A capital gain is a profit that results from investments into a capital asset, such as stocks, bonds or real estate, which exceeds the purchase price. It is the difference between a higher selling price and a lower purchase price, resulting in a financial gain for the investor.  It may also refer to “investment income” that arises in relation to real assets, such as property; financial assets, such as shares/stocks or bonds; and intangible assets such as goodwill.

Capital gain is regarded as one of the major source of income for income tax purpose. Profit or gain arising from the transfer of a capital asset made in a previous year is taxable as capital gain under the head “Capital Gains”. The important ingredients for capital gains are, therefore, existence of a capital asset, transfer of such capital asset and profits or gains that arise from such transfer.

As per the Income Tax Act, 1961 capital gain can be either short term or long term capital gain. The incidence of tax on Capital Gains depends upon length for which the capital asset transferred was held. Ordinarily a capital asset held for 36 months or less is called as ‘short-term capital asset’ and if the period exceeds 36 months, the asset is known as ‘long term capital asset’. However, shares of a Company, the of Unit Trust of India or any specified Mutual Fund or security listed in any recognised Stock Exchange are to be considered as short term capital assets if held for 12 months or less and long term capital assets if held for more than 12 months.

Transfer of a short term capital asset gives rise to “Short Term Capital Gains’ (STCG) and transfer of a long capital asset gives rise to ‘Long Term Capital Gains’ (LTCG). Identifying gains as STCG and LTCG is a very important step in computing the income under the head Capital Gains as method of computation of gains and tax is different for STCG and LTCG.

Taxability of Short term and Long term capital gain

Capital Gain on Shares / Stocks / Equities and Equity Mutual Funds (MFs) – Short Term Capital Gain on sale of shares or equity mutual funds (MFs) through a recognised stock exchange and subject to securities transaction tax (STT) will be taxed @ 15%. And if the sale of shares is not made on a stock exchange it is part of gross total income and normal tax rate is applicable.

Long Term Capital Gain on sale of shares or equity MFs is tax free, and therefore not chargeable to tax.

Short term Capital Gain on sale of all other Capital Assets

Short term capital gain in this case is clubbed with the annual income of the assessee, and is taxed at a rate depending on the tax slab relevant for the assessee.

Short Term Capital Gains is computed as below:

Long term Capital Gain on sale of all other Capital Assets

Long term capital gain in this case is taxed @ 20%.

Long Term Capital Gains is computed as below:

Indexed Cost of Acquisition – Cost of acquisition of an asset is the value for which it was acquired. Expenses of capital nature for completing or acquiring the title are included in the cost of acquisition.

Indexed Cost of Acquisition = Actual Purchase Price * (Cost Inflation Index during the year of sale / Cost Inflation Index during the year of purchase)

Indexed Cost of Improvement – Cost of improvement is the capital expenditure incurred for making any addition or improvement in the capital asset.

Indexed Cost of Improvement = Actual Cost of Improvement * (Cost Inflation Index during the year of sale / Cost Inflation Index during the year of purchase)

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