The taxation of capital gains from the sale of unlisted shares is governed by Section 45 of the Income Tax Act, 1961. Unlike listed shares, which are traded on stock exchanges, unlisted shares are privately held and are not subject to the same market fluctuations. As a result, the tax treatment of capital gains arising from the sale of unlisted shares differs, particularly with regard to the holding period rules.
In this blog, we will explain how capital gains from the sale of unlisted shares are treated under Section 45, the implications of the holding period, and how these factors affect the taxation of such gains.
What is Section 45?
Section 45 of the Income Tax Act, 1961 is the provision that governs the taxation of capital gains in India. It applies to the transfer of capital assets, which include immovable property, securities, and shares, among others. The key aspect of Section 45 is that it taxes any profit or gain arising from the transfer of a capital asset, and the amount is calculated by subtracting the cost of acquisition and cost of improvement from the sale price.
The tax treatment of capital gains depends on whether the asset is classified as a short-term capital asset (STCA) or a long-term capital asset (LTCA), which is determined by the holding period.
Unlisted shares are shares that are not traded on any recognized stock exchange. These shares are typically held in private companies, and their sale can result in capital gains for the seller. The taxation of capital gains from the sale of unlisted shares depends on whether the shares are held for a short term or a long term.
If the unlisted shares are held for a period of less than 24 months, they are classified as short-term capital assets. This means that any gain arising from the sale of these shares will be considered short-term capital gains (STCG) and taxed accordingly.
- Tax Rate: Short-term capital gains arising from the sale of unlisted shares are taxed at a rate of 15% (plus applicable surcharge and cess) under Section 111A.
- Taxable Gain: The taxable capital gain will be calculated as the sale price minus the cost of acquisition and cost of improvement.
If the unlisted shares are held for a period of 24 months or more, they are classified as long-term capital assets, and any gain arising from their sale will be classified as long-term capital gains (LTCG).
- Tax Rate: Long-term capital gains on unlisted shares are subject to tax at 20% (with the benefit of indexation), which helps account for inflation and reduces the taxable gain.
- Taxable Gain: The taxable capital gain is calculated as the difference between the sale price and the indexed cost of acquisition (adjusted for inflation) and indexed cost of improvement.
Indexation allows the cost of acquisition and improvement to be adjusted according to the Cost Inflation Index (CII), thereby reducing the taxable gain by considering inflation over the holding period.
The holding period is crucial in determining whether the capital gains from the sale of unlisted shares will be classified as short-term or long-term, as the tax rate varies significantly between the two.
1. Short-Term Capital Gains (STCG)
- Holding Period: For unlisted shares, the holding period required for the shares to be classified as short-term is less than 24 months.
- Tax Rate: The capital gain arising from the sale of short-term unlisted shares will be taxed at a rate of 15% (plus applicable surcharge and cess). This rate applies regardless of the actual amount of gain realized.
2. Long-Term Capital Gains (LTCG)
- Holding Period: For unlisted shares, the holding period required for the shares to qualify as long-term is 24 months or more.
- Tax Rate: Long-term capital gains are taxed at 20% with the benefit of indexation, which allows for the adjustment of the cost of acquisition and cost of improvement based on inflation during the holding period.
3. Importance of Holding Period in Tax Planning
The holding period not only determines whether the gain will be taxed as short-term or long-term but also affects the amount of tax payable. Since long-term capital gains benefit from a lower tax rate and the advantage of indexation, it is generally advisable for investors to hold unlisted shares for at least 24 months to benefit from these favorable tax provisions.
Let’s consider an example to better understand how the taxation of unlisted shares works under Section 45 based on the holding period.
Example 1: Short-Term Capital Gains (STCG)
- Sale Price: ₹50,00,000
- Cost of Acquisition: ₹40,00,000
- Holding Period: 18 months (less than 24 months)
Capital Gain: ₹50,00,000 – ₹40,00,000 = ₹10,00,000
Since the shares are held for less than 24 months, the gain of ₹10,00,000 will be treated as short-term capital gains and taxed at 15%.
Tax Payable: ₹10,00,000 × 15% = ₹1,50,000
Example 2: Long-Term Capital Gains (LTCG)
- Sale Price: ₹50,00,000
- Cost of Acquisition: ₹40,00,000
- Holding Period: 30 months (more than 24 months)
Capital Gain: ₹50,00,000 – ₹40,00,000 = ₹10,00,000
Since the shares are held for more than 24 months, the gain of ₹10,00,000 will be treated as long-term capital gains. If indexation is applied (assuming CII of 100 for the year of acquisition and 300 for the year of sale):
Indexed Cost of Acquisition: ₹40,00,000 × (300 / 100) = ₹1,20,00,000
Taxable Capital Gain: ₹50,00,000 – ₹1,20,00,000 = ₹8,00,000
Tax will be calculated at 20% with indexation benefits.
Tax Payable: ₹8,00,000 × 20% = ₹1,60,000
Learn more about Tax Provisions on the official Income Tax India website.
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