As per the latest changes proposed in the Union Budget 2024, the short-term capital gains tax on certain “specified” financial assets will be 20%. This limit has been increased from the erstwhile 15%.
When it comes to investing in mutual funds and other financial instruments, it is essential to be aware of the tax implications, especially regarding capital gains. Capital gains are the profits earned from the sale or transfer of an asset, and they can be categorized as short-term or long-term based on the holding period of the asset.
In this article, we will delve into the world of Short-term Capital Gains Tax (STCG), exploring what it is, how it is calculated, and the exemptions available to investors. Whether you are a seasoned investor or a newcomer to the financial world, understanding STCG will help you make informed decisions, and optimise your tax planning strategy.
Union Budget 2024: Short-term capital gains on listed equities hiked from 15% to 20%
In the 2024 Union Budget, Finance Minister Nirmala Sitharaman announced changes to how capital gains will be taxed. Now, the tax rate for short-term capital gains (STCG) on certain assets has been increased to 20%, while other assets will retain their existing rates (15%). For long-term capital gains (LTCG), the tax rate has been raised from 10% to 12.5%.
Additionally, listed financial assets held for over a year will now be classified as long-term. Based on analysis, it is believed that these changes, related to a standardised holding period for domestic equities and mutual funds, will simplify the tax system. Also, they will benefit investors by creating more uniform tax treatment across different asset classes.
What is the current tax rule for STCG?
When you sell a capital asset, like shares or property, the profit or loss you make is categorised into short-term or long-term capital gains/ losses. This determination is based on how long you have held the asset. To qualify as a short-term asset/ long-term asset, different rules apply based on whether the asset is listed or unlisted:
In the case of listed assets: If you hold listed assets for more than one year, they are considered long-term. Whereas, if you sell the assets before a year, the gains are considered short-term.
In the case of unlisted assets: For unlisted financial and non-financial assets, you need to hold them for at least two years to be classified as long-term; else, they are considered short-term.
In the Budget 2024, the tax rate on short-term capital gains (STCG) on specific financial assets has been increased from 15% to 20%. Short-term gains on all the other financial as well as non-financial assets will continue to be taxed at the applicable tax rates.
When it comes to long-term capital gains, all types of assets, whether financial or non-financial, will now be set at 12.5% (up from the previous rate of 10%) for the financial year 2024-25. Additionally, the government has increased the annual exemption limit for long-term capital gains. Previously, individuals could exempt up to Rs. 1 lakh in gains from taxation, but this limit has been raised to Rs. 1.25 lakh. These changes aim to provide more benefits to middle and lower-income individuals by allowing them to keep more of their capital gains tax-free.
It is worth mentioning that no such exemption limit applies while computing short-term capital gains.
What is short-term capital gains (STCG)?
Short-term capital gains (STCG) refer to the profit earned from the sale of a capital asset held for a short period. In most countries, this period is typically less than one year. The gain is calculated as the difference between the selling price and the purchase price of the asset. STCG is usually taxed at a higher rate compared to long-term capital gains, reflecting its potential to contribute to rapid income generation. Common examples of assets subject to STCG include stocks, bonds, real estate, and other investments sold within the short-term holding period.
What are the gains in mutual funds?
Mutual funds yield returnsin two primary forms: capital gains and dividends. Capital gains represent the profit gained by an individual upon selling or transferring mutual fund assets, whereas dividends denote the income received when the underlying assets generate interest or earnings.
For tax purposes, capital gains from mutual funds are taxed at the investors' hands, while dividends on mutual funds are subject to the Dividend Distribution Tax (DDT), which is levied on fund companies on behalf of investors.
Capital gains from different types of mutual funds are categorised into long-term and short-term gainsbased on the duration of fund holding. Funds held for less than 12 months are subject to short-term capital gain tax.
Understanding the varioustypes of mutual funds and the capital gains they generate is crucial for comprehending the tax implications associated with mutual fund investments.
Short-term capital gains tax for FY 2024-25
Type of asset | STCG tax rate |
Listed equity shares | 20% |
Equity-oriented mutual fund units | 20% |
Unlisted equity shares (including foreign shares) | Income tax slab rate applicable to taxpayer income |
Immovable assets (i.e., house, land and building) | Income tax slab rate applicable to taxpayer income |
Movable assets (such as gold, silver, paintings etc.) | Income tax slab rate applicable to taxpayer income |
Current holding period rules for short-term capital gains (STCG)
Type of asset | Holding period for STCG |
Listed equity shares | 12 months or less |
Equity-oriented mutual fund units | 12 months or less |
Unlisted equity shares (including foreign shares) | 24 months or less |
Immovable assets (i.e., house, land and building) | 24 months or less |
Movable assets (such as gold, silver, paintings etc.) | 24 months or less |
This table provides an overview of the holding periods for different types of assets to be classified as short-term.
Tax on short-term capital gains
The tax rate on short-term capital gains depends on the type of asset and the individual'sincome tax slab.
Short-term capital gain tax on equity and non-equity assets
- Equity-oriented assets such as equity mutual funds are subject to STCG tax at a flat rate of 20% if held for less than 12 months. For example, if an investor sells equity shares after holding them for 9 months and earns a profit of Rs. 50,000, the STCG tax of 20% would apply to this gain.
- For non-equity assets like units of debt oriented mutual funds, bonds, and gold, the short-term capital gains tax is added to the individual's total income and taxed as per their applicable income tax slab.
Short-term capital gain tax on shares
Short-term capital gains from shares are profits from selling your holdings after holding them for a specified duration of either 12 months or 24 months. If you sell shares that are listed on a stock exchange within 12 months of buying them, any gains you make are classified as short-term capital gains.
However, for shares not traded on a stock exchange (unlisted), if you sell them within 24 months of purchase, the gains are considered short-term capital gains.
Short-term capital gain tax on property
- Calculation: Short-term capital gain on property = Final sale price - cost of acquisition - improvement cost of assets – Transfer expenses.
- For real estate properties, the short-term holding period is less than 24 months. If a property is sold within this period, any gains made from the sale would be classified as short-term capital gains. Hence, profit earned from selling such capital asset is categorized as an individual’s income and is liable to taxation according to Indian Income Tax Act, 1961.
- Certain exemptions are available on short-term capital gains from the sale of specific assets, like residential house properties under Section 54, which states, if the gains from the sale of a residential house property are reinvested in another residential house property within the specified time, the investor can claim exemption on the capital gains.
Short-term capital gain tax on hybrid funds
- Hybrid funds combine both debt and equity instruments, offering investors portfolio diversification. Tax rates for STCG on these funds vary based on holding periods and equity exposure. Funds with over 65% equity exposure are taxed like equity funds; otherwise, debt fund tax rules apply. It's essential for investors to know the equity exposure of chosenhybrid funds.
Short-term capital gain tax on SIP
SIPs allow investors to regularly invest in mutual funds.Redemption of SIP units follows the first-in-first-out principle. For instance, if you redeem units after 13 months, units bought in the first month incur long-term capital gains, while those bought later incur STCG taxed at 20%, regardless of income tax slab. Additionally, equity mutual fund transactions incur Securities Transaction Tax (STT) at 0.001%.
How to calculate short-term capital gains?
To determine your short-term capital gain, you must calculate the difference between the sale price and the purchase price of your asset after factoring in any additional costs or expenses related to the transaction. To accurately determine your STCG, refer to the following format:
Particulars | Amount | Amount |
Full value of consideration | XXX | |
Less: Expenses incurred wholly and exclusively for such transfer | (XXX) | |
Net sale consideration | XXX | |
Less: Cost of acquisition | (XXX) | |
Less: Cost of improvement | (XXX) | |
Short-term capital gains (STCG) | XXX | |
Less: Exemptions available under section 54B/ 54D | (XXX) | |
Short-term capital gains chargeable to tax | XXX |
Exemption on short-term capital gains
As per the Income Tax Act and the latest changes proposed in Union Budget 2024, you can claim several exemptions available under Section 54B and Section 54D to reduce your tax liability arising from short-term capital gains (STCG). However, this benefit is available upon satisfying some specific conditions. Let’s understand this in detail:
- Section 54B: This section allows you to avoid paying tax on short-term capital gains if you sell agricultural land used for farming and then reinvest the proceeds into another agricultural property.
- Section 54D: This section offers a similar benefit for gains from selling industrial land or buildings. If you reinvest the proceeds in another industrial property, you can also reduce your tax liability.
It must be noted that the primary aim of these exemptions is to promote reinvestment in certain types of properties. Hence, the government lessens the tax burden on gains arising from their sale.
Example of Short-Term Capital Gain Tax (STCG) on Mutual Funds
Calculating short-term capital gain for a share is straightforward. Just subtract the original cost of the share from its final selling price. For example, consider the purchase of 100 shares of ABC Ltd. at Rs. 100 each, sold at Rs. 120 each after six months:
Sale Price =Rs. 120 x 100 shares = Rs. 12,000
Purchase Price = Rs. 100 x 100 shares = Rs. 10,000
Short-Term Capital Gain = Rs. 12,000 - Rs. 10,000 = Rs. 2,000
Tips for reducing taxes on short term capital gains
While minimising taxes is attractive, it shouldn't be your primary driver for choosing mutual funds. A strong investment strategy aligns with your financial goals andrisk tolerance. However, you can incorporate tax-efficiency strategies to enhance your overall returns:
- Harness the power of long-term investing:Holding mutual fund units for a longer period (typically over one year) helps you benefit from lower tax rates. Long-term capital gains (LTCGs) on equity funds attract a more favourable tax treatment compared to short-term capital gains (STCGs).
- Explore tax-saving investment options: Consider allocating a portion of your portfolio to Equity-Linked Saving Schemes. These mutual funds offer a tax deduction on your investment amount underSection 80C of the Income Tax Act.This can significantly reduce your taxable income and offer some tax savings benefits.
By combining a long-term investment approach with tax-efficient options likeELSS funds, you can achieve your financial goals while minimising your tax burden. Remember, consult a financial advisor to ensure these strategies align with your specific investment needs andrisk profile.
Why is understanding STCG important?
The concept of short-term capital gains (STCGs) plays a crucial role in understanding your potential returns and tax implications when investing in mutual funds. Both factors are essential for making informed investment decisions.
STCGs and investment horizon:
- Targeting short-term gains: If your investment horizon is short-term (less than a year), you might prioritise mutual funds with the potential for higher STCGs. This approach can be suitable for meeting short-term financial goals.
- Long-term considerations: For long-term investment goals, tax efficiency becomes more critical. STCGs are generally taxed at a higher rate compared to long-term capital gains (LTCGs). Therefore, if the potential tax difference on a Rs. 5,000 STCG outweighs the immediate gain (e.g., facing a Rs. 6,000 higher tax bill), holding the investment for the long term to qualify for LTCG benefits might be a wiser strategy. This allows you to potentially keep more of your returns.
Conclusion
In conclusion, short-term capital gains tax (STCG) is an important aspect of taxation that investors must consider while making financial decisions. Understanding the holding period of assets and the applicable tax rates can help investors optimise their tax liabilities and plan their investments more efficiently.
Additionally, exploring the exemptions available on short-term capital gains can further enhance the tax efficiency of your investment portfolio. As with any tax-related matters, it is advisable to seek professional advice and stay updated with the latest tax regulations to make the most of your investments and achieve your financial goals effectively.
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