Grandfathering provisions under Capital Gains

By Finance Act, 2018 the grandfather clause has been introduced in respect of investment made on or before 31 January 2018 in equity shares or units of an equity-oriented mutual fund.

Grandfather provision means – a grandfather clause/grandfather policy/grandfathering is a provision in which an old rule continues to apply to some existing situations while a new rule will apply to all future cases. Those exempt from the new rule are said to have grandfather rights or acquired rights, or to have been grandfathered in.

A proposal was made by Finance Act 2018 to remove Section 10(38) of the Income Tax Act, 1961 (‘IT Act’) which provides that the Long-Term Capital Gains (‘LTCG’) arising on sale of equity shares or units of an equity-oriented mutual fund on which Securities Transaction Tax (‘STT’) is paid was exempt from taxation.

It is noted that Short-Term Capital Gains (‘STCG’) on the transfer of equity shares or units of an equity-oriented mutual fund on which STT is paid, is taxable at the rate of 15%.

The Finance Act 2018 introduced Section 112A of IT Act by withdrawing Section 10(38).  Section 10(38) has been withdrawn w.e.f. 1^st April 2019 by inserting a proviso to Section 10(38) as under-

“Provided also that nothing contained in this clause shall apply to any income arising from the transfer of long-term capital asset, being an equity shares in a company or a unit of an equity-oriented fund or a unit of a business trust made or after the 1^st day of April, 2018.”

With the insertion of Section 112A of IT Act, a corresponding clause was also inserted in Section 55 of IT Act. Clause (ac) of subsection 2 of section 55provides for the determination of Cost of Acquisition of an asset referred to in Section 112A.

Section 112A was inserted by the Finance Act 2018 to tax long-term capital gains from the sale of listed equity shares, units of equity-oriented mutual funds and units of business trust. The schedule 112A brought to tax gains which were earlier exempt until Financial Year (FY) 2017-18 (i.e. AY 2018-19). Earlier, section 10(38) allowed a capital gains exemption from the sale of listed equity shares, units of mutual fund and business trust.

The LTCG tax is applicable at a rate of 10% on gains over and above Rs 1 lakh a year, and there is no benefit of indexation. The provisions of this section will apply from the FY 2018-19, i.e. AY 2019-20. This otherwise means any transfer carried out after 1 April 2018, resulting in LTCG above Rs 1 lakh, will attract tax at the rate of 10%.This means LTCG covered under section 112A are not taxable up to Rs 1 lakh per financial year. The gains exceeding Rs 1 lakh are liable to tax at 10% plus education cess and applicable surcharge.

A resident Individual or HUF whose total income after reducing the long-term capital gains is below the basic exemption limit, and then the long-term capital gains stand reduced by such shortfall.Let us suppose, a taxpayer’s total income is Rs 4,00,000 and (net) LTCG under section 112A is Rs 2,00,000. Here, the balance income after reducing LTCG is Rs 2,00,000 which is below the basic exemption limit. The amount by which the reduced total income falls short of basic exemption limit is Rs. 50,000 (Rs 2,50,000 – Rs 2,00,000). The taxable LTCG will be Rs 1,50,000 (Rs 2,00,000 – Rs 50,000).

This section further provides that when an assessee has income from Long Term Capital Gain, no deduction under Chapter VI-A will be allowed against LTCG. However, where the gross total income of an assessee includes LTCG under section 112A, the deduction under Chapter VI-A shall be allowed from gross total income as reduced by such capital gain.

Cost of Acquisition

With the insertion of section 112A, a corresponding clause was also inserted in section 55. Clause (ac) of subsection 2 of section 55 provides for the determination of Cost of Acquisition of an asset referred to in Section 112A. Accordingly, where a Capital asset referred in section 112A is acquired before 1st February, 2018, the Cost of Acquisition of such asset shall be the higher of:-

(i) Cost of Acquisition of the asset and

(ii) Lower of–

A. Fair market value of the asset as on 31st January, 2018 and

B. Full value of consideration received or receivable as a result of the transfer of the capital assets.

After combined perusal of the above provisions of section 112A and Clause (ac) of subsection 2 of section 55 of IT Act, the following scenarios may be seen as under-

1. Purchase and Sale before 1/02/2018.

In this case, the entire Capital Gain shall be exempt under section 10(38) of IT Act (if the same is LTCG).

2. Purchase before 01/02/2018 and sale before 01/04/2018.

In this case, the Cost of Acquisition will be determined as per clause (ac) of section 55 of IT Act, as the asset is purchased before 1st February, 2018. However, the provisions of Section 112A of IT Act is not applicable as the Section 112A has been inserted by the Finance Act, 2018 w.e.f. 01/04/2019 (i.e.the transfer has taken place before 1st April, 2018). In this case, the entire Capital Gain shall be exempt under section 10(38) of IT Act (if the same is LTCG).

3. Purchase before 01/02/2018 and sale on or after 01/04/2018.

In this case, Section 10(38) of IT Act is not applicable as the same has been withdrawn w.e.f. 01/04/2018. Further, the Cost of Acquisition will be determined as per clause (ac) of section 55 of IT Act, since the asset is acquired before 1st February, 2018. Also, the provisions of Section 112A shall apply since the transfer has taken place on or after 1st April, 2018 (subject to transfer is of long-term capital asset). Therefore, any LTCG in excess of Rs. 1,00,000 shall be taxed at the rate of 10% under section 112A.

4. Purchase on or after 01/02/2018 and sale before 01/04/2018.

In this case, the provisions of Section 112A of IT Act is not applicable as the Section 112A has been inserted by the Finance Act, 2018 w.e.f. 01/04/2019 (i.e.the transfer has taken place before 1st April, 2018). Moreover, since the asset is transferred within a period of 3 months, the same shall be considered as Short-Term Capital Asset and any gain shall be charged to tax in accordance with the provisions of Section 111A.Thereofre, Section 10(38) of IT Act is also not applicable as the same is applicable in case of Long-Term Capital Assets.

5. Purchase on or after 01/02/2018 and sale on or after 01/04/2018.

In this case, the Cost of Acquisition will not be determined as per clause (ac) of subsection 2 of section 55 of IT Act, since the asset is acquired on or after 1st February, 2018. However, the provisions of Section 112A shall apply since the transfer has taken place on or after 1st April, 2018 (subject to transfer is of long-term capital asset). Therefore, any LTCG in excess of Rs. 1,00,000 shall be taxed at the rate of 10% under section 112A.

Remark: Please note that in case where the provision of Section 112A of the IT Act is applicable, the benefit of indexation is not available to the asset.

*****

Disclaimer: Nothing contained in this document is to be construed as a legal opinion or view of either of the author whatsoever and the content is to be used strictly for informational and educational purposes. While due care has been taken in preparing this article, certain mistakes and omissions may creep in. the author does not accept any liability for any loss or damage of any kind arising out of any inaccurate or incomplete information in this document nor for any actions taken in reliance thereon.