A Capital Asset is described as any movable or immovable asset which adds to the net worth of the individual owning the same. It is also characterized by appreciation in the value of the asset, which is essentially capital gains. A real estate asset or property falls under the same classification of a capital asset. Even though its value increases due to the market inflationary forces, the capital gains arises only when it is sold or transferred to someone else. The time period for which the seller of the property in question holds the same before selling it, determines whether the sale will be classified as a long term or short term and similarly the capital appreciation on the same is long term capital gains or short term capital gains. Any property that is sold or transferred within one year of its purchase is termed as short term capital gains and any sale beyond the period of one year is long term capital gains.
Indian Taxation treats the LTCG and short term capital gains (STCG) differently with different rates of taxation. While STCG is taxed at individual’s total income tax slab with no indexation benefit, LTCG is taxed at a flat rate of 20% with indexation benefit.
Indexation is a linking adjustment made to the value of the property based on a predetermined index. The income tax authorities publish the index value for every financial year, through government notification. This method takes care of the rising cost of living of different years and maintains the price effect after inflation. This system was introduced in1980, which is taken as the base year with an index value of 100.
Let us examine the concept of indexation.
A property which was purchased in the financial year 1990-91, has been sold. The cost of the property in that year was 300000 INDIAN RUPEES. In the year 2016-17, the same property is sold for 8 million INDIAN RUPEES. The indexed cost of this property would be INDIAN RUPEES (1125 / 182 X 300000 = 1.85 million INDIAN RUPEES). So the LTCG on this property will be INDIAN RUPEES 6.15 million.
It has to be noted that if indexation was not available then the LTCG would have been INDIAN RUPEES 7.70 million, where as with indexation the same is 6.15 million INDIAN RUPEES. This takes care of the inflationary cost of living as well as the burden of tax is lower, since 20% on 6.15 million INDIAN RUPEES is quite lower than the same on an unindexed 7.70 million INDIAN RUPEES.
The next question in our minds comes as to how can we save the tax and avail the exemptions available in the income tax laws of India. The tax savings are as much applicable to a resident Indian as they are available to Non Resident Indians. Under the income tax law sections 54 , 54 F & 54 EC provide for exemptions where LTCG if invested as below need not be paid, and is a direct tax saving.
Section 54 – This section states that any long term capital gains arising out of the sale of a house property of a non resident, either self occupied or not, will be exempt from capital gains to the extent of investment of the said capital gains in a house property either 1 year before or 2 years after the sale of such house property, or utilized in the construction of a house property within 3 years from the date of transfer or sale of the house property. Plus , the new house property which is acquired is not sold or transferred with in a period of 3 years from the date of purchase or acquisition and if this new house property is sold within the period of 3 years as above, then the cost of acquisition will be reduced by the amount of capital gains earlier enjoyed. This will be for the purpose of calculating the capital gains. This new house sale would be treated as short term capital gains.
Section 54 F – This section states that if there is any sale of long term capital asset (asset acquired more than 3 years and other than a house property) , the long term capital gains on such sale shall be exempt , if the capital gains are employed in purchase of a house property before 1 year or after 2 years from such sale of the capital asset. Or the non resident constructs a house with the same proceeds within three years after such sale or transfer.
Section 54 EC – This section states that non residents can get their capital gains exempted if they invests the same or to such extent in certain bonds issued by the Govt. of India. These bonds are issued by the National Highways Authority of India or Rural Electrification Corporation. These bonds have a lock-in period of 3 years. If this exemption has been availed, no other exemption or deductions would be allowed for the same investments . These investments have to be made within a period of 6 months from the date of sale or transfer, plus the investment has to be made before the return filing date. Since the financial year 2014-2015, the government capped the same to an amount of 5 million Indian Rupees in one financial year.
The non resident can invest in advance and show the relevant documents to the buyer, so that they do not deduct the TDS from the sale proceeds. The non resident can also claim refund according to the income tax laws of India.