Evolving Capital Gains Regulations under Modi Government 3.0

The Hon'ble Finance Minister presented the Finance Bill (No. 2) 2024 (Finance Bill) in the Parliament on 23 July 23 2024.

The Finance Bill proposes significant relief measures for taxpayers, including abolishing angel taxation, discontinuing the equalisation levy on online sale of goods and services, and rationalising provisions relating to TDS. Simultaneously, changes have been proposed to streamline and rationalise capital gains taxation provisions.

Three key changes are proposed in the taxation of Capital Gains: (a) classifying the holding period into two ambits; (b) increase in tax rates; and (c) removal of indexation benefit for the calculation of long-term capital gains (currently available for property, gold, and other unlisted assets).

Indexation benefit on long-term capital gains (LTCG) was introduced vide the Finance Bill, 1992 by inserting second proviso to section 48 of the Income-tax Act, 1961 (the Act). The purpose behind introduction of indexation on cost of acquisition and cost of improvement was to tax the gains on real income instead of book gains arising from the transfer of long-term capital asset. However, the present Government has proposed to withdraw this indexation benefit effective from 23 July 2024, to simplify the computation of capital gains for taxpayers and the tax administration.

The Finance Bill has also proposed to streamline taxes on LTCG at 12.5% across all classes of capital assets. Furthermore, it suggests increasing the tax rate on short-term capital gains (STCG) referred to in section 111A from the current 15% to 20%, also effective from 23 July 2024.

Here is a summary of the proposed amendments regarding the period of holding and tax rates for various classes of capital assets:
 

Sr.	Nature of transfer	For transfer of capital assets before 23 July 2024		For transfer of capital capitals on or after 23 July 2024
		Period of holding	Tax rate	Period of holding	Tax rate
1.	STCG referred to in section 111A	Less than 12 months	15%	No change	20%
2.	LTCG referred to in section 112(1)(a)/(b)/ (c)(i)/ (c)(ii) and (d) [other than capital gains referred to in section 10(33) and 10(36)]	Unlisted shares, property (land/ building) - more than 24 months Others - more than 36 months	20% (with indexation benefit)	More than 24 months	12.50% (no indexation benefit)
3.	LTCG referred to in section 112(1)(c)(iii)	More than 24 months	10%	No change	Not applicable for transfers on or after 23 July 2024
4.	LTCG referred to in section 112A exceeding INR 1.25 lacs	More than 12 months	10%	No change	12.50%
5.	LTCG referred to in section 115AB, 115AC, 115ACA, 115AD and 115E	More than 12/ 24/ 36 months	10%	More than 12/ 24 months	12.50%
6.	STCG other than referred to in section 111A (such as unlisted shares, depreciable assets)	Unlisted shares, immovable property - less than 24 months Others - less than 36 months	Applicable rates	Less than 24 months	No change
7.	LTCG on listed bonds and debentures	More than 12 months	20% (without indexation)	No change	12.50%
8.	Unlisted bonds and debentures	More than 36 months	STCG: Applicable rates LTCG: 20% (without indexation)	More than 24 months	Applicable rates (deemed as STCG irrespective of period of holding)

In addition to the above, first proviso to section 48 of the Act currently provides for taxability of capital gains arising from the transfer of long-term capital assets such as listed securities (excluding units) or zero-coupon bonds at a rate of 10% without allowing for indexation benefit. The said proviso is proposed to be withdrawn w.e.f. 23 July 2024.

Furthermore, the Bill has also proposed consequential amendments to sections 196B and196C, which are withholding tax provisions applicable to non-residents, to align with the proposed changes in rates of capital gains tax which are set to increase from 10% to 12.50%.

From the details above, it is important to note that effective 23 July 2024, the tax rate on LTCG from the transfer of listed equity shares (STT paid), units of equity-oriented funds, and business trusts under section 112A is proposed to be increased from 10% to 12.50%. Simultaneously, the exemption limit is proposed to be raised from INR 1 lakh to INR 1.25 lakh. In contrast, taxes on long-term capital assets (other than those referred to in section 112A of the Act) are proposed to be significantly reduced from 20% (with indexation) to 12.5% (without indexation benefit).

With the proposed removal of indexation benefit on the transfer of immovable property held for the long term, taxpayers may now consider either holding such assets or reinvesting in residential property to claim exemptions on capital gains (up to INR 10 crore), thereby boosting the real estate sector.

Issues that need clarification:

  •  Withdrawal of section 112(1)(c)(iii) of the Act

Current provision: The beneficial tax rate of 10% is applicable for non-residents on LTCG from the transfer of capital assets such as unlisted securities or shares of a closely held company where such capital gains are computed without giving reference to first proviso (i.e., foreign exchange fluctuation benefit) and second proviso (i.e., indexation benefit) to section 48 of the Act (section 112(1)(c)(iii)).

Proposal: The Finance Bill proposes to withdraw the provision of section 112(1)(c)(iii) of the Act. Consequently, such capital gains will now be taxed at the streamlined rate of 12.50% for LTCG.

Issue: The Finance Bill does not explicitly address whether non-residents can still claim the foreign exchange fluctuation benefit when computing tax on these capital gains.

Our thoughts: In the absence of a clear provision, non-residents can still claim the foreign exchange fluctuation benefit, which may not be the intent of the legislature. Accordingly, the said aspect requires clarification.

  •  Withdrawal of indexation benefit under second proviso to section 48 of the Act

Current provision: The second proviso to section 48 allows for considering "indexed cost of acquisition" and "indexed cost of any improvement" for the transfer of long-term capital assets, except for capital gains arising from the transfer of shares or debentures of an Indian company by a non-resident as per the first proviso to section 48. Additionally, for properties acquired before 01 April 2001, the Fair Market Value (FMV) as of 01 April 2001, is considered for computing the indexed cost of acquisition.

Proposal: The Finance Bill proposes to withdraw this benefit effective from 23 July 2024. Accordingly, no indexation benefit shall be available on the transfer of immovable property, gold, and unlisted shares held as long-term capital assets on or after 23 July 2024.

Issue: For properties acquired before 01 April 2001, the issue arises as to whether the indexation benefit on FMV as on 01 April 2001 can be considered while computing the cost of acquisition.

Below is an example showcasing the variance in the capital gains computation before and after the proposed amendment.

E.g.: A house property was purchased in the year 1980 for INR 1 lakh. The FMV of the said property as on 01 April 2001 was, say, INR 10 lakhs. The said property was then sold for a sum of INR 75 lakhs on 20 July 2024 vis-à-vis on 28 July 2024, i.e., pre-amendment and post amendment respectively (Cost Inflation Index for FY 2001-02 is 100 and for FY 2024-25 is 363).

Particulars	Sold on 20 July 2024	Sold on 29 July 2024
Sale Consideration	75,00,000	75,00,000
Less: Cost of acquisition (FMV as on 01 April 2001)	-	10,00,000
Less: Indexed Cost of Acquisition (FMV * CII of FY 2024-25 / CII of FY 2001-02)	(36,30,000) [10,00,000*363/100]	-
LTCG	38,70,000	65,00,000
Taxes on LTCG @ 20%/ 12.5%	7,74,000	8,12,500

As is evident from the details above, the absence of indexation benefit for immovable properties purchased before 01 April 2001 means that the tax outflow on capital gains from the transfer of such properties on or after 23 July 2024 will be higher compared to those transferred before this date.

Our thoughts: In summary, the sale of all legacy properties which were bought on or before 01 April 2001 may be subject to higher capital gains tax. In a country like India where inheritance of properties and other capital assets is widespread, taxpayers could face increased tax implications realised from such gains.

Given these considerations, the proposed amendment should be revised to reinstate the indexation benefit on immovable properties acquired before 01 April 2001.

Concluding thoughts:

Rationalising and simplifying capital gains rates and holding periods is a commendable initiative by the Modi Government 3.0. However, the withdrawal of indexation benefit for immoveable property represents a significant setback for taxpayers, inevitably resulting in higher tax payments on capital gains.

Source:- Taxmann