Last Updated on October 8, 2023 at 1:44 pm
Under certain circumstances, long-term or short-term capital gains tax to be paid can be significantly reduced. It is not routinely possible and therefore important to recognize this possibility if and when it arises. This post stems from a discussion at Facebook Group Asan Ideas for Wealth, started by Subrat Dash, with the circumstances explained by Ashal Jauhari and contributions by Harrsh Ankola.
For the purposes of this post, 80C shall refer to the sum of all deductions (eg. 80D, 80G …_) possible under Chapter VI-A. So please treat 80C here as a nickname and not in the literal sense. Section 80C is far more recognizable than Chapter VI A!
For all the calculations we will consider a resident taxpayer, less than 60 years old.
Let us go through a series of Examples. Please note these examples are not everyday examples but can occur in certain instances. For example, a single earner making 1.5L a year can never invest 1.5L in an 80C instrument. But a second earner can if the primary earner handles all expenses.
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All these examples are from numbers entered in ITR2. NOTE: Enter the basic information like age, nationality etc before using the form else it will not calculate.
Example 1: Total Income from Salary = 4 Lakh.
80C deduction = 1.5L
What is the taxable income? 4L – 1.5L = 2.5L.
What is the tax to be paid? Zero.
Example 2: Total Income from Salary = 1 Lakh.
What is the taxable income? Zero
Now suppose, 80C investment = 1.5L (the effective deduction allowed = 1L)
What is the taxable income? Zero again.
Now, to arrive at this, would you
(a) Say 1 Lakh < 2.5 Lakh, so no taxable income
OR
(b) 1 Lakh (salary)- 1 Lakh (80C) = 0. So no taxable income?
If you wish to complete reading the entire post (explained below), (a) vs (b) will come in handy. For now, leave it be.
Example 3: Total Income from Salary = 1 Lakh.
No 80C investments.
Taxable income = zero.
Suppose, there was a taxable long-term capital gain (say from the sale of a house or debt fund etc.) or a short-term capital gain (all such gains are taxable) of say 3 Lakh, what is the taxable income.
Yes, yes it will not happen every financial year, but it can and as explained below I think it is the duty of the income tax department to account for it in a consistent manner.
When there are no 80C investments, there is no problem.
The income from salary = 1 lakh.
The tax-free income limit = 2.5 Lakh. Room in the tax-free bracket = 1.5L
Reported taxable capital gain = 3 Lakh.
The law permits you (and does this automatically in ITR forms) to take an amount equal to the room in the tax-free bracket from the capital gains and add it to the income.
So in this case the total income = 1L + 1.5L(from capital gains ) = 2.5L (there is no tax on this income)
The taxable capital gain is reduced to 1.5L. That is a significant reduction!!
Credit to Mr. Sundaram Anathkrishnan for educating on this a couple of years ago. He went to great trouble in digging out official example illustrating this. You can test this out in ITR2.
Example 4: Total Income from Salary = 1 Lakh.
Total 80C investments = 1 Lakh.
Taxable Capital Gain = 3 Lakh.
What is the taxable income and taxable capital gain?
This is what the IT department is doing:
First it computes net income as = 1L(salary) – 1L(80C) = 0
So the room in the tax-free bracket is the full 2.5L
So it says, taxable capital gain = 3L – 2.5L = 0.5L
Taxable income = Zero.
Let us do one more with arbitrary nos
Example 5: Total Income from Salary = 2,00,123
Total 80C investments = 99,877.
Reoprted Taxable Capital Gain = 2,51,239.
What is the taxable income and taxable capital gain?
The taxable income is already zero.
But the IT dept first calculates 2,00,123 – 99,877 = 1,00,246
Then it says, then tax free income limit = 2.5L So there is a room of
2,50,000 – 1,00,246 = 1,49,754.
It then deducts this “room” from the reported capital gain of 2,51,239.
2,51,239 – 1,49,754 = 1,01,485
So it say 1,01,485 (rounded to 1,01,490) is the taxable capital gain!
That is a reduction of nearly 60% in the taxable capital gain
Timeout: What follows is my opinion as to how the above calculation is flawed and that the tax outgo should be higher. In other words, an inaccuracy or a loophole if one can call it that. You can stop reading the post if you dont care for what I have to say – often a smart move.
What is my problem anyway?
Example 4 Revisited: Total Income from Salary = 1 Lakh.
Total 80C investments = 1 Lakh.
Taxable Capital Gain = 3 Lakh.
What is the taxable income and taxable capital gain?
The IT department deducts 2.5L from the capital gain of 3L because it computes the net income as 1L(salary) – 1L(80C) = 0
The 1L is already tax-free income and it is deducting the 80C investment from it. This is similar to double-counting. A deduction from taxable income is applied to tax free income. Which I think is wrong.
When income is less than tax-free limit, 80C deductions have no relevance.
Therefore in this example, in my opinion, only 1.5L from capital gains should be added to income and the rest 1.5L is the taxable capital gain.
Since it deducts 80C investment from tax-free income, it is able to add 2.5L of the capital gains, resulting only in 0.5L taxable capital gain.
Dear income tax department, applying a deduction from taxable income to tax free income makes no sense. It will not matter in ordinary circumstances. However, it can result in a significant reduction of taxable capital gains.
The formula used for calculating taxable capital gain is
If (total-income -2.5L – total-deductions) > 2.5 Lakh
Taxable Capital Gain = Reported Capital Gain
Else
Taxable Capital Gain = (Total-Capital-Gain-Reported) + (total-income -2.5L – total-deductions)
Now, when total income = total deductions, a maximum deduction of 2.5L is possible from the reported capital gains.
When total income = 2.5L, the total deductions can be deducted from the reported capital gains.
I believe this is due to an incorrect double deduction when income < 2.5L
(total-income – 2.5L – total-deductions).
Anyway, who cares what I think anyway.
The title says when and how capital gains tax can be reduced. I have discussed the when. The how, legally rare as it is, should be self-evident.
Note: I have expressed an opinion about an existing rule. I am sure most of you will disagree. If the above scenario can be interpreted in a different manner, please disucss below.
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