Calculation of Capital gains

We learnt that capital gain is Sale price less purchase price. But how do we arrive at the sale price and purchase price to ensure we pay the correct tax (not excess). Most of the details are taken from the Income Tax India Site.

Let us look at each

SHORT TERM CAPITAL GAINS (STCG)

Short Term Capital Gains is computed as below:

1.    Find the Value of consideration.

2.    Deduct the following

a.     Expenditure incurred wholly and exclusively in connection with such sale

b.    Cost of acquisition (purchase price as well as other charges incurred to acquire the asset)

c.     Cost of improvement

3.    The balance amount is STCG

LONG TERM CAPITAL GAINS (LTCG)

Long Term Capital Gains is computed as below:

1.    Find the Value of consideration.

2.    Deduct the following

a.     Expenditure incurred wholly and exclusively in connection with such sale

b.    INDEXED Cost of acquisition (purchase price as well as other charges incurred to acquire the asset)

c.     INDEXED Cost of improvement

d.    Deduct exemptions available under section 54

3.    The balance is LTCG

Now if you noticed we have mentioned indexed cost. How do we get the indexed cost? The indexed cost is based on cost inflation index (CII). CII is available the Income Tax India site. (Click here) 

Indexed cost of acquisition =

Cost of acquisition   x	CII of year of sale
	CII of year of acquisition

Indexed cost of improvement = 

Cost of improvement  x	CII of year of Sale
	CII of year of improvement

Deduction under Chapter VIA should not be given from LTCG.

COST OF SALE

This may include brokerage paid for arranging the deal, legal expenses incurred for preparing conveyance and other documents, cost of inserting advertisements in newspapers for sale of the asset and commission paid to auctioneer, etc. However, it is necessary that the expenditure should have been incurred wholly and exclusively in connection with the transfer.

Besides an expenditure which is eligible for deduction in computing income under any other head of income, cannot be claimed as deduction in computing capital gains.

COST OF ACQUISITION

Cost of acquisition of an asset is the sum total of amount spent for acquiring the asset.

Where the asset was purchased, the cost of acquisition is the price paid.

Any expenditure incurred in connection with such purchase e.g. brokerage paid, registration charges and legal expenses also forms part of cost of acquisition.

The cost of acquisition of bonus shares is nil.

COST OF IMPROVEMENT

The cost of improvement means all expenditure of a capital nature incurred in making additions or alternations to the capital asset. However, any expenditure which is deductible in computing the income under the heads Income from House Property, Profits and Gains from Business or Profession or Income from Other Sources would not be taken as cost of improvement. 

What are Capital Gains?

A capital gain results from sale of asset such as shares, bonds, real estate, etc. where there is a difference between purchase price and sale price. Capital gain, can either a profit or a loss. When the proceeds from the sale of a capital asset are less than the purchase price it is a capital loss.

When the proceeds from the sale of a capital asset are more than the purchase price it is a capital Profit. Capital gains may refer to investments that arise in relation to real assets, such as property or financial assets, such as shares or bonds.

We have tax on Capital Gain, although relief or exemption would be available in relation to holding period or type of asset or to compensate for the effects of inflation.

Classification of Capital Gains

Capital gain is classified into two types, depending on the period of holding of the asset.

·         Short Term Capital Gain (STCG)

·         Long Term Capital Gain (LTCG)

This classification also varies depending on the type of the asset. So, let’s understand this classification based on the type of asset.

Short Term Capital Gain (STCG)

If the type of asset is a share or mutual fund and held for less than 12 months before selling, the gain arising is classified as STCG. The only condition here is that the share should be sold on a recognized stock exchange, and securities transaction tax (STT) should be paid on it. In case of equity mutual fund, when redeemed the Asset Management company would deduct STT.

If the sale of shares is off-market (that is, if the sale is not on a recognized stock exchange) or non-equity mutual fund, the gain would be classified like that for other capital assets (given below). In this case, the short term capital gain is taxed at 15% of the gain. A short term capital loss can be set-off against short term capital gain, as long as both the sales occur in the same financial year. (Click here for set-off details)

In case of all other capital assets if the capital asset is held for less than 36 months before selling, the gain arising from it is classified as STCG. This short term capital gain is clubbed with your income for the year and is taxed at the rate applicable to you.

Long Term Capital Gain (LTCG)

If shares or mutual funds are held for more than 12 months before selling, the gain arising is classified as Long Term Capital Gain. In the case of long term capital gain arising out of the sale of shares or mutual funds, there is no income tax if STT has been paid. The long term capital gain in this case is tax free.

In case where STT has not been paid the capital gain tax is 10% if the cost of acquisition is not indexed, and it is 20% if the cost of acquisition is indexed. For all other assets, if the capital asset is held for more than 36 months before selling, the gain arising from the sale is classified as Long Term Capital Gain.

The long term capital gain is taxed at 20%. In other words, 20% of the long term capital gain has to be paid as income tax.

Income under the Income tax Act

In my earlier article I had mentioned that filing returns is easy. I had also mentioned that we need to identify all our sources of Income. What are the sources of Income that are taxable under the Income Tax Act? Income Tax Act defines the term Income as an inclusive definition i.e. it includes almost everything. Also it is not necessary that it has to be in cash. It can be in kind or notional as well. If excluded it would be specifically given. As per the Act the term Income includes:

a. Profits and gains of Business or Profession: This includes income from carrying on a business or income earned by doing any profession.

b. Dividend:

c. Profit in lieu of Salary (perquisite): This includes any amount received by an employee from his employer other then the salary amount.

d. Allowances granted to an employee to meet expenses incurred for performance of his duties: This includes allowances such as HRA, Medical allowance, etc given by the employer.

e. Any capital gains: This means any profit on sale of asset.

f. Winning from lotteries, crossword puzzles, races, card game, T.V. Game shows, etc.

Gifts are not treated as income (click here for details).

An interesting part of all this is income includes loss as well, as per the Income Tax Act loss is nothing but negative income.

Now that we have some idea on what can be income let us see the Heads of Income under which our income would be taxed.

Heads of Income

As per the Income Tax any income earned is broadly categorized into five heads of income. The five heads of income are:

1. Income under Head Salaries: This head taxes the income earned by an individual as salary from any firm or organization.

2. Income from House Property: This head taxes rental income received by any person from way of renting of any immoveable property. In case you have 2 houses and have not been given on rent, then one would be treated as rented (you can decide which one) at notional rent.

3. Profits and Gains of Business or Profession: This head of income broadly covers income earned by a person as a result of some business or professional set-up by him. As the head defines Profits and Gains not gross but net and if the net is a loss i.e. negative income would be taken.

4. Capital Gains: This head of income taxes the income earned on sale of any investment in form of gold, precious ornaments, shares, etc or immoveable property. Here you have to segregate between short term and long term.

5. Income from other Sources: This head of income covers any income which is not chargeable to tax under any of the above heads of income. Any income including gambling or profit/loss on running of race horses, camels, interest income , etc are chargeable to tax under this head of income.

Filing of income tax returns is easy

We have been talking a lot of financial planning and tax planning. We did all that, now it’s time to file your returns. When it comes to filing income tax returns we are a bit skeptical. Why? We are scared to get caught on the wrong foot. But if we know that we have not done anything wrong then filing of income tax returns is easy.

Let’s go through what we would need to file our returns.

Identify your income sources
This is the starting point. Identify the various sources from where you got your income during the last year. As far as salary is concerned you do not have to worry, your employer would give you your form 16, which would give all the details. What about those who are self employed or have additional income by doing part time business? Make a sum of gross income and make a sum of all expenses which went into making the income. Now the difference would be the Net Income. Now go through your passbook and ensure that all deposits are accounted for, if there is income other that business or salary then make a list of the same, e.g. Rent, sale of shares or mutual funds, Interest, Dividends, etc. These would need to go into heads of Income from house property, Capital gains or other income.  (Refer to topics under taxation for details.)

Identify deductions
Sum all deductions available under the different sections of 80. If you have salary income and you have submitted the details to your employer, he would have shown it in form 16. Under each head of income there are deductions available, refer to http://en.wikipedia.org/wiki/Income_tax_in_India for details.

Finding out the tax payable
The final taxable income and tax rate differs depending on your category i.e. are you a woman, senior citizen or other individuals

For individual tax payers, no tax for income below Rs 1,60,000
Women tax payers have no tax for income below Rs 1,90,000
Senior citizens do not have to pay tax if their income is below Rs 2,40,000

The income tax slabs for assessment year 2009-10 as per the Finance Ministry website:

Income tax slab (in Rs.)	Tax
Income tax slabs for Individuals
0 to 1,60,000	No Tax
1,60,001 to 3,00,000	10%
3,00,001 to 5,00,000	20%
Above 5,00,000	30%
Income tax slabs for Women
0 to 1,90,000	No Tax
1,90,001 to 3,00,000	10%
3,00,001 to 5,00,000	20%
Above 5,00,000	30%
Income tax slabs for Senior Citizens
0 to 2,40,000	No Tax
2,40,001 to 3,00,000	10%
3,00,001 to 5,00,000	20%
Above 5,00,000	30%

Calculating tax payable
Reduce the total deductions from the gross total income under each head of income to arrive at the actual amount on which the tax is to be paid. Calculate the tax payable based on the slab rates in which you fall. If you have any tax deducted at source (TDS) this should be deducted from your total tax liability.

Filling the correct ITR form
This depends on your source of income. ITR-1 is the form to be filled in by individuals having income from salary or pension and income in the form of interest.

ITR-2 is the form should be filled in by persons who in addition to the above list of income from capital gains, house property and income from other sources.

All self-employed individuals making income from business or profession should fill in the ITR-4 form.

Filing tax return
This can be done offline and online. The income tax department has good excel worksheets which help in creating XML files which can be used for doing online filing(http://www.incometaxindia.gov.in/). Online payment of taxes can be done through e-filing website, and through internet banking.

If you are still not confident contact your chartered accountant.

Plan for a New Financial Year

We are at the start of a new financial year. This is the best time to plan for the year. Most of the companies give increments from April. So this also helps in planning. So what should we do? As a starter write down what you would to do or achieve during the year. Once you have written down what you want to do, write down when you want to do it, i.e. in which month.

This is important, since if you are not aware of what you want to do or achieve and when you want it, there would be nothing to plan. Now that you have that written what and when, we can start planning how to reach there. So to reach there what we need would be money, right and if the expenditure is going to be big, I am sure you would have been planning for some time now.

To achieve that you would have made some investments. So now have a relook at your investments. If you have some time to reach the goal for which the investment has been made and the investment is not giving the returns you had expected, get out of it. This is a good time, the market has picked up, and so you could minimize the losses.

Now that you have done it, next allocate funds on a monthly basis to each of you needs. This process is called Asset Allocation. I am sure in the list you would have also listed liabilities that you would like to get out of. If you have surplus funds after doing your allocation, utilize the funds to get of high interest rate liabilities.

In fact if your new or fresh investments would yield less than what you would pay to service a liability, it’s better to use the funds to retire the liability then making the investment.  The faster you retire such liabilities, the faster you could build your assets to achieve your goals.

When you planned did you consider Tax? If not, add it to your plan. What I meant is investment to reduce tax liabilities. Don’t wait till March to do your Tax investments, the earlier you do it, the lesser the pressure on you. At the start when I increments, along with that some companies also disburse bonus’s.

Bonus is given for the efforts you had put in during the previous year, and you would definitely want to enjoy. Don’t plan to spend all of it, keep some aside for the future. How much is up to you.