Tax on Long-term Capital Gains (LTCG) on Equity Funds

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The Process of Tax Calculation on LTCG from Equity Mutual Funds and Equity Shares

To orderly understand how to calculate long-term capital gains (LTCG), it firstly is important that people become well versed with the concept of capital gains and the taxes related to it. Any type of profit or gains that a person earns from the sale of a capital asset is referred to as capital gains. Inheriting a property can however not be considered as capital gains as in this process there is no sale involved, just a transfer of ownership. As per the income tax act of India, assets received through an inheritance or will, or a gift is specifically expected from the capital gains tax. When trying to find how to calculate income tax, it also is important to note that capital gains tax would be applicable for people who decide to sell an inherited asset.

What is Considered as Capital Assets?

Capital assets can be referred to as buildings, lands, vehicles, jewelry, patents, leasehold rights and trademark.  Rights in or about any Indian Company, as well as the rights of control or management, or any legal right can also be considered to be a capital asset. Conversely, here are a few elements that do not fall under the category of capital assets:

  • Raw material, consumable goods, or stock that has been held for any professional purpose or business
  • Various items meant for personal use, including clothes and furniture
  • Agricultural land present in rural India
  • National defense gold bonds (1980) or 7% gold bonds (1980) or 6½% gold bonds (1977) that have been issued by the central government of India
  • Special bearer bonds (1991)
  • Gold deposit certificate that has been issued under the Gold Monetization Scheme, 2015

The two types of Capital Assets

Short-term Capital Assets

This refers to as an asset that has been held for 36 months or less. This 36 months criterion was essentially reduced to 24 months from FY 2017-18 for various immovable assets, such as a house, building, and land.

Long-term Capital Assets

Asset held for greater than thirty-six months is considered to be a long-term capital asset. The reduced period of 24 months mentioned above tends to do not apply to any type of movable property, like debt-oriented mutual funds and jewelry. These items would ideally be classified as a long-term capital asset in case it has been held for greater than thirty-six months, as it was prevalent earlier.

When they are held for 12 months or less, certain items are considered to be short-term capital assets in case the date of transfer is after July 10th, 2014. These assets can include:

  • Preference or equity share in an organization listed on a recognized stock exchange in the country.
  • Securities that have been listed on any recognized stock exchange in India. These securities can include bonds, debentures, and government securities.
  • Units of UTI, both quoted and not.
  • Zero-coupon bonds
  • Units of distinct equity-oriented mutual funds, both quoted and not.

In case the assets mentioned above have been held for more than a period of 12 months, they tend to be considered as a long-term capital asset. In the scenario that an asset is acquired as an inheritance, succession, or gift, the period for which the relevant asset was held by its earlier owner tends to be also included in determining whether it is a long-term or short term capital asset. When dealing with rights shares or bonus share, the period of holding essentially is counted right from the date of its allotment.

Calculating Tax on Long-Term Capital Gains from Equity Shares and Equity Mutual Funds

After orderly understanding the concept of the capital asset and capital gains, people would be able to grasp the steps and elements needed to calculate tax on long-term capital gains from equity shares and equity mutual funds. People typically would need these steps when trying to know how to calculate income tax. The reason behind this being such long-term capital gains (LTCG) have become taxable now in India. As of now, Indian taxpayers would have to efficiently calculate LTCG that arises from the sale of both equity mutual funds and equity shares to file their income tax returns or ITR.

In the Budget of 2018, the long-term capital gains were made taxable. This rule ideally applies to any of such transactions made on, or after the 1st of April 2018. This rule will be suitably applicable for any of these transactions made from the financial year of 2018-19 onwards.

Capital gains or losses that arise from the sale of equity mutual funds and equity shares are considered to be long term in nature in the scenario that they are held for more than a single year from the very date of investment. In case these investments are sold before a single year, then the gains and losses arising from that amount of sale shall consider being short term capital gains or losses.

According to the new rule, the tax would be levied at the rate of ten percent the indexation benefit of the LTCG that arises from the sale of equity mutual funds and equity shares in case the gains in a single financial year tends to exceed the amount of Rs 1 lakh.

To adequately make sure that only the gains and losses incurred from the date of the tax announcement, which was February 1st, 2019, till the date of transactions that are being taken into consideration for taxation, a distinct grandfathering clause has been used. This clause helps in calculating the relevant long term capital gains, as well as losses. To calculate the LTCG, a person would first have to calculate the CoA or cost of acquisition by using a specific formula.

There are two steps involved in arriving at the cost of acquisition of equity mutual fund or equity shares.

Step 1: Pick the lower of the following:

  • The fair market valuation of the asset as on 31st January 2018. [ This would be the highest valuation of share on the stock market on January 31, 2018,  or when the share was traded last or the NAV of the unit as of 31.01.2018 in the scenario of equity mutual fund], and
  • A full valuation of the accruing or consideration received as the output of the capital asset transfer.

After arriving at the lower valuation, the very next step would be to pick the higher value.

Step 2: Pick the higher of the following

  • Lower value as found on the step mentioned above
  • The actual cost of purchase of the asset

The resultant found through these steps would be used to calculate the LTC gains or losses.

The LTCG is computed by subtracting the cost of acquisition from the whole value of consideration on the transfer of the distinct long-term capital asset in question.

Here are a Few Scenarios that Underline the Method of the Calculation of Long-Term Capital Gains:

Scenario 1 - On January 1stof 2017, an equity share is acquired at Rs. 100, and its fair market value on January 31st, 2018 is Rs.200. This asset is then sold at Rs.250 on the 1st of April.

As on January 31st, 2018, the fair market value is greater than the actual cost of acquisition, the fair market value [Rs.200] would be considered as the cost of acquisition. Hence, in this scenario, the long-term capital gain will be [Rs. 250 - Rs. 200] Rs.50.

Scenario 2 - On January 1st, an equity share is acquired at Rs. 100, and its fair market value on 31st of January, 2018 is Rs.200. This asset is then sold at Rs.150 on April 1st.

In the above-mentioned scenario, the fair market value is greater than the actual cost of acquisition on the 31st of January, 2018. However, on that date, the sale valuation is also less than the fair market value. Hence, in this case, the Rs.150 of the sale value would be considered to be the cost of acquisition. Hence, the ultimate long-term capital gain would be (Rs. 150 - Rs. 150) NIL.

Scenario 3 - On January 1stof 2017, an equity share is acquired at Rs. 100, and its fair market value on January 31st, 2018 is Rs.50. This asset is then sold at Rs.150 on April 1st.

In the above-mentioned case, the fair market value is lesser than the actual cost of acquisition on January 31st, 2018. Hence, Rs.100 as the actual cost is taken into account as the actual cost of acquisition. As a result, the long-term capital gain shall be 50 (Rs. 150 - Rs. 100) Rs.50.

Scenario 4 - On January 1stof 2017, an equity share is acquired at Rs. 100, and its fair market value on January 31st, 2018 is Rs.200. This asset is then sold at Rs.50 on the April 1st.

In such a scenario, the fair market value is greater than the actual cost of acquisition on January 31st, 2018. The sale valuation is also less than the fair market value on that date. Hence, in this scenario, the actual cost of Rs.100 would be considered as the cost of acquisition. The ultimate long-term capital loss, in this case, would be (Rs. 50 - Rs. 100) Rs.50.

The above-mentioned examples can go a long way in enabling people to orderly understand how to calculate the long term capital gains or even losses from equity shares and equity mutual funds. These steps would especially be useful when people are trying to understand how to calculate income tax, to file their tax returns.

Summing it Up

People should read the above-mentioned steps and try to properly understand all of the examples so that they do not face any problems in calculating tax on long-term capital gains from equity shares and equity mutual funds.

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