In a two part series, our columnist discusses the various tax-saving devices on capital gains
It hurts to pay tax on capital gains. A large part of these gains are a result of the endemic inflation that has taken place during the last 20 years.
In terms of real money value, the actual gains are negative. Yet, tax is levied on these gains. To counter this we should take a close look at the various tax-saving devices that are available.
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A short-term capital asset is a financial asset held for 36 months or less immediately preceding the date of transfer. Certain financial instruments like equity shares, UTI/MF units, become long-term assets if they are held for 12 months.
The cost of acquiring bonus shares is to be taken as nil whereas that of rights and renunciation of the entitlement to apply for rights is to be taken at the cost to the investor.
Long-term gains will be computed by deducting from the full value of the consideration i) any expenditure incurred in connection with the transfer ii) indexed cost of acquisition and iii) indexed cost of improvement.
The option of substituting the fair market value (FMV) in place of original cost is open to the assessee. In other words, for assets acquired prior to 1.4.81, if the actual cost of acquisition is lower than FMV as on 1.4.81, the assessee may adopt the FMV to be his cost of acquisition.
On the other hand, if the actual cost of acquisition is greater than the FMV as on 1.4.81, the assessee may adopt such cost. The cost inflation index based on 1981-82 only will be taken into account, whatever be the choice of the assessee.
Note that an assessee has the right to take the FMV as on 1.4.81 even for bonus shares allotted to him prior to that date. The same is true for other assets, normally required to be taken at nil value.
Flat Rate of Tax Sec. 112
Long-term capital gains are taken as a separate block and charged to tax at a flat rate of 10 per cent before allowing indexation or at the rate of 20 per cent with indexation, whichever is less, irrespective of the size of the gains.
Note that the quantum of the capital gains is always to be computed with indexation. If the assessee decides to pay tax at the rate of 10 per cent without indexation, the quantum does not change.
The assessee will not get any deduction under section 80L, 80D etc., or the rebate under section 88. However, a tax rebate under section 88B for senior citizens and the under section 88C for non-senior citizen ladies,is certainly applicable.
Sec. 54F gives exemption from tax on long-term capital gains arising out of sale (or transfer) of a financial asset other than a residential house, provided the assessee has purchased within a year before or 2 years after the date of sale or has constructed within 3 years after that date.
At the time of the sale, the assessee should not be an owner of more than one residential house. The exemption is 100 per cent where the cost of the new house is less than or equal to the net sale proceeds of the financial asset.
If only a part of the sale proceeds is used, the exemption would be pro-rata. The excess will be chargeable to tax.
Sec. 54 also grants a similar exemption on long-term gains arising out of the sale of a residential house but requires re-investment of only the amount of capital gains and not the entire sale proceeds.
It is important to note how the set off of losses works. There is no distinction between short-term and long-term losses. These can be set off only against short-term and long-term gains and not against income under any other head.
The balance, if any, has to be carried forward to the next year for set off against only short-term or long-term gains, if any. No loss can be carried forward for more than eight years immediately succeeding the year for which the loss was first incurred.
Strategy
Let us now examine how these provisions can be used in various situations. To begin with, we shall take the case of Dastur who has a carried forward loss of Rs 20 lakh to his credit.
He has earned during the current financial year 01-02 long-term gains of Rs 50 lakh and long-term/short-term losses of Rs 22 lakh Table-1 is prepared in chronological order in which the shares were sold. The loss thus gets settled in chronological order.
Now, refer to Table-2 which takes into account the fact that on a few of these items it is advantageous to pay tax at the rate of 20 per cent than at the rate of 10 per cent. These items should be settled against the losses first.
To enable this, a column is prepared indicating the difference between the tax 20 per cent and 10 per cent and all the items are sorted on this column. The set-off then is carried out in the order of the items. To arrive at the set-off of Rs 22 lakh, one of the items is split up into two.
It is found that by doing this Dastur will save tax of Rs 32,131( Rs 3,36,721 minus Rs 3,04,594). Next time we will examine the best method offered by exemption under section 54F.
(The author may be contacted at anshanbhag@yahoo.com)