LONG AND SHORT-TERM CAPITAL GAINS AND LOSSES

Long and Short-Term Capital Gains and Losses



Long and Short-Term Capital Gains and Losses

Introduction

Under the existing law, profits and gains arising from the transfer of capital asset made in a previous year is taxable as capital gains. A capital asset is distinguished on the basis of the period of holding. A capital asset, which is held for more then three years, is categorised as a long-term capital asset. However, if the capital asset is in the nature of equity, it is categorised as a long-term capital asset if it is held for more then one year. All capital assets other then long-term capital asset is termed as a short-term capital asset.

Discussion

The profits and gains arising from the transfer of a short-term capital asset are treated as short-term capital gains and included in the total income of the taxpayer for taxation at the rates applicable to him. Where a taxpayer incurs a loss from the transfer of a short-term capital asset (such loss is termed as “short-term capital loss”) the same is allowed to be set off only against gain from the transfer of another short-term or long-term capital asset (Zodrow, 1993). In a case where the short-term capital loss remains unabsorbed, the same is allowed to be carried forward for set off only against gain from the transfer of another short-term and long-term capital asset in the subsequent year. However, such carry forward is restricted for a period of eight years. In other words, a short-term capital loss cannot be set off against income from salaries, house property, business or profession or income under the head “other sources” (Mark and Douglas, 1999).

Similarly, the profits and gains arising from the transfer of a long-term capital asset are treated as long-term capital gains. Since long-term capital gains represent accumulation of income over a period of time, these could turn out to be illusory in real terms. Accordingly, the cost of the asset is adjusted for inflation during the period of holding. The increased cost is set-off against the sale consideration of the long-term capital asset to determine the long-term capital gain. Such long-term capital gain is subjected to concessional rate of tax to eliminate the bunching effect. Furthermore, the long-term capital gains are fully exempt if the proceeds are invested in specified savings plan / schemes (Jack and Thomas, 2000). In view of the liberalized personal income tax rate schedule comprising of only two rates, the adverse impact in the form of increased tax burden arising from bracket creep due to bunching of capital gains would be considerably reduced and in most cases eliminated (Gompers, Paul, and Josh Lerner, 2000).

Therefore, we concessional treatment of long-term capital gains through a reduced scheduler rate of tax must be abolished. In other words, the long-term capital gains would be aggregated with other incomes and subjected to taxation at the normal rates. Further, since we have recommended the abolition of various saving incentives, we do not ...