Long term capital gains tax in India

Capital gains, as the word suggests, is some kind of monetary gain and most probably from some Capital goods. That is what it would mean, in very simple and layman terms.

However we will clear the cloud from such a vague meaning, and provide you with a complete understanding of what Long Term Capital Gains Tax (LTCG is the short form, as well as the Indian Income Tax Department’s terminology) means, as per the Income Tax Department of India.

In practice Long Term Capital Gains is applied for Sale of two types of Capital Assets. One is House, and the other is shares / mutual funds. Any monetary gain thus accrued as a result of sale of either type of Capital Asset attracts Capital Gains Tax. In this there are two variations. One is Short Term Capital Gains Tax, and the other one is what this article is all about, which is LTCG or Long Term Capital Gains Tax.

If you sell an asset such as bonds, shares, mutual fund units, property etc, you must pay tax on the profit earned from it. This profit is called Capital Gains. The tax paid on this amount of capital gains is called capital Gains tax. Conversely, if you make a loss on sale of assets, you incur a capital loss.

Long Term Capital Gains – If you sell the asset after 36 months from the date of purchase (After 12 months for shares and mutual funds)

How does the Indian Income Tax Laws Treat LTCG

Income Tax laws have a provision of reducing the effective tax burden on long-term capital gains that you earn. This provision allows you to increase the purchase price of the asset that you have sold. This helps to reduce the net taxable profit allowing you to pay lower capital gains tax. The idea behind this is Adjustments against the inflation – since we know inflation reduces asset value over a period of time. This benefit provided by Income Tax laws is called ‘Indexation’.

What is Indexation

Under Indexation you are allowed by Income Tax Laws to inflate the cost of your asset by a government notified inflation factor. This factor is called the ‘Cost Inflation Index’, from which the word ‘Indexation’ has been derived. This inflation index is used to compute the cost price of your Asset adjusted against the cumulative inflation on year-on-year basis. This helps to counter the erosion of value in the price of an asset and brings the value of an asset at par with prevailing market price. The government every year notifies this cost inflation index factor. This index is in the form of a numerical value and is announced every year due to inflation. The base year for Cost Inflation Index has been determined by Indian Income Tax Department as 1981 and had assigned 100 points for this year. We will see in the later part of this article how this numerical value gets factored in the Long Term Capital Gains Tax Calculations.

The cost inflation index (CII) is calculated as shown

CII = Inflation Index numerical value for year in which asset is sold DIVIDED BY Inflation Index numerical value for year in which asset was bought MULTIPLIED by the cost of the asset. This index is then multiplied by the cost of the asset to arrive at inflated cost.

Let us try to understand this with a simple example.

  • An asset was purchased in FY 1996-97 for Rs. 2.50 lacs
  • This asset was sold in FY 2004-05 for Rs. 4.50 lacs
  • Cost Inflation Index in 1996-97 was 305 and in 2004-05 it was 480
  • So, indexed cost of acquisition would be:

Rs. 2,50,000 * (480/305) = Rs. 3,93,443

Long Term Capital Gains would be calculated as => Capital Gains = Selling Price of an asset – Indexed Cost i.e. Rs. 450000 – Rs. 393443 = Rs. 56557. Therefore tax payable will be 20% of Rs. 56557 which comes to Rs. 11311.

Had it not been for indexation The Capital Gains tax would have been = Selling Price of an asset – Cost of acquisition i.e. Rs. 450000 – Rs. 250000 = Capital Gains is Rs. 200,000. Therefore tax payable @ 10% of Rs. 200000 would have come to Rs. 20,000.

So you save Rs. 8,689-00 in taxes by using the benefit of indexation.

For the benefit of our readers we are providing you with a Ready Reckoner Chart of CII Values starting from the base year which is 1981. The same is provided underneath.

COST INFLATION INDEX FROM 1981 TO 2009
Financial Year Cost Inflation Index Financial Year Cost Inflation Index
1981-1982 100 1995-1996 281
1982-1983 109 1996-1997 305
1983-1984 116 1997-1998 331
1984-1985 125 1998-1999 351
1985-1986 133 1999-2000 389
1986-1987 140 2000-2001 406
1987-1988 150 2001-2002 426
1988-1989 161 2002-2003 447
1989-1990 172 2003-2004 463
1990-1991 182 2004-2005 480
1991-1992 199 2005-2006 497
1992-1993 223 2006-2007 519
1993-1994 244 2007-2008 551
1994-1995 259 2008-2009 582
    2009-2010 632
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