Fundas: Long Term Capital Gains

The government had decided that it will reward you for making long term investments, so tax on long term gains is generally lower than the regular tax. Currently long term capital gains tax is 20% or 10% or even 0%, the difference between the three is explained below.

Capital gains is the PROFIT obtained when you buy today and sell a while later. Therefore LTCG is the difference between the selling price and the buying price. But you could have bought something for Rs. 10,000 in 1980 and sold today for rs. 100,000 - have you made a profit? Not really, because Rs. 10,000 in 1980 was a big amount of money! Inflation has reduced your profit, and in this case you may have actually made a loss!

So the tax department allows you to "index" your purchase according to inflation. They release a Cost Inflation Index (CII) table every year containing an "index" value for each year - 1980 being 100, 1981 being 109, 1990 being 182 and so on. (See: http://incometaxindia.gov.in/ItInformation/CostInflation.asp)

This means something bought in 1980 for Rs. 10,000 and sold in 1990 for Rs. 20,000 does not mean Rs. 10,000 profit! The CII for 1990 (year of sale) is 182, and CII for year of purchase is 1980. So real cost of purchase is Rs. 18200, arrived at like this:

Rs. 10,000 x (182 divided by 100)

The real profit therefore is Rs. 1,800, and tax = 20% of that, = Rs. 360.

This concept is called "Indexation" meaning you are accounting for inflation of your purchase value.

So if you index your purchase, government charges you 20% LTCG tax.

But what if you bought in 2003 and sold today? The CII for 2003 is 447 and this year is 519. So if you bought for Rs. 10,000 in 2003 and sold today for Rs. 20,000 what is your "indexed" purchase value?

Indexed purchase value = Rs. 10,000 x (519 / 447) = Rs. 11,610

So you have still made a profit of approximately Rs. 8,400 and 20% of that is payable as tax = Rs. 1,680. But there is an alternative:

The government allows you on extra benefit: If you don't want to index your purchase, you can pay only 10% of a non indexed purchase - in this case it means you will use a purchase price of Rs. 10,000 only. So your non indexed profit is Rs. 10,000 and therefore LTCG tax @ 10% is Rs. 1,000 - this is a lot lesser than the indexed gain!

Finally, if you invest in stocks or equity mutual funds, the government deducts a "securities transaction tax" (STT) from your transaction (about 0.25% of the entire transaction value). If you pay STT, LTCG tax is ZERO.

SO in short:

(Note: Why I say "where you pay STT" is - if you do not sell in an exchange or surrender stocks in a buy back offer or surrender stocks in an ADR offer like in Infosys recently , no STT will be paid, and therefore the 20% or 10% taxes will apply)

Also read: http://theinvestorblog.blogspot.com/2005/11/capital-gains-tax-primer.html

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This entry was posted on Wednesday, December 20th, 2006 at 4:52 AM and is filed under CapitalGains, IncomeTax. You can subscribe to any comments to this entry via RSS 2.0. You can leave a response, or trackback from your own site.