Capital gains in India are governed by a well-defined legal framework under the Income Tax Act, 1961. The essence of capital gains taxation lies in taxing the profit or gain that arises when a person transfers a capital asset. According to section 45(1), any profits or gains arising from the transfer of a capital asset effected in the previous year are chargeable to income tax under the head ‘Capital Gains’ in the previous year in which the transfer took place, unless specifically exempt under sections 54, 54B, 54D, 54EC, 54F, 54G, 54GA, and 54H. This provision ensures that the income arising from capital assets is taxed in the year of realization and not merely on accrual.
Defining Capital Assets under the Income Tax Act
As per section 2(14), a capital asset refers to any property of any kind held by a person, whether or not connected with his business or profession. This definition also includes securities held by a Foreign Institutional Investor by SEBI regulations, and any Unit Linked Insurance Policy issued on or after 1 February 2021, where exemption under section 10(10D) is not applicable.
However, certain assets are specifically excluded from the scope of capital assets. These include stock-in-trade (except securities held by FIIs), consumable stores, and raw materials held for business or professional purposes. Movable personal effects such as clothes and furniture held for personal use are also excluded, except jewellery, drawings, paintings, archaeological collections, sculptures, and other works of art, which are treated as capital assets.
Agricultural land in India is generally excluded from being considered a capital asset if it is located in a rural area, defined based on the population and proximity to a municipality or cantonment board. In addition, specific government-issued instruments such as the Special Bearer Bond, 1991, and gold deposit bonds under the 1999 or 2015 schemes are not considered capital assets.
To counter the impact of a landmark Supreme Court judgment, an explanation was added to section 2(14) in the Finance Act, 2012. This clarification stated that the term ‘property’ includes any rights in or related to an Indian company, including management or control rights. This retrospective amendment effectively broadened the scope of what constitutes a capital asset.
Distinction Between Stock-in-Trade and Capital Assets
Determining whether an asset qualifies as a capital asset or stock-in-trade is crucial, as it affects the nature of income and the applicable tax provisions. This classification does not depend on the nature of the asset itself but on the intent and manner in which the asset is held. For instance, a real estate developer holding land or buildings for sale would treat them as stock-in-trade, whereas an investor holding the same property to earn rental income would consider them capital assets.
The classification is often fact-specific and guided by various judicial precedents and regulatory guidelines. The key considerations include the frequency of transactions, duration of holding, the scale of activity, and the treatment of the asset in the books of account. It is important to note that mere classification in financial records is not determinative; the overall facts and context take precedence.
In the context of securities and shares, the distinction between capital assets and trading assets has been the subject of extensive litigation. To reduce ambiguity, the Central Board of Direct Taxes issued a circular clarifying that listed shares held for more than 12 months can be treated as capital assets if the taxpayer consistently opts for such treatment in subsequent years. Conversely, if the taxpayer treats shares as stock-in-trade, the income will be classified as business income. These clarifications are aimed at minimizing disputes and bringing consistency to tax treatment.
Further, as per a CBDT instruction issued on 2 May 2016, unlisted shares will be treated as capital assets irrespective of the holding period. This removes uncertainty regarding the classification of such shares, particularly in the case of private companies and startups.
Treatment of Precious Metals and Jewellery
Precious metals, particularly in the form of jewelry, are treated distinctly under capital gains provisions. As per the explanation to section 2(14), jewellery includes ornaments made of gold, silver, platinum, or other precious metals or their alloys, with or without embedded precious or semi-precious stones. It also includes loose precious stones or those embedded in any other article, including clothing.
The law specifically excludes jewelry from the definition of personal effects, meaning that gains from the sale of jewelry are taxable as capital gains. For example, gold utensils, despite being used for ceremonial purposes, are not treated as personal effects and are thus considered capital assets. On the other hand, silver utensils used in traditional functions or family events may be exempt as personal effects, provided they are not in excessive quantities or held purely for investment.
Judicial pronouncements have provided clarity on the treatment of such items. In one case, silver utensils such as dinner plates, bowls, and jugs were held to be personal effects based on their use, even if not daily. In contrast, in another case involving a large collection of similar silver items, the court held that the items were not for personal use and thus subject to capital gains.
The core principle is that only those effects that have a close and intimate connection with the person of the assessee can be classified as personal effects. Articles used for religious or ornamental purposes that do not meet this standard will be treated as capital assets. For instance, loose diamonds or collectible coins are considered capital assets even if they are held for religious or decorative purposes.
Classification of Capital Assets Based on Holding Period
The Income Tax Act differentiates capital assets into short-term and long-term based on the duration for which the asset is held. As per sections 2(42A) and 2(29AA), the classification criteria differ depending on the type of asset and the date of transfer.
For securities listed on a recognized stock exchange in India, units of equity-oriented mutual funds, units of the Unit Trust of India, and zero-coupon bonds, an asset is considered short-term if held for twelve months or less. For land, buildings, and unlisted shares, the short-term threshold is twenty-four months. For all other capital assets, the general threshold was thirty-six months, but this has now been aligned to twenty-four months, effective from 23 July 2024.
Certain assets, such as specified mutual funds acquired after 1 April 2023 and market-linked debentures, are always treated as short-term, regardless of holding period. Similarly, unlisted bonds or debentures transferred or redeemed on or after 23 July 2024 are automatically treated as short-term capital assets. This classification ensures uniformity in tax treatment and simplifies compliance for taxpayers.
An important legal principle established by courts is that the period of holding is calculated by including both the acquisition date and the transfer date. This has been upheld in several judicial decisions, which emphasized that even if the asset is sold the very next day after the threshold period is completed, it qualifies as a long-term capital asset.
Classification of Capital Gains and Applicable Tax Rates
Capital gains under Indian tax laws are primarily classified into two categories: short-term capital gains (STCG) and long-term capital gains (LTCG). This classification depends on the nature of the capital asset and the period for which it is held before its transfer. The tax treatment varies for each type of gain, with distinct computational provisions, exemptions, and rates.
Taxation of Short-Term Capital Gains
Short-term capital gains are taxed differently based on whether the asset in question is covered under section 111A or not. Section 111A applies to the sale of equity shares listed on a recognized stock exchange in India, units of equity-oriented mutual funds, and units of a business trust, provided the transaction is subject to Securities Transaction Tax (STT).
For such assets, the short-term capital gain is taxed at a concessional rate of fifteen percent, irrespective of the income tax slab of the assessee. This preferential treatment aims to incentivize long-term investment in Indian capital markets while ensuring that gains from short-term trading are brought to tax.
If the short-term capital gains do not fall under section 111A—such as in the case of property, gold, or unlisted shares—the gains are taxed at the normal slab rates applicable to the taxpayer. These rates can go as high as thirty percent for individuals in the highest income bracket. However, no indexation benefit is allowed for short-term gains, and the gains are computed by simply deducting the cost of acquisition and transfer expenses from the sale proceeds.
Taxation of Long-Term Capital Gains
Long-term capital gains enjoy a more favorable tax treatment. For most assets, such as land, buildings, and unlisted shares, the gains are taxed at twenty percent after allowing the benefit of indexation. Indexation adjusts the cost of acquisition to account for inflation, thereby reducing the taxable gain and resulting in lower tax liability.
For listed equity shares, equity-oriented mutual funds, and units of business trusts, a separate provision under section 112A applies. As per this provision, gains exceeding one lakh rupees in a financial year are taxed at ten percent without indexation. This threshold ensures that small investors are not burdened with tax on modest returns. The cost of acquisition for such assets acquired before 1 February 2018 is determined using the fair market value as on 31 January 2018, ensuring that gains accrued before that date are grandfathered.
For debt mutual funds and other non-equity-oriented schemes purchased on or after 1 April 2023, all gains are treated as short-term and taxed at slab rates, irrespective of the holding period. This move was aimed at reducing arbitrage between different types of mutual funds and aligning tax treatment with the underlying nature of the investment.
Zero-coupon bonds and sovereign gold bonds, when held for more than twelve months, also qualify for long-term capital gains treatment and are taxed at ten percent without indexation. However, the benefit of reduced tax rates is not available for unlisted debentures, which are always considered short-term after 23 July 2024, irrespective of the holding period.
Special Provisions for Non-Resident Taxpayers
For non-resident investors, capital gains are subject to specific provisions under the Act. In the case of shares of an Indian company or securities listed on a recognized Indian stock exchange, gains are taxed at ten percent without indexation. If the securities are unlisted, or if the gains are from assets situated outside India, the tax treatment varies depending on the relevant double taxation avoidance agreement (DTAA).
Section 48 contains a special computation method for non-residents, wherein the capital gains from the sale of shares or debentures of an Indian company are calculated in the foreign currency in which the investment was made. The resultant gain is then converted into Indian currency. This provision aims to neutralize the impact of currency fluctuations on taxation and ensure equitable treatment for non-residents.
Rebate, Reliefs, and Set-Off Provisions
For resident individuals, short-term capital gains under section 111A can be offset against the basic exemption limit if the total income is below the threshold. However, long-term capital gains under section 112A are not eligible for such set-off beyond the initial exemption of one lakh rupees. Also, no deduction under Chapter VIA is allowed against capital gains.
Losses from capital assets are treated distinctly under the Income Tax Act. Short-term capital losses can be set off against both short-term and long-term capital gains. However, long-term capital losses can only be adjusted against long-term gains. Any unadjusted loss can be carried forward for up to eight assessment years, provided the return of income is filed within the due date.
It is important to note that capital losses arising from the transfer of an asset where gains are exempt from tax—such as agricultural land in rural areas or specified government bonds—cannot be claimed or carried forward.
Impact of Surcharge and Cess on Capital Gains
While computing the final tax liability, capital gains are subject to surcharge and health and education cess. The surcharge is levied based on the total income and may range from ten percent to twenty-five percent. However, in the case of capital gains taxed under sections 111A and 112A, the surcharge is capped at fifteen percent, even if the total income exceeds the highest slab.
This cap on surcharge for certain capital gains is a significant relief for high-net-worth individuals and foreign portfolio investors who would otherwise face very high marginal tax rates. In addition, a four percent health and education cess is levied on the total tax, including surcharge, in all cases.
Illustration of Capital Gains Tax Computation
To understand the computation of capital gains, consider a resident individual who sells equity shares listed on the stock exchange after holding them for eighteen months. The shares were purchased in January 2022 for two lakh rupees and sold in March 2025 for five lakh rupees. The cost of acquisition as of 31 January 2018 is irrelevant here, as the shares were bought after that date.
The total gain is three lakh rupees, of which one lakh rupees is exempt under section 112A. The remaining two lakh rupees are taxed at ten percent, resulting in a tax liability of twenty thousand rupees, plus surcharge and cess as applicable.
In contrast, if the same individual sells an apartment after holding it for three years, and the indexed cost of acquisition is fifty lakh rupees against a sale price of one crore rupees, the long-term capital gain would be fifty lakh rupees. Tax at twenty percent would amount to ten lakh rupees, plus surcharge and cess.
Capital Gains Exemptions: Reinvestment Options under Indian Tax Law
While capital gains are generally taxable, Indian tax legislation offers various exemptions to promote productive reinvestment of sale proceeds into specific asset classes. These provisions not only help reduce immediate tax outgo but also align with broader policy objectives such as boosting real estate, infrastructure development, and retirement savings.
Exemptions are available under specific sections—such as 54, 54F, and 54EC—and are applicable only under defined circumstances. Understanding these provisions is essential for taxpayers seeking to structure their transactions tax-efficiently.
Section 54: Exemption on Sale of Residential Property
Section 54 provides relief to individual and Hindu Undivided Family (HUF) taxpayers who sell a residential house (a long-term capital asset) and reinvest the capital gains into another residential house property. The exemption is available if the following conditions are satisfied:
- The asset sold must be a long-term residential house property.
- The new house must be purchased within one year before or two years after the sale, or constructed within three years.
- The exemption is limited to the amount of capital gains or the cost of the new property, whichever is lower.
From Assessment Year 2021–22 onwards, the exemption is available for investment in two residential houses, provided the capital gain does not exceed two crore rupees. However, this benefit can be availed only once in a lifetime by an assessee.
If the new property is sold within three years, the exemption claimed earlier is withdrawn, and the previously exempted gain becomes taxable in the year of sale.
Section 54F: Exemption for Sale of Non-Residential Assets
Section 54F offers an exemption when a taxpayer sells a long-term capital asset other than a residential house (such as land, shares, or gold) and uses the net sale consideration to purchase a residential house property.
The conditions are:
- The taxpayer should not own more than one residential house (other than the new one) on the date of the transfer.
- The full net consideration—not just the capital gain—must be invested to claim full exemption.
- A proportional exemption is allowed if only part of the sale proceeds is reinvested.
Similar to section 54, if the new house is sold within three years, the exemption is revoked.
Section 54EC: Bonds for Capital Gains Exemption
Section 54EC allows an exemption from long-term capital gains if the taxpayer invests the gains (not the full sale value) in specified bonds within six months of the sale. These bonds are issued by:
- National Highways Authority of India (NHAI)
- Rural Electrification Corporation (REC)
- Power Finance Corporation (PFC)
- Indian Railways Finance Corporation (IRFC)
The lock-in period for these bonds is five years, and the investment is capped at ₹50 lakh in a financial year. The bonds carry an interest rate of about 5–5.25% per annum, which is taxable.
This option is especially popular for taxpayers not seeking to reinvest in real estate but who want to avoid paying long-term capital gains tax.
Section 54B: Agricultural Land Reinvestment
If an individual or HUF sells agricultural land used for agricultural purposes and reinvests the capital gains in purchasing another agricultural land within two years, they can claim exemption under Section 54B. The new land must also be used for agriculture for at least two years after purchase.
This provision is specifically designed to support farmers and preserve agricultural landholding.
Section 54D, 54G, 54GA: Industrial and Urban Asset Reinvestment
These lesser-known provisions allow exemption from capital gains arising from the compulsory acquisition of land or buildings used for industrial purposes or business in urban areas:
- Section 54D: Industrial undertakings where land/buildings are compulsorily acquired.
- Section 54G: Shift of business from one urban area to another location.
- Section 54GA: Shift of industrial undertaking to Special Economic Zones (SEZs).
These are niche provisions but vital for business entities undergoing relocation or infrastructure disruptions.
Deposit Scheme: Capital Gains Account Scheme (CGAS)
If a taxpayer is unable to reinvest capital gains before the due date of filing the return, they can deposit the amount in a Capital Gains Account Scheme (CGAS) with an authorized bank to temporarily claim exemption under sections 54, 54F, or 54B.
The funds must be used within the prescribed time to purchase or construct the specified asset. If not, the unutilized amount becomes taxable in the year when the deadline expires.
CGAS thus offers flexibility in managing timelines and avoiding immediate tax liability, particularly in high-value transactions.
Withdrawal and Revocation of Exemptions
It is crucial to understand that these exemptions come with strict compliance requirements. Any violation, such as:
- Using the reinvested property for non-specified purposes
- Selling the reinvested asset prematurely
- Failing to use the CGAS funds within the stipulated timeframe
— will lead to revocation of the exemption, and the exempted gain will be added back to income in the year of default.
Real-Life Scenario: Using Section 54 to Save Tax
Imagine an individual sells a long-held residential flat in Mumbai for ₹2 crore, with a long-term capital gain of ₹80 lakh. They purchase another residential flat in Pune for ₹90 lakh within one year.
Under section 54, the individual can claim the entire capital gain of ₹80 lakh as exempt, as it is fully reinvested. Thus, no tax is payable on the capital gain.
Had the individual purchased only ₹40 lakh worth of property, the remaining ₹40 lakh of capital gain would be taxable at 20%, resulting in a tax liability of ₹8 lakh, plus surcharge and cess.
Such strategic reinvestments can result in considerable tax savings if planned correctly.
Planning Considerations and Taxpayer Vigilance
Exemption claims must be substantiated with proper documentation such as:
- Sale deed
- Purchase agreement
- Construction invoices
- Proof of CGAS deposit
Taxpayers are advised to keep detailed records to avoid scrutiny during assessment. It is also wise to consult a tax advisor to ensure that the timeline, amount, and nature of reinvestment conform to the applicable exemption section.
Common Compliance Requirements
Capital gains require precise reporting and documentation to avoid interest, penalties, or audit triggers. Key compliance requirements include:
1. Disclose All Capital Gains in ITR
All capital gains—long-term or short-term—must be reported under the relevant schedule in the Income Tax Return (ITR) form. The appropriate ITR depends on the type of income:
- ITR-2 for salaried individuals with capital gains
- ITR-3 if capital gains are part of business income
- ITR-5/6 for partnership firms and companies
2. Maintain Documentation
Taxpayers should maintain records like:
- Purchase and sale deeds
- Brokerage and transaction statements
- Fair market value reports (if acquired before 2001)
- Invoices and CGAS deposit receipts (for exemptions)
3. Advance Tax Payment
Capital gains are subject to advance tax liability. Taxpayers must estimate gains and pay quarterly advance tax to avoid interest under sections 234B and 234C.
Recent Changes and Legal Developments
Indian capital gains taxation has seen significant changes in recent years, aimed at tightening exemptions and redefining asset classifications.
1. Debt Mutual Fund Taxation (2023)
From April 1, 2023, capital gains from debt mutual funds (where equity exposure is <35%) are now taxed as short-term gains, regardless of holding period. Indexation benefits have been removed, and gains are taxed at the slab rate.
2. Grandfathering of LTCG (Equity)
LTCG on listed equity acquired before 31 Jan 2018 is grandfathered. The cost of acquisition is considered the higher of the actual purchase price or FMV as of 31 Jan 2018.
3. Section 54/54F Cap
From FY 2023–24, the maximum deduction under sections 54 and 54F has been capped at ₹10 crore. Any gains above that limit are now taxable even if reinvested.
4. Virtual Digital Assets (VDAs)
A separate regime has been introduced for crypto and NFTs:
- Gains are taxed at a flat 30% without any deduction (except cost).
- Losses cannot be offset or carried forward.
- TDS at 1% under section 194S for transactions >₹10,000.
This isolates VDAs from normal capital asset rules.
Court Rulings and CBDT Clarifications
1. Indexed Cost for Inherited Property
Courts have ruled that the indexed cost of acquisition applies from the year the previous owner acquired the asset, not from the year of inheritance. This benefits taxpayers by extending indexation benefits.
2. No Exemption Without Reinvestment
CBDT clarified that merely intending to purchase a new property under section 54/54F isn’t sufficient. Proof of actual reinvestment or deposit in CGAS before the due date is mandatory.
Common Pitfalls to Avoid
- Assuming all capital gains on equity are tax-free (LTCG above ₹1 lakh is taxable).
- Forgetting to report capital gains from gifts, ESOPs, or inheritance.
- Not using the Capital Gains Account Scheme (CGAS) when reinvestment is pending.
- Selling a new asset too soon after claiming exemption (3-year holding lock).
- Delayed advance tax on capital gains leading to penal interest.
Conclusion
Capital gains taxation in India is a nuanced space governed by evolving tax laws, asset reclassifications, and policy shifts. While the government continues to streamline and rationalize these provisions, taxpayers must proactively plan asset disposals, utilize exemptions wisely, and stay compliant with filing and payment timelines.
By integrating capital gains planning into overall financial strategy and seeking professional advice when needed, taxpayers can not only reduce tax burdens but also make sound reinvestment decisions that align with long-term goals.