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Budget 2018: Overhauling tax regime for long term capital gains
By Nishit Parikh PrincipalSudit K. Parekh & Co.

Background

The buoyancy in capital markets and renewed interest of investors had led the Indian stock markets to life time highs. Like last year investors were fearing introduction of long term capital gains on listed equity shares. The Indian Government in budget 2018 has taken the bold step of introducing long term capital gains on listed equity shares as well as equity oriented mutual funds. In this article, authors have examined the key budget provisions surrounding the long term capital gains. 

 

Existing Provision

Under the existing regime, long term capital gains arising from transfer of long term capital assets, being listed equity shares of a company or units of equity oriented fund or units of business trust, are exempt from tax under section 10(38) of the Indian Income Tax Act subject to payment of Securities Transaction Tax (STT).

 

New Provision introduced through Budget 2018

The Indian government was of the view that existing regime was inherently biased against the manufacturing sector as this regime encouraged diversion of investment in financial assets. Thus, in order to minimize economic distortions and curb erosion of tax base, Budget 2018 has proposed to introduce long term capital gains tax of 10% on gains exceeding INR 1 lakh from Financial Year 2018-2019. It is proposed to withdraw the exemption provided under section 10(38) of Indian Income Tax Act and introduce a new section 112A in the Act.

One notable thing from the Government was that it stuck to its promise of not introducing this tax retrospectively. In fact they have also grandfathered the investments made up to 31 January 2018.

The new section 112A provides for taxation of long term capital gains arising from transfer of a long term capital asset being an equity share in a company or a unit of an equity oriented fund, or a unit of a business trust shall be taxed at the rate of 10% if such capital gains exceed INR 1 lakh.

 

The concessional rate of 10% on long term capital gains exceeding INR 1 lakh as proposed under section 112A of the Act shall be applicable if STT has been paid on:

  • acquisition and transfer of listed equity shares of a company; or
  • transfer of a unit of equity oriented fund or a unit of a business trust.

 

However, the requirement of payment of STT on transfer of unit of equity oriented fund or unit of a business trust shall not apply if transfer is undertaken on a recognized stock exchange located in any International Financial Services Centre (IFSC) and the consideration for such transfer is received or receivable in foreign currency. Further, Government would also notify nature of acquisitions in respect of which this requirement of payment of STT shall not apply.  This may mainly include transactions like shares received in Initial Public Offer, Bonus Shares, ESOP, etc.

 

Other key provisions of section 112A are as follows:

  • Indexation benefit or foreign currency fluctuation benefits not available.
  • Cost of acquisition for the purpose of computing capital gains in respect of long term capital asset acquired on or before 31 January 2018 shall be deemed to be the higher of:
  • actual cost of acquisition of such asset; and
  • Lower of fair market value of such asset or the full value of consideration received or accruing as a result of the transfer of a capital asset.
  • The Fair Market Value of capital asset shall be in case where:

 

Particulars

Fair Market Value (FMV)

Capital asset listed on any recognized stock exchange (RSE)

 

Highest price of the capital asset quoted on an exchange on 31 January 2018

(Given that this provision is a beneficial provision, in our view, the highest price of any RSE can be considered)

Capital asset is not traded on 31 January 2018

Highest price of the capital asset quoted on an exchange on a date immediately preceding 31 January 2018 when such asset was traded

Capital asset is a unit and not listed on any recognized stock exchange

Net Asset Value (NAV) of such asset as on 31 January 2018

 

The term “Recognized Stock Exchange” would have to be understood as per the definition laid down in the Act which inter-alia provides that it shall have the same meaning assigned under the Securities Contracts (Regulation) Act, 1956. In other words, RSE would include National Stock Exchange (NSE) or the Bombay Stock Exchange (BSE) or any other stock exchange notified by the Government in the Official Gazette.

 

  • The benefit of chapter VI-A Deductions as well as rebate under section 87A shall be allowed from the gross total income as reduced by such capital gains.

 

Example – LTCG on listed equity shares

10,000 Shares Purchased in 2005 on recognised stock exchange at INR 100 per share

Highest Price on 31 January 2018 – BSE INR 525 per share or NSE INR 524 per share

  • Scenario 1 – 10,000 Shares sold on 28 March 2018

 

No long term capital gains tax payable as the provisions apply from 1 April 2018

 

  • Scenario 2 – 10,000 Shares sold on 10 May 2018 at INR 600 per share 

 

Particulars

Amount

Sale Price per share

INR 600

Cost of Acquisition per share – Higher of the following

a)       Actual cost of acquisition (INR 100)

b)      Sale Price as on May 10 2018 (INR 600) or

Market Value as on January 31 2018 (INR 525), whichever is lower

INR 525

Long Term Capital Gains per share

INR 75

Total long Term Capital Gains (10,000 X 75)

750,000

Less: Exemption threshold

(100,000)

Taxable long Term Capital Gains

650,000

 

Concluding Remarks

As expected from the Government of India, Budget 2018 has introduced long term capital gains tax on listed equity shares, unit of equity oriented fund and unit of a business trust with effect from Financial Year 2018-19. Further, this tax would also apply to the Foreign Portfolio Investors (FPI).

Taxation of capital gains on listed securities is also prevalent in various developed countries like USA, UK, Denmark, etc. However, it remains to be seen whether this move may actually benefit the manufacturing sector as anticipated by the Government of India or this may merely result in hampering inflows into financial assets.

Furthermore, it also needs to be seen whether FPI investors look at changing base to Netherlands or France which still provides for certain capital gains exemptions. 

 

Author

Nishit Parikh

Principal, Sudit K Parekh & Co

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