Tax on LTCG
A new Sec. 112A has been introduced to withdraw the exemption u/s 10(38) and to
tax LTCG on equity share in a company or a unit of an equity oriented MF or a unit
of a business trust @10% if STT has been paid on both acquisition and transfer.
The requirement of STT being paid at the time of acquisition shall not apply to
purchases made before 1.4.2004 when STT was introduced and some additional notified
transactions. The tax of 10% is applicable only on amount of capital gain exceeding
₹ 1 lakh.
The cost of acquisitions in respect of the long term capital asset acquired by the
assessee before 1.2.2018 shall be deemed to be the higher of —
- the actual cost of acquisition of such asset; and
- the lower of
- the ‘Fair Market Value’ (FMV) of such asset; and
- the full value of consideration received or accruing on the transfer of such asset.
The LTCG will be computed without giving effect to the 1st proviso to Sec. 48 dealing
with cost inflation indexation and also the 2nd proviso dealing with foreign currency
in the case of NRIs.
A new Sec. 43AA has been inserted to provide that any gain or loss on a transaction
arising from any change in forex rates shall be treated as income (or loss). Such
transactions include those relating to monetary/non-monetary or translation of financial
statements of foreign operations or forward exchange contracts or forex translation
reserves.
FMV for this new Section has been defined to mean –
- in a case where the capital asset is listed on any recognised stock exchange, the
highest price of the capital asset quoted on such exchange on 31.1. 2018. Where
there is no trading in such asset on that date, the FMV shall be its highest price
on a date immediately preceding date when it was traded.
- in a case where the capital asset is a unit not listed on recognised stock exchange,
its NAV on 31.1.2018.
The benefit of deduction under chapter VI-A as well as the rebate u/s 87A and also
the exemption u/s 54EC is not available on such capital gains.
However, gains arising from a transaction on a recognized stock exchange in any
International Financial Services Centre and where the consideration is received
or receivable in Forex, shall be eligible under this Section without payment of
STT.
Sec. 115D has been amended to make all these changes applicable to FIIs, consequent
to deletion of Sec. 10(38).
Indexation of cost for unlisted shares has been made possible.
Our Comments
All this is very complicated indeed. For clarity ---
The way it will work is that LTCG on any sale of investments made before 1st of
February, 2018 will be split into two. The capital gain earned till 31st of January,
2018 will be exempted from tax. The rest of the gains (from 31st January till date
of sale) will attract tax at the flat rate of 10% without indexation.
If the sale price is lower than the cost as on 31st of January, 2018, then in effect,
there would be no capital gain.
The following table details the various scenarios that may emerge.
|
SCENARIOS
|
I
|
II
|
III
|
|
Cost of Acquisition of long term shares
|
100
|
100
|
100
|
|
Market price as on 31st Jan, 2018
|
80
|
120
|
150
|
|
Sale value anytime after 31st March 2018
|
90
|
110
|
200
|
|
Taxable Gain
|
-10*
|
0**
|
50#
|
(* 90-100 **110-110 # 200-150)
In Scenario I, since the result would be a long-term loss, this loss should be available
for set-off against other taxable long-term gain. The point hasn't been highlighted
in the general media. Also it needs to be noted that this tax just cannot be saved
i.e. there is no provision / deduction available that offers a deduction / exemption
from this new long-term tax. Even Sec. 54EC bonds (as explained further on) cannot
be used.
Also, so far as investment decisions are concerned, please note that nothing changes.
The reason for this is two fold. Firstly, the tax (as you can see from the table)
is applicable basically only to the difference between sale value and the cost as
on 31st of January. So almost all the capital gain would be exempted in any case.
W.e.f. 1.10.04, STT has been slapped on all purchase and sale transactions of shares
in a recognised stock exchange in India in securities and also sale or redemption
transactions in units of equity-based MF schemes, irrespective of whether the purchaser
or seller is a taxpayer or not and also whether the transaction entails a capital
gain or loss.
The intention of bringing in STT was counterbalance the loss in revenue arising
out of making LTCG exempt u/s 10(38). The ‘give’ is in terms of making the LTCG
exempt u/s 10(38) and STCG exigible to tax at the concessional rate of 15 u/s 111A.
F18 has retained the STT slapped capital gains tax on such transactions.
The following table gives the current STT rate:
|
Transaction
|
Rate
|
|
Purchase of Equity share
|
0.100%
|
|
Sale of Equity Share
|
0.100%
|
|
Purchase of Equity-oriented Units of MFs
|
Nil
|
|
Sale of Equity-oriented Units of MFs
|
0.001%
|
|
Sale of Equity Share/MFs non-delivery based
|
0.025%
|
|
Sale of Option in Securities
|
0.050%
|
|
Sale of Option in Securities (Option Exercised)
|
0.125%
|
|
Sale of Futures in Securities
|
0.010%
|
The New LTCG on Equity and Equity MFs
The new LTCG regime is related with Equity Shares listed on a recognised stock exchange
in India, Units of an Equity-oriented Fund of an MF or Units of a Business Trust.
For acquiring long-term status, there is no change in the current requirement of
the holding period of 1 year and payment of STT both at the time of sale and purchase
(except in the case of purchases made before 1.4.04 when STT was introduced).
Cost of Acquisition has changed
The change as such has taken place in the definition of cost of acquisition. To
begin with, it will be the actual cost at the time of its purchase, as is the normal
convention. Now come complications, starting with definition of Fair Market Value
(FMV) --- In case of a listed equity shares or an unit, the FMV means the highest
price of such share or unit quoted on the exchange on 31.1.18 and if there was no
trading on this date, immediately preceding this date on which it was traded. Then
comes the definition of ‘cost of acquisition’ --- If the actual cost is less than
the FMV, the FMV will be deemed to be the cost of acquisition. However, if the full
value of consideration on transfer (sale value) is less than the FMV, then such
full value of consideration or the actual cost, whichever is higher, will be deemed
to be the cost of acquisition. In the case of unlisted unit, the net asset value
of such unit on 31.1.18 will be the fair market value.
The holding period will be counted from the date of acquisition. There will be no
TDS to a resident tax payer. Tax @10% will be deducted from payment of long-term
capital gains to a non-resident tax payer. FIIs will be on par with resident tax
payers.
The tax payable is @10% on such LTCG, so computed (without indexation of the cost
of acquisition) exceeding ₹ 1 lakh.
Since such LTCG is now treated as normal income at the so called ‘concessional tax
rate’, ---
- STCG will be continued to be taxed @ 15%. LTCG will be taxed lower @10%. The method
of calculating the gain is identical for ST and LT. Also, if the normal income (without
LT gains) of a Resident individual or HUF, happens to be below the tax threshold
applicable to the person, then, the LTCG shall be reduced by the amount by which
the normal income falls short of the tax threshold. Moreover, the rebate u/s 87A
shall be allowed on the income-tax on the total income as reduced by tax payable
on such capital gains.
- Long-term capital loss arising from transfer made on or after 1.4.18 will be allowed
to be set-off and carried forward in accordance with existing provisions of the
Act. Therefore, it can be set-off against any other LTCG and unabsorbed loss can
be carried forward to subsequent 8 years for set-off against long-term capital gains.
This is possibly a boon in some cases. For instance, say Ramesh had bought some
shares of Jaiprakash Associates (JP) on 30.6.09 for ₹ 204.02 and its value
now has crashed down at ₹ 17.60. Earlier, since the gains were tax-free, the
losses were also tax-free. So the entire loss was wasted - nothing could be done
about it. However, now, the same is available for set-off against other long-term
gains.
- Valuation of bonus shares is another area where investors would be benefited. The
cost of acquisition of bonus shares acquired before 31.1.18 is not longer required
to be taken at nil value. For example, the same Ramesh, on account of his holding
had received a 1:2 bonus on 18th of January, 2010. Earlier, he would have to take
the cost of these bonus shares as nil. However, now he can adopt the value of JP
as on 31.1.2018 as his cost.
Stamp Duty Valuation
At present, while taxing capital gains u/s 50C, business profits u/s 43CA and gifts
u/s 56(2x) arising out of transactions in land or building or both, the sale consideration
or stamp duty value, whichever is higher is adopted. The difference is taxed as
income both in the hands of the purchaser and the seller. FA18 has declared that
no adjustments shall be made in a case where the stamp duty is higher than the sale
consideration by not more than 5%.
Conversion of Stock-in-trade into Capital Asset
Sec. 45 provides that capital gains arising from a conversion of capital asset into
stock-in-trade shall be chargeable to tax. However, in cases where the stock-in-trade
is converted into, or treated as capital asset, the existing law does not provide
for its taxability. Sec. 28(via) has been inserted to provide that any profit or
gains arising from conversion of inventory into capital asset or its treatment as
capital asset shall be charged to tax as business income. The FMV of the inventory
on the date of conversion or treatment determined in the prescribed manner, shall
be deemed to be the full value of the consideration received or accruing as a result
of such conversion or treatment. Consequential changes have been effected in Sec.
2(24), Sec. 2(42A) and Sec. 49.
Sec. 54EC
This Section exempting LTCG invested in the Bonds of NHAI, REC and other notified
Bonds, within 6 months has undergone 2 major changes —
- The exemption has been restricted only to LTCG arising from land or building or
both. In other words, Sec. 54EC cannot be used anymore for LTCG arising from shares
and securities, Bonds, precious metals and ornaments, archaeological collections,
drawings, paintings, sculptures, any work of art, stock-in-trade, etc. Moreover,
this exemption is no more available for LTCG arising out of Sec. 54F on any asset
other than land.
- The lock-in period of such Bonds has been increased from 3 years to 5 years.
Our Comments
There were five basic inherent problems associated with these bonds. And these problems
as listed hereunder continue to exist even after the new regime as envisaged by
the recent Budget.
- Firstly, the interest rate, which is abysmally low. An investment in these bonds
comes with a give and take. The give is the exemption and the take is the low interest
rate fully taxable, payable annually. This rate has been brought down from 6.00%
to 5.25% w.e.f. 1.12.16. Thankfully, there is no TDS.
- The face value of the Bonds is ₹ 10,000. Suppose you have earned a capital
gain of ₹ 3,000. You cannot buy Bonds worth ₹ 3,000. You have two choices
--- i) Buy the Bond worth ₹ 10,000 to save the tax on LTCG of ₹ 3,000.
The extra ₹ 7,000 earns the lower interest rate of ₹ 5.25% but does
not save any more tax. or ii) Pay tax on ₹ 3,000 @20.8% flat and invest rest
of the amount earning market rate of interest from an equally safe source which
is higher. Which choice should a taxpayer opt for? Basically should one invest in
the bonds and save tax or pay the tax and invest the post-tax proceeds in greener
pastures? We shall answer this query a little later.
- The investment can be made within the stipulated period of 6 months. Now suppose
the assessee has incurred capital gains during February/March. The period of 6 months
within which the Bonds have to be purchased falls in August/September. However,
he has to file his tax returns on or before 31st July. What is to be done? We have
no answer to this problem.
- Irrespective of the date on which you make the payment, the deemed date of allotment
is the last day of the month during which the application amount has been cleared.
The period of 6 months from the date of transfer of the original asset will end
on this date and not the date when you have actually made the investment. Ditto
for the lock-in period of 5 years (earlier, before the Budget, it was 3 years).
Take care.
- The bonds are non-transferable, non-negotiable and cannot be offered as a security
for any loan or advance. Issued by institutions with such high pedigree and with
a lock-in of five years, the least the authorities could have done is to make the
bonds eligible as security for bank loans.
These inherent problems have not been addressed but w.e.f. 1.4.18 FA18 has diluted
the advantage by adding two more stipulations ---
- The exemption would be available only in respect of LTCG earned from immovable property
and not from any other asset. In other words, Sec. 54EC cannot be used anymore for
LTCG arising from securities, bonds, precious metals, ornaments, paintings, sculptures
etc., and most importantly shares.
- The lock-in period that was 3 years has been now increased to 5 years. In other
words, the assessee is forced to accept the lower rate of 5.25%, fully taxable,
for an extended period of two more years.
To Buy or Not to Buy the Bonds
Now to the question that we began with - should you buy the bonds and save tax or
pay tax and invest the post tax money elsewhere? To address this question, to begin
with we assume that ---
- The long term capital gain is a round figure of ₹ 10,000.
- You are in the highest tax bracket of 31.2% (30%+cess of 4%).
- The market rate of interest from an equally safe source is 13.01%, fully taxable.
Why such an odd figure? Please bear with us and read on.
If you decide to pay tax on CG (flat rate of 20.8% irrespective of your tax zone),
the tax payable is ₹ 2,080 and your take home CG is ₹ 7,920. This is
the amount you can deposit in a 5-year FD @ 13.01% taxable. The after-tax take home
interest rate works out at 8.95%. The maturity value of ₹ 7,920 invested @8.95%
works out at ₹ 12159.65 (= 7920*(1.0895^5).
On the other hand, if you decide to buy the Bonds, your take-home CG is ₹
10,000 available to you after 5 years from the date of allocation of the Bonds.
During this term of 5 years, you earn every year interest of ₹ 525. After
paying tax thereon @31.2%, your take-home interest is ₹ 361.20. It is this
amount that you can invest in a 5-year SIP @13.01% taxable, which is 8.95% take-home.
The maturity value of this SIP is
= 361.20 x (1 + 1.08951 + 1.08952 + 1.08953 + 1.08954)
= 361.2 0x (1 +1.0895 + 1.1870 + 1.2932 + 1.4090)
= 361.20 x 5.9787 = 2,159.65.
Maturity Value = 10,000 + 2,159.65 = 12,159.65
The take-home after 5 years in both the cases is the same. In other words the Break-Even
Rate (BER) i.e., the rate of return where you would be agnostic between buying the
bonds or investing the after tax proceeds for the 31.2% tax-zone is 13.01% p.a.
It is found that the BER for 20.8% zone is 12.11% p.a. and that for 10.4% zone is
11.41% p.a.
Net Conclusion
If the math looks complicated, please ignore it. The net takeaway is the following
--- Assuming you are in the 31.2% tax bracket, if you can earn a rate of return
in excess of 13.01% p.a. from the post tax proceeds, then you are better off paying
the tax. If not, you are better off buying the bonds.
Note however that this is for round figures of capital gains in multiples of ₹
10,000. For any other odd value of gains, the BER would change accordingly. For
example, in the 31.2% tax bracket, if say the LTCG was ₹ 5,13,000 - then for
₹ 5,10,000, the BER is 13.01% p.a. as mentioned - but for the additional ₹
3,000, the BER works out to be 7.35% p.a. Therefore, one would invest ₹ 5,10,000
in the bonds and ₹ 3,000 in say RBI bonds where the rate is higher at 7.75%
p.a. The relevant rates for the 20.8% and the 10.4% tax brackets are 7.10% p.a.
and 6.61% p.a. respectively.
Lastly, the only avenue where returns could be higher than the above mentioned BER
would be the stock market. So those who have a good risk appetite and do believe
that the Indian stock market, thanks to the many reform measures undertaken by the
government, is slated to rise at a steady rate, may consider going in for equity-based
schemes of MFs instead of the bonds. Else, investing in the bonds is like saving
tax and getting paid for it!
Transaction not Regarded as Transfer
New Sec. 47(viiaab) has been inserted to provide that any transfer of a Bond or
GDR referred to in Sec. 115C(1) or rupee denominated bond of an Indian company or
derivative, made by an NRI on a recognised stock exchange located in any International
Financial Service Centre and where the consideration is paid or payable in forex,
shall not be regarded as transfer.
Forex Fluctuations
A new Sec. 43AA has been inserted to provide that any gain or loss on a transaction
arising from any change in forex rates shall be treated as income (or loss). Such
transactions include those relating to monetary/non-monetary or translation of financial
statements of foreign operations or forward exchange contracts or forex translation
reserves.