Long Term Capital Gain Tax on Shares

Capital gains refer to the profit earned from selling or transferring movable or immovable property, known as capital assets. These assets are classified into two categories based on how long they are held before sale — long-term capital assets and short-term capital assets.

The holding period required to determine whether an asset is long-term or short-term differs depending on the type of asset. In most cases, securities become long-term capital assets when they are held for more than 12 months. If they are sold within 12 months, they are treated as short-term capital assets. The tax treatment also differs for each category.

Long-Term Capital Gains are what an individual earns by selling shares or any other specified security after holding them for a period of 12 months. The profit which is earned from this sale, if exceeds a certain limit will be considered as LTCG. LTCG is different from STCG which is anything held below 12 months. It is important to create LTCG because the tax on these gains will usually be lower as compared with STCG, which would make it a more tax-efficient option for an organic creation of wealth over time.

For calculating the long-term capital gain tax on shares, one must subtract the cost of acquisition and any expense charges from the total sale value. What you get as a result is the capital gain which may be taxable under income tax laws. For Example: If a person bought shares of Rs. 1,00,000 and after two years sold them for Rs. 1,50,000 then the LTCG will be Rs. 50,000.

In India, the applicability of long-term capital gain tax on shares is provided for in Section 112A of the Income Tax Act. Under this provision, LTCG on the sale of equity shares and equity-oriented mutual funds are subject to a tax rate of 12.5% if the gain exceeds Rs. 1.25 lakh in a financial year. That rate ultimately applies, but no indexation is applied to the purchase price. The good news is that the first Rs. 1 lakh of LTCG in a financial year is tax exempt which is a massive comfort for small investors.

Over the years, there have been a series of changes concerning long-term capital gains on shares and tax provisions. Before Budget 2018, long-term capital gain (LTCG) on equity shares listed in stock exchanges and equity-oriented mutual funds were exempt from tax if Securities Transaction Tax (STT) was paid both at the time of purchase as well as sale. However, the long-term capital gain tax on shares was reintroduced in Budget 2018 at a rate of 10% for gains that exceeded Rs. 1 lakh without any indexation benefit. This amendment was intended to broaden the tax base and mitigate inequality between different types of income, while still providing an exemption threshold to protect smaller investors.

As per the Union Budget 2024, LTCG on the sale of equity shares and equity-oriented mutual funds are subject to a tax rate of 12.5% if the gain exceeds Rs. 1.25 lakh in a financial year.

Income tax on LTCG on shares is calculated at the rate of 12.5% if gains exceed Rs 1.25 lakh. The following is how tax is calculated on that:

This table allows us to understand what are the tax liabilities that arise out of the calculation of long-term capital gain on shares.

Section 54F

• An individual or a Hindu Undivided Family (HUF) can claim exemption from long-term capital gains (LTCG) tax on the sale of any long-term capital asset other than a residential property.
• To claim this exemption, the taxpayer must invest the sale proceeds in purchasing a residential house property. For example, shares can be sold and the amount received can be used to buy a house.
• The new residential property must be purchased within three years from the date of selling the shares.
• If the amount invested in the new house is equal to or greater than the capital gain, the entire LTCG becomes tax exempt.
• If the investment in the new house is lower than the net sale consideration, the exemption is calculated proportionately using the formula:

LTCG × (Amount Invested / Net Consideration)

Grandfathering was introduced when the government reintroduced long-term capital gains tax in 2018. Grandfathering is in place to prevent the tax from being applied retroactively on gains achieved before January 31, 2018. This means no new LTCG tax is applicable on the gains made in shares or equity-oriented mutual funds until this date.

This is a provision to protect investors who had already made profits ahead of the tax being imposed. Since these investors would otherwise have had to pay a tax on gains accrued before any such tax existed, grandfathering protects them from paying any untoward taxes. On the 31st January 2018, grandfathering froze the value of stocks or units till this date and allowed tax incidence for any gains beyond that to attract LTCG taxes.

When calculating Long Term Capital Gain on shares under the grandfathering provisions, if the fair market value (FMV) as of 31st January 2018 is higher than the purchase price but less than the sale value of the purchases before this date, the cost of acquisition of the shares is used. Here is the calculation process:

1. Determine the FMV: The highest of share price traded on 31 January 2018 is its fair market value (FMV). If there was no trading on that date, the most immediate previous day of trade is considered instead.
2. Compare FMV with the Purchase Price: If the FMV is higher than the actual purchase price, it will be used as the cost of acquisition to calculate LTCG. If the FMV is lower, tax will be calculated on the actual purchase price.
3. Calculate the Gain: The sale price of shares subtracted from the cost of acquisition (as calculated above) will result in the total gains received. If the gains are more than Rs. 1.25 lakh, it is subject to LTCG tax at 12.5%.

Let’s say shares were purchased at Rs. 100, FMV as of 31st January 2018 is Rs. 150 and then the shares were sold for Rs. 200 then the gain will be calculated using the cost of acquisition as Rs. 150.

The formula used to calculate long-term capital gains (LTCG) tax is:

LTCG = Sale Price of Shares – (Cost of Acquisition + Cost of Improvement + Transfer Expenses + Other Incidental Charges)

Where:

• Sale price of shares: The amount received from selling the shares
• Cost of acquisition: The original price paid to purchase the shares
• Cost of improvement: Expenses incurred on improving the shares or related assets, if applicable
• Transfer expenses: Costs involved in transferring the shares, such as brokerage charges
• Other incidental charges: Additional expenses related to the purchase or sale of shares, including legal or administrative fees

After calculating the LTCG amount, the applicable long-term capital gains tax is charged according to the prevailing tax laws of the respective country. The tax rate and exemptions may vary depending on the type of asset, holding period, and current government regulations.

There are several strategies by which investors can reduce capital gains tax liability. These include:

• Utilising exemptions: Making a point every financial year to make full use of the Rs 1.25 lakh exemption.
• Investing in specified assets: Specified bonds can be invested in, to claim an exemption on LTCG, under Section 54EC.

Tax loss harvesting

While this may sound counterintuitive or even risky, tax loss harvesting is a strategy in which investments that are performing poorly are sold at a loss to offset any capital gains earned on other assets. This will tend to reduce overall tax liability. When gains and losses are dealt with strategically, it will lower the amount of capital gains that are subject to tax, thereby creating a smaller tax liability. This tip is particularly handy at the end of a financial year as an investor can re-evaluate their portfolio and make decisions to optimise the resultant taxable amount.

Indexation

Indexation is a way to reduce the amount of capital gains subject to tax by adjusting the purchase price of an asset for inflation. Indexation, although, does not apply to LTCG on listed equity shares but it is valid for other long-term assets. Indexed cost of acquisition is calculated by using the formula:

Indexed Cost = Cost of Acquisition × Cost Inflation Index (CII) of the Year of Sale​/ CII of the Year of Purchase

It is vital to disclose LTCG accurately when filing for income tax returns (ITR). Here are some key points:

• Report all gains exceeding Rs 1.25 lakh.
• Use Schedule CG in the ITR form to disclose LTCG.
• Attach supporting documents such as transaction statements.
• Claim exemptions under Section 54F or 54EC if applicable.

To avoid any penalties, ensuring proper disclosure and compliance with tax laws is a must.

Investors who would like to minimise their tax liability need to realise the importance of knowing and computing long term capital gain tax on shares. Understanding how to use these exemptions, grandfathering provisions and strategies like tax loss harvesting can go a long way toward making sure you manage your tax bill.

Bajaj Finance is a platform that can provide keen insights and guidance to navigate the complexities of calculating capital gains on shares to maximise savings. In this regard, they offer smart tools and resources to monitor your tax savings. The platform provides a range of financial services and also helps you find your own income tax slabs.

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