Taxation of Capital Gains in India – FAQs

1. Concept of Capital Asset and Capital Gain

In Indian tax law, capital gain is the profit or loss that arises when a person transfers a capital asset for a consideration that differs from its cost of acquisition and improvement, after allowing for permissible deductions and adjustments. The charge is generally triggered when there is a transfer of a capital asset – such as a sale, exchange, relinquishment of rights, extinguishment of rights or certain conversions.

A capital asset is broadly any property held by a person, whether or not connected with business or profession. It includes land, buildings, shares, mutual fund units, bonds, debentures and many other forms of property. Certain items are specifically excluded, such as stock-in-trade (taxed as business income), some personal effects like wearing apparel and furniture, specified rural agricultural land and a few other categories.

The essence of capital gains taxation is that it seeks to tax the accretion in value when a capital asset is disposed of. This is different from business income (which arises from trading activity) and from salary or house property income. Treating capital gains as a separate head allows the law to apply special periods, rates and exemptions tailored to investment behaviour rather than day-to-day business or employment.

2. Short-Term vs Long-Term Capital Assets

2.1 Period of Holding and Classification

The tax treatment of capital gains depends crucially on whether the asset is short-term or long-term. The classification is based on the period of holding the asset before transfer. Different assets have different thresholds, but broadly:

• Certain listed equity shares and equity-oriented mutual fund units become long-term if held for more than a specified period (often 12 months).
• Most other capital assets – such as land, building, unlisted shares, debt mutual funds, jewellery and similar – become long-term if held beyond a longer threshold (commonly 24 or 36 months, depending on category and prevailing rules).

If the holding period does not exceed the specified threshold, the asset is a short-term capital asset and the resulting gain or loss is short-term. If the period exceeds the threshold, the gain or loss is long-term.

2.2 Importance of Classification

Classification matters because the law applies:

• Different tax rates to short-term and long-term gains.
• Indexation benefits primarily to certain categories of long-term gains on non-equity assets.
• Different set-off and carry-forward rules for short-term vs long-term capital losses.

Careful tracking of acquisition dates, corporate actions (splits, bonuses, rights) and exact holding period is therefore essential to avoid misclassification and incorrect tax computation.

3. Computation of Capital Gains – General Framework

3.1 Basic Formula

In simplified form, the capital gain for a particular transfer is:

The result is a capital gain (if positive) or capital loss (if negative). For certain assets, the law allows the cost and improvements to be indexed by a cost inflation index, usually only where the asset is long-term and eligible for indexation.

3.2 Special Rules for Certain Assets

Some asset categories have special computation rules, for example:

• For certain listed shares and units, long-term gains may involve grandfathering rules for periods before a cut-off date.
• For self-generated assets like goodwill or tenancy rights, special rules determine how cost of acquisition is computed, sometimes treating cost as nil unless otherwise provided.
• Where assets are acquired by inheritance, gift or certain tax-neutral transfers (such as amalgamation or demerger subject to conditions), the previous owner’s cost and period of holding may be allowed to be adopted.

3.3 Full Value of Consideration and Deeming Provisions

While capital gains usually use the actual sale price as consideration, the law often employs deeming provisions to substitute a fair value in certain cases, such as:

• Where immovable property is sold for less than stamp-duty valuation, a higher deemed sale value may be substituted.
• In some transfers of unlisted shares of closely-held companies, fair value rules can influence or substitute the stated consideration.

These provisions are anti-avoidance measures aimed at preventing artificial undervaluation.

4. Taxation of Short-Term Capital Gains

4.1 Short-Term Gains on Non-Equity Assets

For most capital assets other than specified equity instruments, short-term capital gains are simply added to total income and taxed at the normal slab rates applicable to the taxpayer. The rate thus depends on whether the taxpayer is an individual, HUF, firm, company or other entity and on the applicable slab or corporate rate.

Examples include sale of property, unlisted shares, debt mutual funds, gold or jewellery within the short-term holding period.

4.2 Special Rate for Certain Short-Term Equity Gains

A subset of short-term equity gains – typically on listed equity shares, equity-oriented mutual funds or specified units traded on recognised stock exchanges where securities transaction tax (STT) is paid – may be taxed at a special concessional rate distinct from the normal slab rates.

The intent is to recognise the role of capital markets, while still taxing short-term speculative or trading-type gains at a differentiated rate structure.

5. Taxation of Long-Term Capital Gains

5.1 Long-Term Gains on Equity and Equity-Oriented Units

Long-term capital gains on specified equity assets – such as listed equity shares, equity-oriented mutual funds and certain units of business trusts – are given a special regime. Subject to specified conditions, these gains may enjoy a combination of:

• A basic exemption threshold up to which gains are not taxed.
• A concessional flat rate on gains above that threshold.
• No indexation benefit on cost for such equity-type long-term gains.

In addition, grandfathering provisions for appreciation up to a certain historical date have been used to protect past gains from retroactive taxation when the regime changed.

5.2 Long-Term Gains on Non-Equity Assets

For long-term gains on non-equity assets – such as land, building, unlisted shares, jewellery and many other properties – the law traditionally allows the benefit of indexation. Under indexation, cost of acquisition and improvement is adjusted using a cost inflation index so that only real gains are taxed.

These long-term gains are usually taxed at a flat rate on the indexed gain, plus applicable surcharge and cess. This recognises that long-term holding often involves erosion of purchasing power due to inflation.

6. Exemptions and Roll-Over Relief on Capital Gains

6.1 Residential House Exemptions

Significant reliefs are available when capital gains from a residential house or other eligible long-term capital asset are reinvested in another specified residential property within prescribed time limits. Subject to conditions regarding:

• The nature of original and new assets.
• The amount of capital gain vs the amount invested.
• Time limits for purchase or construction.
• Restrictions on number of houses and overall caps.

The capital gain can be wholly or partly exempted. If the new property is sold within a short lock-in period, earlier exempted gains may be brought back to tax.

6.2 Exemption via Bonds and Specified Investments

Capital gains from certain long-term assets can also be sheltered by investing the gains in specified bonds within a stipulated period. These bonds typically finance infrastructure or development projects and come with a lock-in period and an overall cap on investment for exemption.

This mechanism aligns individual tax planning with the financing of long-term national projects, though it requires locking up liquidity for a fixed period.

6.3 Agricultural Land and Other Special Exemptions

Certain transfers of rural agricultural land are completely outside capital gains tax because such land is not considered a capital asset. Even for some urban agricultural land or compulsory acquisitions, specific relief provisions exist. Additional exemptions apply to charitable trusts, certain non-profit entities and some corporate reorganisations when they meet strict neutrality conditions.

7. Set-Off and Carry Forward of Capital Losses

7.1 Intra-Head Set-Off

Capital losses are ring-fenced within the capital gains head. In general:

• Short-term capital loss (STCL) can be set off against both STCG and LTCG.
• Long-term capital loss (LTCL) can be set off only against LTCG.

Within the same year, gains and losses must be netted off on this basis before arriving at net capital gains to be included in total income.

7.2 Carry Forward of Capital Losses

If, after set-off, capital losses remain unabsorbed, they may be carried forward for a specified number of assessment years, subject to conditions such as timely filing of the return. In later years:

• Brought-forward STCL can again be set off against any capital gains.
• Brought-forward LTCL can only be set off against LTCG.

Capital losses cannot be set off against salary, business income, house property or income from other sources in any year.

8. Special Topics – Bonus, Rights, Inherited Assets and Corporate Actions

8.1 Bonus and Rights Issues

Corporate actions like bonus and rights issues affect capital gains computation:

• Bonus shares are typically treated as acquired on the date of allotment, often with a specific rule on cost (such as nil or apportioned cost).
• Rights shares have a subscription price and date; renunciation of rights can generate capital gains for the renouncer.

Investors must track acquisition dates, subscription amounts and any renunciation proceeds to compute gains correctly when these securities are later sold.

8.2 Inherited and Gifted Assets

When assets are acquired by inheritance or gift, the current holder generally adopts the cost and period of holding of the previous owner. So, capital gains computation often looks back to the original acquisition date and cost in the hands of the previous owner.

Documents such as original purchase deeds, gift deeds, wills and court orders become essential evidence for establishing cost and holding period.

8.3 Demergers, Slump Sales and Business Transfers

Complex corporate transactions like demergers, slump sales and business transfers have specific capital gains rules. A tax-neutral demerger may allow shareholders to receive new shares without immediate tax, while slump sales treat an undertaking as a single capital asset with special rules for cost and gain computation.

Such transactions require detailed structuring to satisfy conditions for any available exemptions or neutrality.

9. Compliance and Practical Issues in Capital Gains Reporting

9.1 Documentation and Record-Keeping

Capital gains reporting depends heavily on robust documentation. Taxpayers should maintain:

• Purchase and sale contracts, contract notes and demat statements.
• Property purchase and sale deeds, stamp-duty and registration records.
• Proof of improvement costs, brokerage, legal fees and transfer expenses.
• Evidence of reinvestments in residential property or specified bonds if exemptions are claimed.

Without adequate records, computing accurate gains and defending positions during scrutiny becomes difficult.

9.2 Reporting in Income-Tax Returns

Capital gains must be correctly reported in the appropriate schedules of the income-tax return:

• Short-term vs long-term.
• Equity vs non-equity and specific categories.
• Gains eligible for special rates, indexation, exemptions or grandfathering.
• Correct mapping of set-off and carry forward of losses.

Authorities increasingly cross-check these disclosures with third-party information such as depository data, property registration systems and consolidated statements.

9.3 Advance Tax, TDS and Interest

Significant capital gains may trigger advance tax obligations. Failure to pay sufficient advance tax can lead to interest for shortfall. In some cases (for example certain property sales or non-resident transfers), buyers must deduct tax at source on consideration and deposit it, providing TDS certificates to sellers.

Ignoring the advance tax and TDS aspects of capital gains can result in unexpected interest costs even when gains are eventually declared.

10. FAQs on Taxation of Capital Gains in India

FAQ 1: Is every profit from sale of shares a capital gain?

Not always. If shares are held as investments, profits on sale are generally treated as capital gains. If the activity resembles trading – frequent short-term transactions as a business – profits may be treated as business income. Intention, holding period, volume, frequency and accounting treatment all influence classification. Taxpayers should adopt a consistent approach and document their policy.

FAQ 2: Can I choose whether an asset is stock or capital asset?

There is some flexibility, but the choice must be genuine and consistent. For example, a builder may hold some flats as stock-in-trade and others as long-term investments. A securities dealer may maintain separate trading and investment portfolios. Merely re-labelling assets for tax advantage without substance can be challenged.

FAQ 3: Are all long-term gains taxed at lower rates than short-term gains?

Generally, long-term gains enjoy preferential treatment via concessional rates and, for many non-equity assets, indexation. However, the effective comparison depends on the taxpayer’s slab rate, surcharges and specific long-term rate for the asset. In some cases, the advantage may be reduced by high income levels and surcharges, even though the structural preference for long-term holdings remains.

FAQ 4: If I reinvest sale proceeds into another property, do I always get full exemption?

No. Exemption for reinvestment depends on multiple conditions: the type of original asset, the type and timing of the new property, the amount of capital gain vs the amount invested, caps on the exemption and limits on number of properties. Only if the specific conditions of the relevant exemption provision are satisfied will the gain be fully or partially exempt; the balance remains taxable.

FAQ 5: How are capital gains on my self-occupied house computed?

A self-occupied house is still a capital asset. On sale, capital gains are computed using sale consideration (or deemed value where applicable) minus indexed or non-indexed cost of acquisition, improvement and transfer expenses, depending on whether the asset is long-term and the rules in force. You may be eligible for reinvestment-based exemptions or bond-based relief subject to conditions.

FAQ 6: I have both short-term and long-term capital losses. How should I use them?

First set off STCL against any capital gains (short or long term). Then set off LTCL only against LTCG. If losses still remain after these adjustments, they may be carried forward within the permitted period if return filing conditions are met. Planning the timing of disposals near year-end can help optimise loss utilisation.

FAQ 7: Do non-residents pay capital gains tax in India?

Non-residents are generally taxable in India on capital gains from assets situated in India, such as Indian shares and property, subject to applicable tax treaties. Some treaties may provide relief or allocate taxing rights differently. For certain transactions, the buyer must deduct tax at source on payments to non-resident sellers. Special computation rules may apply for foreign-currency assets held by non-residents.

FAQ 8: Is indexation always beneficial and always available?

Indexation tends to be beneficial when inflation has been significant and the holding period is long, because it increases the cost base. But indexation is not available for all long-term assets – equity-type assets often do not get indexation. Where inflation is low or the period is short, the benefit may be modest.

FAQ 9: How does capital gains tax interact with wealth and succession planning?

Capital gains tax is central to succession and estate planning. While gifts and inheritance may not themselves trigger capital gains, subsequent sale by heirs will. Decisions such as gifting assets during lifetime vs bequeathing them, holding assets personally vs via HUFs, trusts or companies, and restructuring holdings before a sale all carry capital gains implications. Good planning balances family needs, commercial realities and tax efficiency.

11. Conclusion

Taxation of capital gains in India is a detailed and evolving area at the intersection of investment behaviour, fiscal policy and fairness. By distinguishing between short-term and long-term holdings, equity and non-equity assets, and by offering reinvestment-based reliefs, the law attempts to tax real economic gains while encouraging productive capital formation.

For taxpayers, the key is to understand classification rules, maintain strong documentation, compute gains carefully, use exemptions and losses prudently, and comply fully with reporting requirements. Where transactions are complex or amounts large, professional advice is essential. Done right, capital gains planning allows long-term investing with clear, lawful tax outcomes; done casually, it can lead to unexpected tax, interest, penalties and disputes.