As per the proposed amendment and insertion of new section 112A of the Income-tax Act, 1961, long-term capital gains made on sale of equity shares or equity-oriented unit to be taxable at the rate of 10% with effect from 1 April 2018.
The Hon’ble Finance Minister presented the budget in the Parliament where one of the key proposed amendments was taxation of Long Term Capital Gains (LTCG) on sale of equity-oriented shares by way of insertion of section 112A of the Income-tax Act, 1961 (the Act).
Provisions of section 112A
Section 112A states that capital gains arising on transfer of 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 on which Securities Transaction Tax (STT) has been paid appropriately, shall be taxed at the rate of 10% on such LTCG exceeding Rs. 1 lakh.
The provision further states that the capital gains shall be computed without the benefit of indexation or foreign currency translation available to non-residents as per the first and second proviso to section 48 of the Act.
Calculation of LTCG
Capital gains shall be computed in the same manner as laid down in section 48 of the Act.
For the purpose of computing LTCG as per section 112A of the Act, where the long-term capital asset is acquired on or before 31st January, 2018, the cost of acquisition would be the higher of the following:
a. Actual cost of acquisition; and
b. The lower of:
i. Fair Market Value of the asset (discussed below); and
ii. Full value of consideration on transfer of asset
It would be pertinent to analyze the definition of “Fair Market Value” for the purpose of computing LTCG. The Finance Minister in his speech mentioned that the all gains made up to 31st January, 2018 would be grandfathered.
Where the capital asset is listed on a recognized stock exchange, the highest price quoted on such exchange on 31st January, 2018 provided the same is traded on the same day shall be deemed to be the Fair Market Value.
Where the capital asset is not traded on 31st January, 2018, the highest price quoted on such previous day when the asset was traded, shall be the Fair Market Value.
In case of a unit, not listed on a recognized stock exchange, the net asset value as on 31st January, 2018 shall deemed to be the Fair Market Value.
Then and Now
LTCG on sale of equity shares or units of an equity-oriented fund, where STT was paid were exempt under section 10(38) of the Act.
Mr. P. Chidambaram, the then Finance Minister had introduced the provision in Finance Act, 2004 to abolish the taxation of LTCG on sale of securities transaction altogether by way of section 10(38). Replacing the tax on LTCG on sale of securities, STT was introduced at the rate of 0.15% of the value of the security.
However, vide the proposed amendment, the STT shall continue in tandem along with the tax on LTCG at the rate of 10%. Whether this would amount to additional or double taxation may be argued.
Effect of section 112A
The amendment would take effect from 1 April 2018 i.e. relevant to Assessment Year 2019-20.
The Finance Minister stressed in his speech that the investment was being diverted from manufacturing industry to investment in financial instruments, which was in turn resulting into revenue loss.
An illustration explaining the tax on LTCG vis-a-vis the grandfathering provision is listed below:
|Particulars||Scenario A (Rs.)||Scenario B (Rs.)||Scenario C (Rs.)||Scenario D (Rs.)|
|A||Shares purchased on 1 September 2017||100||100||100||100|
|B||Fair Market Value as on 31 January 2018||125||125||90||125|
|C||Actual Sale Price on 1 October 2018||150||90||125||110|
|D||Cost of Acquisition: Higher of:
a. Actual cost of acquisition; and
b. Lower of:
i. Fair Market Value
ii. Sale consideration
It has been clarified that an assessee would be able to claim long-term capital loss (Scenario 2) for set-off or carry forward against any other LTCG and unabsorbed loss for a period of 8 subsequent years.
However, any long-term capital loss incurred on sale of equity share or equity-oriented unit before 1st April, 2018 would not be available for set-off against LTCG earned in Assessment Year 2019-20. The reason being that the gains on such capital asset continue to remain exempt under section 10(38) of the Act till 31st March, 2018.
Further, it is worth noting that ideally, the cost of acquisition of bonus shares and right shares would be the Fair Market Value as on 31st January, 2018.
Tax Deduction at Source (TDS) on LTCG
As clarified vide the FAQs issued by the Government, there will be no TDS required to be withheld on the LTCG earned by a resident. However, TDS at the rate of 10% shall be withheld on payment of LTCG paid to a non-resident (other than Foreign Institutional Investor). In view of section 196(2) of the Act, there shall be no TDS on LTCG paid to a Foreign Institutional Investor.
After effects of the proposed amendment
The Sensex and Nifty (BSE and NSE), two of the premier most stock exchanges in India took a hit due to the proposed amendment of taxing LTCG on equity shares. Over a period of the next 5 days, the Sensex was trading 1,400 points lower. Financial investors have suddenly brought under the ambit of tax which has resulted in the loss of lakhs of crores of market value.
Authors- CA Devesh K. Shah is Proprietor of Devesh K. Shah & Co. And CA Megh D. Shah is associated with Devesh K. Shah & Co.