Increasing Tax Savings: Methods for Capital Gains Tax Elimination

The capital gains tax may have a big effect on your income statements. You can reduce or even completely eliminate this tax liability, though, with the aid of a number of provisions and strategies. Using the Indian Income Tax Act as well as other international practices, this article examines various ways to achieve zero capital gains tax.

Here are some ways in which you can do so with the help of some provisions:

WHAT IS CAPITAL GAINS TAX?

In India, the government levies a tax known as capital gain tax on the proceeds from the sale of specific assets, including stocks, bonds, real estate, and other investments. This tax is levied against both individuals and companies. A capital gain occurs when the asset is sold for more than it was originally purchased for. In contrast, you incur a capital loss when you sell an asset for less than what you originally paid for it. Usually, capital gains tax is only levied on the gains themselves, not the entire amount received from the sale.

WHAT IS LONG TERM CAPITAL GAINS?

When you sell an investment or other asset that you have held for a specific amount of time, any profit you make is regarded as a Long-Term Capital Gain (usually over a year). Depending on the asset's nature, different holding periods are needed to classify it as a long-term capital asset. If held for more than a year, listed equity shares and equity-oriented mutual funds are eligible, but holdings of more than 24 months are needed for unlisted equity shares and immovable properties like houses, buildings, and land. If held for more than 36 months, debt-oriented mutual funds and other assets are typically classified as long-term. Depending on the type of asset, different tax rates apply to long term capital gains.

You may be liable for taxes if you sell a property and realise sizable long-term capital gains (LTCG). Nonetheless, Sections 54 and 54F as well as the Capital Gains Account Scheme (CGAS) of the Indian Income Tax Act provide ways to lessen or postpone this tax burden. These significant exemptions are your avenue to pursue if you're wondering how to avoid paying capital gains tax.

1.   SECTION 54 OF INCOME TAX ACT:

Section 54 of the Income Tax Act of India addresses Long-Term Capital Gains (LTCG) arising from the sale of a residential property, providing for LTCG tax exemption if the proceeds are reinvested in another residential property. To be eligible for this benefit, the reinvestment must take place within one year before or two years after the sale. Furthermore, the new property must be located in the country. The maximum exemption allowed under Section 54 is equal to the Long-Term Capital Gains incurred, providing a regulatory framework to encourage the timely and domestic reinvestment of proceeds from the sale of residential property.

Eligibility Criteria: To qualify for this exemption, the new property must be purchased within two years or constructed within three years of the sale of the original property. Additionally, the exemption is capped at ₹10 crores.

Benefits: This strategy is particularly useful for individuals looking to upgrade their living situation or invest in real estate, allowing them to defer or eliminate their capital gains tax liability while securing a new home.

EXCEPTION UNDER SECTION 54F

Section 54F of India's Income Tax Act Mirrors Section 54 by exempting Long-Term Capital Gains (LTCG). Unlike Section 54, Section 54F extends its applicability beyond gains derived from property sales to include any LTCG.

To take advantage of this exemption, the taxpayer must reinvest the proceeds in a residential property under the same terms as outlined in Section 54. These conditions include a reinvestment timeline that requires the taxpayer to invest either one year before the sale or two years after the sale. Essentially, Section 54F expands the scope of tax relief, encouraging the reinvestment of LTCG from various sources into residential properties.

The Capital Gains Account Scheme (CGAS):

The Income Tax Act allows for the deferral of Long-Term Capital Gains (LTCG) tax liability by parking the gains in Capital Gains Accounts Scheme (CGAS)-approved bonds within six months of selling the asset.

To qualify for this deferral, a minimum investment of ₹25 lakhs is required, with a three-year lock-in period. It is important to remember that any interest earned on these bonds is taxable as income. The primary advantage of this scheme is its ability to defer the LTCG tax liability until the maturity of the bonds or until the gains are reinvested in a specified asset in accordance with the CGAS rules.

2. Investment in Specified Bonds (Section 54EC)

Another viable method under Indian tax laws is to invest the capital gains in specific bonds within six months of the sale.

Section 54EC of the Income Tax Act of 1961 provides a valuable option for exempting long-term capital gains (LTCG) earned from the sale of any asset other than a residential property. To qualify for this exemption, invest the entire sale proceeds in specific notified government bonds within six months of the asset sale.

CONDITIONS AND EXCEPTION:

Eligible assets include gold, jewellery, shares, debentures, and immovable property other than residential houses that have been held for more than 24 months.

Investment period: All sale proceeds must be invested in specified bonds within six months of the asset sale.

Lock-in period: The bonds must be held until they mature, which is typically five years. Early redemption incurs a penalty and eliminates the tax exemption. Tax exemption limit: There is no limit to the amount of LTCG that can be exempt under this section.

• Eligible Bonds: Currently, the following bonds issued by the National Highways Authority of India (NHAI) and Rural Electrification Corporation Limited (RECL) are eligible for Section 54EC exemption: NHAI Series 11 Tax-Free 5-year NHAI Bonds NHAI Series 12 Tax-Free 5-year NHAI Bonds RECL Tax-Free 5-year Bonds

3.Saving Tax on LTCG from Equity Investments with Section 112A

Section 112A of the Income Tax Act of 1961 governs the taxation of long-term capital gains (LTCG) arising from the sale of listed equity shares and equity-oriented mutual fund units. While exemptions can result in significant tax savings, understanding the conditions and calculations is critical.

EXCEMPTIONS UNDER SECTION 112A:

1.    The first ₹1 lakh of LTCG in a financial year is tax-free. This promotes long-term equity investments

2.    If you reinvest the entire LTCG amount within six months in specified bonds such as Capital Gains Bonds (CGBs), National Highways Infrastructure Development Corporation Ltd. (NHIDCL) bonds, and so on, the LTCG tax liability is zero.

3.    If you use LTCG to buy a new residential property within one year or two years of selling the equity asset, you can claim an exemption. Alternatively, use the gains to build a new home within three years. The exemption is limited to the cost of the new property.

Conditions:   

·        The equity shares or mutual fund units must be held for more than one year to qualify for LTCG benefits.

·        The maximum investment allowed under Section 54EC is Rs. 50 lakhs in a single financial year.

Minimizing or eliminating capital gains tax requires strategic planning and a thorough understanding of tax laws and available exemptions.

By leveraging provisions such as Section 54, 54EC, and 54F of the Indian Income Tax Act, or utilizing global practices like retirement accounts, tax-loss harvesting, and Opportunity Zones, taxpayers can significantly reduce their tax burden and optimize their financial outcomes.