation is the process of adjusting the original purchase price of an asset or investment in order to neutralise the impact of inflation on it.
• It involves revising upward the cost of the acquisition of an asset based on the inflation over the period for which it was held.
• Inflation reduces the value of money over time, and therefore, when an asset is sold or investment is redeemed, indexation helps in arriving at the cost of acquisition with the impact of inflation over the holding period factored in.

Conclusion

Understanding capital gain tax, particularly the differences between long-term and short-term capital gain tax, is essential for effective financial planning. Utilizing the indexation benefit can help investors minimize their tax liability on long-term investments, making it a valuable tool for maximizing returns. As tax laws and rates change, staying informed and seeking professional advice is crucial to optimize your investment strategy and comply with current regulations.

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