Written in : May 1998

There is another interesting aspect of capital gains in development deals which is quite interesting. This can be of use in many circumstances - both in land development deals and in regular sales of apartments, houses etc. This arises from the charm of long term capital gains

You know that long term capital gains have two advantages over other types of income:

• You get taxed at 20% instead of 30%
• You can deduct not merely the cost of the asset sold, but also an additional amount to adjust for inflation since you owned the property. This adjustment results in your deducting 'indexed cost of acquisition' from the sale value.

Thus, you end up paying tax at a much lower rate than 20%

It, therefore, needs no guessing to decide what you would choose if you had a choice between normal income or long term capital gains.

More important, if you can, you will want to maximise income under the head 'long term capital gains' than otherwise.

Now consider this example. You have purchased a plot of land in 1981 for Rs.1 lakhs and constructed a house in 1996 spending Rs.10 lakhs. You then sold the house in 1997 for Rs.25 lakhs. How would you calculate capital gains?

The first question is whether your gains of Rs.14 lakhs are long term capital gains or short term. To answer this, you need to answer the question: what did you sell? You sold the house and plot as an integral unit. What you sold was acquired by you in 1996 and not before - you only had a plot till then. So, what you have earned is short term gains and not long term. You do not get the benefit of indexation even if you held the plot for over 15 years. Not only that, the entire amount of Rs.14 lakhs will be taxed at normal rates.

Is there some way in which you can help yourself by reducing taxes? Yes, with some care, thought and planning - and proper drafting - you can save tons of money.

Of course, you also need to know one interesting aspect of property law in India. It is possible in law to treat land and building (super structure) separately. That is, it is possible for you to own land and for another to own the building on it. Your ownership of the land does not get extinguished when you allow another person to build on it. Land and building are separate. You can, of course, treat it as one for all practical purposes.

So when you sell the house, you can sell the land and building separately. And receive consideration separately. This is where careful drafting of documents comes in.

If you do so, you can end up paying long term capital gains tax on gains from land and normal tax on gains arising from sale of the building. The result? Substantial saving in tax.

Next time you are selling property, remember that there are many such issues and circumstances that become relevant and can have a bearing on tax.

We shall continue our discussion on capital gains in the coming weeks with similar interesting issues

You may have read that the Government has started the process of issuing new 10-digit Permanent Account Numbers in various cities including Hyderabad. You have to apply for the new PAN even if you were allotted a PAN earlier. While we shall discuss this in detail later on, remember that the last date is now extended to June 30.

A couple of weeks after hearing a sermon on Psalms 51:2-4 (knowing my own hidden secrets) and Psalms 52:3-4 (lies and deceit), a man wrote the following letter to the Income Tax Department:

"I have been unable to sleep, knowing that I have cheated on my income tax. I understated my taxable income and paid less tax. I now enclose a further payment of Rs.10 lakhs.

If I still can't sleep, I will send the rest."

And to end, two statements from Einstein

"Any intelligent fool can make things bigger, more complex, and more violent. It takes a touch of genius -- and a lot of courage -- to move in the opposite direction."

"The hardest thing in the world to understand is the income tax."

Amen to that!