Investments fall into different categories: property, stocks and shares, mutual funds, jewellery and more. But there’s one common thread that ties all of them together: capital gains tax. So what is capital gains tax, and how is it calculated? Here’s an explainer.
What is capital gains tax?
In India, any profit or “gain” earned from the sale of a capital asset is treated as capital gains and taxed under the Income Tax Act, 1961. Under the Act, a capital asset includes property of any kind held by an individual — this could be land, real estate/buildings, equities, bonds, debentures, and jewellery. However, it does not include stock-in-trade, agricultural land, or certain specified bonds.
These gains are categorised as either short-term or long-term, based on the duration for which the asset is held: short-term capital gains (STCG), based on shorter holding periods; and long-term capital gains (LTCG) which is applicable when assets are held longer. The distinction is important because each category is taxed differently, often with preferential treatment for long-term holdings to encourage investment stability.
However, this wasn’t always the system: capital gains has seen multiple iterations since independence and has evolved with the economy and markets. Here’s a breakdown.
The Independence era, 1947-1956
The earliest iteration of capital gains can be traced back to 1947, when Section 12B was introduced into the Income Tax Act, 1922. The goal was to curb speculative activity in a volatile, post-war economy. However, it was short-lived. Within two years, the tax was abolished, largely because policymakers feared it would discourage investment and hinder the development of nascent capital markets. This early reversal highlights a theme that would recur repeatedly: the tension between taxing wealth creation and enabling it.
Reintroduction and institutionalisation, 1956-1961
After a little less than a decade, capital gains tax was reintroduced in 1956, following the recommendations of economist Nicholas Kaldor, with the aim of improving tax equity and boosting revenue. This time, it was structural inclusion in India’s tax system and with the enactment of the Income Tax Act, 1961, capital gains became a formal head of income.
Differentiation and adjusting for inflation, 1980s-early 1990s
As India’s markets evolved, so did the capital gains tax structure. This period saw a more sophisticated framework emerge, with the introduction of short-term vs long-term classifications, different holding periods for various asset classes, and separate tax rates for each category.
Post-Liberalisation rationalisation, 1991–2004
The Indian markets opened up and transformed following economic liberalisation in 1991, attracting foreign investment and trade, increased privatisation and greater economic growth. The nation’s tax policies evolved to keep up. Capital gains structures were simplified, tax rates were rationalised and brought closer to global norms at the time, and incentives were introduced to encourage investment in equities as the markets grew. There was also a landmark reform in 1992, when indexation (adjusting for inflation) was introduced. This allowed taxpayers to adjust the purchase price of assets for inflation, ensuring that only “real” gains were taxed. It was a shift from a controlled system to a more market-friendly one.
LTCG Exemption & STT, 2004-2018
A little over a decade later, another major reform was introduced: removing long-term capital gains (LTCG) on listed equities. Short-term capital gains (STCG) were taxed at concessional rates (10–15%), and Securities Transaction Tax (STT) was introduced. STT is a small tax levied on the buying and selling of securities like shares, derivatives, and equity mutual funds, on recognised stock exchanges in India, and is charged at the time of the transaction itself. In simple terms: taxing the trade itself, to bring in more transparency and to record trades. These reforms saw retail participation in the markets surge, and Indian equity markets deepened significantly.
Reintroduction of LTCG Tax, 2018
After 14 years of no LTCG, it was reintroduced in the 2018 Union Budget. The key features were:
- 10% LTCG tax on gains above ₹1 lakh
- No indexation benefit or adjusting for inflation
- Grandfathering clause to protect past gains (the old rules would apply to existing investments; the but future investments would fall under the new tax rules)
The move aimed to bring in some balance: raising state revenue, but without destabilising markets. While it did feel like a shock after more than a decade of tax-free gains, the levy of a relatively low tax (10%), that too applicable on gains of over 1 lakh, and protection of previous investments helped make it feel incremental.
Further reforms and rationalisation, 2020 onwards
In recent years, capital gains taxation in India has moved toward a more simplified structure and reduced arbitrage across asset classes.
- LTCG rate increased to 12.5%
- STCG rate on equities increased to 20%
- Exemption threshold increased to ₹1.25 lakh
- Debt mutual funds (made after 2023) taxed at income tax slab rates
- Indexation benefits removed and inflation is no longer considered
While it may seem like investors are being taxed more, these changes aim to bring in a degree of neutrality across asset classes, reducing the tax advantages that certain classes once enjoyed.
The big picture
From its brief abolition in the 1940s, to the removal of LTCG in the 2000s to rationalisation in the 2020s, capital gains tax in India has evolved alongside the economy itself, with three standout themes:
- A push-and-pull between revenue and growth
- Increasing policy sophistication
- A gradual shift toward tax neutrality across assets
In that sense, capital gains taxation has become a tool policymakers use to influence how and where people invest, determining where money flows.
Sources
Capital Gains Tax in India: An Explainer
Short-Term vs Long-Term Capital Gains Tax: Key Differences
Journey of Capital Gains Tax on listed equity in our country
India: FAQs on new Long Term Capital Gains tax on equities
Rationalisation of long term capital gains proposed
Budget 2018: Govt introduces LTCG tax of 10% on capital gains over Rs1 lakh
Long-Term Capital Gains Tax on Shares in India Explained
Budget 2018: Govt introduces LTCG tax of 10% on capital gains over Rs1 lakh