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Does all long-term capital gains tax come with indexation?

Indexation benefit is not applicable to all long-term capital gains and you must know the nuances in order to file your taxes accurately.

Capital gains arise when you sell an investment at a price higher than its original cost. While gains are the objective of investing, in certain types of investments the returns come only in the form of interest income or dividend income rather than capital gains. 

In some cases, the tax liability arising from capital gains is adjusted lower thanks to indexation. Indexation benefit is not applicable to all long-term capital gains and you must know the nuances in order to file your taxes accurately. 

Where is indexation applicable?

Indexation essentially enables you to measure the cost of your asset after adjusting the purchase value of the asset-based on official inflation estimate for the number of years you have held the asset. 

Indexation benefit is applicable only where the capital gains are long term in nature. What is long term? This is defined distinctly, depending on which asset is under consideration. Long term for exchange-listed equity assets including equity funds qualifies if you have remained invested for over 12 months. For listed debt securities like bonds, long term is a holding period beyond 12 months and for unlisted debt securities, including debt funds, long term is considered after you have been invested for at least 36 months.

In case of unlisted equity shares, the long term time frame is when you are invested for at least 24 months. For property or real estate assets too, long-term is assessed as a holding period of at least 24 months. Other than for listed equity, the benefit of indexation is applicable to all long-term capital gains. 

The idea behind indexation is to make a fair assessment of gains on the real value of the property or financial asset rather than taxing gains based on the nominal face value. 

How does it benefit you?

Indexing your cost of purchase helps in rationalising the tax liability on a long-term asset to the extent that inflation has reduced the value of the asset. 

Let’s say you bought a debt mutual fund in August 2016 and are selling it now. The value of your original investment may have been Rs 10,000 which has grown to Rs 13,600 at an average annualised return of 8%.

The Government notifies the official annual cost of inflation index for the purpose of calculating indexation benefit. 

In the latest series, the base year is considered as 2001-02 and the value of the index in that year is assumed to be 100. Each subsequent year sees the index value increase as much as the annual inflation. Hence, in 2002-03 the value moved to 105 and then 109 and so on. In 2016, the cost of inflation index was 254 and the current index is at 301. 

Hence your indexed cost of purchase is 10,000 * 301/254, which comes to Rs 11850. This shows the cost price of the asset as it would be today after taking into account the impact of inflation. On this indexed cost of purchase, you calculate gains by reducing it from the sale price of Rs 13,600. The capital gains tax on this gain is calculated at 20%.  In this case, tax amounts to Rs 350.

The idea behind indexation is to make a fair assessment of gains on the real value of the property or financial asset rather than taxing gains based on the nominal face value. 

Keep in mind that these capital gain taxes will have to be assessed by you and included in your annual tax return. If you estimate that the capital gains tax arising on your account can be more than Rs 10,000 in any transaction then you will have to pay advance tax in the preceding quarterly advance tax payment schedule. To arrive at a tax of Rs 10,000 or more, your capital gain would be at least Rs 50,000 or more. 

Don’t forget to index your cost of purchase for a long-term capital asset, other than for long term listed equity shares and mutual funds. For the above, the rate of capital gain tax is lower at 10% without the benefit of indexation. 

 

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