What Is Section 45 Of Income Tax: Assessment, Calculation And How Capital Gains Are Taxed
Any gains or profits that you earn from the sale or transfer of any capital assets is referred to as capital gains. According to Section 45 of the Income Tax Act, assessees are liable to pay capital gains tax on such profits. The IT Department will deem these profits as income in the year in which the sale or transfer of capital assets took place.
This article is a complete guide to Section 45 of the Income Tax Act – how capital gains from transfer or sale of capital assets are taxed, types of transfer, how to calculate the holding period and various sub-sections of Section 45. Read on!
What are Capital Assets?
Section 2(14) of the Income Tax Act defines capital assets for the purpose of taxation. Here are some capital assets:
- Any property owned by the taxpayer (This property may be for business or personal uses)
- Securities held by Foreign Institutional Investors; however, FIIs must hold these securities according to provisions of SEBI Act 1992.
However, capital assets exclude the following:
- Raw materials or stock in trade you hold for business purposes.
- Movable property owned by the taxpayer or their family members and used for personal reasons. However, jewellery, precious stones, gold, silver or platinum ornaments, any archaeological collections, paintings, and sculptures will come under capital assets even if they are used for personal purposes.
- Some specific Gold Bonds.
- Deposit certificates under Gold Monetisation Scheme 2015.
- Agricultural land situated in rural areas of India.
What are Short Term and Long Term Capital Assets?
Capital assets not held for more than 36 months by the owner comes under short term capital assets. However, some assets may also qualify as short term if their holding period is 12 months. These include:
- Equity oriented mutual funds units
- Equity/preference shares listed in India
- Units of UTI
- Zero-interest bonds
All unlisted shares held by individuals and immovable property will come under short term capital assets if their holding period is not over 24 months.
Long term capital assets are those having a holding period of more than 12, 24, or 36 months immediately preceding the transfer date. The holding period varies for different asset classes.
Short Term Capital Gains Taxation
According to Section 45 of the Income Tax Act India short term capital gains will be taxed as below:
- When a taxpayer does not pay STT on any securities transactions, he/she adds total gains from that transaction to their taxable income, and taxation occurs as per respective slabs.
- When STT is applicable on any transaction, then the rate of taxation is 15% plus any cess and surcharges as applicable.
Long Term Capital Gains Taxation
Section 45 under Income Tax Act provides for the taxation of long term capital assets. Accordingly, taxation occurs as per the following:
- Sale of all assets except the sale of shares and equity-based mutual funds is taxable at the rate of 20%.
- Sale or transfer of shares and equity-oriented mutual funds is subject to taxation at the rate of 10% + applicable cesses and surcharges. However, this is only applicable when the transaction value is more than Rs. 1,00,000.
Also Read: Differences Between Taxes On Long-Term and Short-Term Capital Gains
How Can Taxpayers Calculate Period of Holding?
Here are ways of calculating the holding period of various capital assets:
- When an individual is holding shares of any company under liquidation, then the time after the liquidation date is not taken while calculating the holding period.
- Time period for which the asset was with its previous owner is also taken into account while determining the holding period.
- If a taxpayer holds shares of a merged company in lieu of shares in a merging company, then time period is applicable from the date of acquiring shares in the merging company.
- In the case of financial assets that one has acquired without making any payment, the holding period is applicable from the date of allotment of such assets.
- In case capital assets are shared in any Indian company which becomes one’s asset due to demerger, the holding period will be valid from the date when he/she acquires asset in such company.
- Assets like equity shares or clearing rights of any stock exchange which an individual has acquired as a part of corporatisation of stock exchange in India, then-
The holding period of such assets will include the time for which the individual was a member of that stock exchange immediately before corporatisation.
Also Read: Capital Gains Calculator: Process, Uses And Taxation Rates
Types of Transfer with Respect to Capital Assets
On doing an analysis of section 45 of the Income Tax Act, one comes across the following types of transfer of capital assets:
- Any sale or exchange of the capital asset
- Annulment of the rights therein
- Compulsory acquisition as per any law
- Owners of capital assets may change them to inventories for business purposes. This also comes under a transfer
- When a zero-coupon bond matures
- Some specific transactions involving a transfer of immovable properties. This includes a power of attorney transactions as well
Scope and the Chargeability Year of Various Subsections
- Section 45(1A) of Income Tax Act: Amount received from insurance entities
Whenever an assessee receives a payment or some asset from any insurance firm, then gains or profits from such receipts also come under the head of capital gains. Tax authorities will deem them as income in the year in which it was received.
- Section 45(2) of Income Tax Act: Conversion of capital assets into stock in trade
Gain from such conversion will attract taxation as it will be treated as income in the preceding year in which such transfer or sale of assets took place.
- Section 45(2A) of Income Tax Act: Transfer of interest in securities
When an individual had a beneficial interest in securities during the previous year, then profits from the transfer of such beneficial interest by the Depository shall be taxable as income of the owner in the year in which the transfer took place.
- Section 45(3) of Income Tax Act: Capital assets taken as capital contributions
Whenever an entity transfers capital assets to AOP or a firm, in that case, gains arising from such transfers are chargeable to income tax of the preceding year in which such transfers happened.
- Section 45(4) of Income Tax Act: Distribution of assets in case of liquidation of the firm
All transfers of assets in case of liquidation of the entity also come under the purview of capital gains taxation. Gains from such transfers are taxable to the income of the company in the previous year in which such transfers took place.
- Section 45(5) of Income Tax Act: Compulsory Acquisition
IT Department levies capital gains tax In case of compensation for compulsory acquisition by state or Central Governments. Profits from these are taxable to the income of the beneficiary in the year of receiving the compensation.
Final Word
Gains from transfers of capital assets attract capital gains tax under Section 45 of the Income Tax Act. Individuals must look for deductions allowed in Section 54 and its subsections to reduce their tax liability.
FAQs on Section 45 Of Income Tax
Ans: The formula for the computation of short term capital gains tax is given below:
STCG = Full value consideration – (cost of transfer + cost of improvement + cost of acquisition)
Ans: The formula for computing LTCG is:
Long term capital gains tax = Full consideration value received – (cost of transfer + indexed cost of improvement + indexed acquisition cost)
Ans: Section 54 of the Income Tax Act allows certain Long Term Capital Gains exemptions. Gains arising from the sale of residential property are available as exemptions given the fulfilment of certain conditions.
Ans: Profits arising from industrial buildings and property acquired by Government under specific laws are also eligible for exemptions. However, taxpayers must have used the property for at least 2 years immediately before such acquisition. Moreover, taxpayers must reinvest the proceeds to acquire another immovable property.
Ans: This section is applicable for individuals selling or transferring a part of a capital asset from a large block of assets on which they availed depreciation. In such a case, any gain from this sale or transfer comes under head capital gains. Individuals can compute capital gains when either a part of the asset is sold or the entire block is transferred.
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This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
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