Introduction
In the words of Michael Hudson “In real estate you can avoid ever having to pay a capital gains tax, decade after decade, century after century. When you sell a property and make a capital gain, you simply turn around and buy a new property. The gain is not taxed. It’s called “preserving your capital investment” – which goes up and up in value with each transaction.”
It seems like a simplistic solution but is it really one?
The proposed Finance (No. 2) Bill 2024, w.e.f. 23 July 2024,[1] and onwards, has shaken the conscience of investors with one of its proposals for “Rationalising and Simplification of Capital gain”. It suggests the substitution of the existing mechanism of adjusting the assets cost for inflation i.e. indexation available under the second proviso of Section 48, Income Tax Act 1961 (‘IT Act’) with a rationalise rate of tax i.e. 12.5% without indexation for long-term capital gain on properties like gold and other unlisted assets. This change aims to simplify capital gains computation for taxpayers and the tax administration.[2]
These proposed amendments in the Union Budget 2024-25 have garnered mixed reactions, following which forced the government to tweak the provisions. For better understanding, this article will simplify the understanding of the Indexation for long-term capital gain, especially for real estate (Capital Asset), and explain the process of calculating the adjusted indexed taxable amount with suitable examples. It also assesses the impact assessment of the proposed amendment in Union Budget 2024-25 on the real estate sector.
Page Contents
Pre-Amendment: Overview of Indexation in Long-Term Capital Gains
According to the provisions of the IT Act, the individual’s income is taxed under five heads, one of which is income under the head ‘Capital Gain’.[3] As per Section 45(2),[4] whenever there is a transfer or conversion of capital assets into business stock, the profit from selling or conversing that stock will be taxed as income in the year it is sold. Further, this gain accrued on the transfer or conversion of short-term capital assets[5] and long-term capital assets[6] is taxed as short-term capital gain and long-term capital gain respectively.
The income chargeable under the head ‘capital gain’ except capital gain to non-resident[7] is computed on the principle of indexation. The cardinal principle of indexation is propounded by a renowned professor of Economics, Mr Edward Shapiro. According to him, ‘indexation is a method used in the taxation of capital gains income, to adjust the purchase price of an asset for inflation for accruing gain from the transfer of the assets.’ Additionally, this reflects the real income of the individual after adjusting for inflation.[8]
This indexation was introduced in 1992 vide Circular no. 636/1992[9] to ensure that the taxpayers are taxed only on real or actual gain rather than on the inflation-induced rise in the property’s capital value. This approach was also supported by the Hon’ble Delhi High Court in Arun Shungloo Trust v. CIT.[10] It was enacted to compute capital gain by allowing the purchased asset’s cost to be adjusted for inflation before calculating the gain from its sale. This effectively reduced the amount of capital gain that would be taxed.
Budget 2024: Proposed Amendments for Altering Indexation of Long-Term Capital Gains
Out of 85 amendments in the Finance Bill, 2024, the amendment regarding the taxability of long-term capital arising out of the sale or transfer of property w.e.f on and onwards 26 July 2024 has grabbed everyone’s attention. People are confused about the logic and goals behind this change. The said amendment is made under Sections 2(42), 48, 112 and 112A of the IT Act which prima facie increases the burden on the taxpayers.
Firstly, the amendment is proposed under Section 2(42) to include clause (42A) stating that there will be strict holding periods of 12 and 24 months for determining the short and long-term capital gain respectively. As a result, the holding period for all listed securities will be 12 months and for other assets including property will be 24 months.[11]
Secondly, the amendment is proposed under Proviso 2 of Section 48, stating that the method of computation for indexation (i.e. Indexed Cost of Acquisition and Indexed Cost of Improvement) shall be only applicable to the assets that are purchased before 23 July 2024.[12]
Thirdly, the amendment is proposed under clause (i) of sub-section (2) of Section 112A, stating that the rate of long-term capital gain will be 12.5% across all categories of transfer assets sold on or after 23 July 2024. The same rate was before 20% with indexation benefit under Section 112(1)(a)(ii) read with Section 48 of the IT Act.[13]
Lastly, considering the slow or stagnant growth in property rates, the finance minister has suggested the Grandfathering amendment in sub-section (1) of Section 112 to rationalise the impact of eliminating the indexation benefit. In accordance with the mentioned amendment, clauses (a), (b), (c), (d) and proviso 1 to Section 112 are substituted. It mentions that if any individual or Hindu Undivided Family (‘HUF’) made any transfer of the acquired property before the proposed amendments via Financial Bill, 2024 on or after 23 July 2024, can choose between two options to compute their taxes i.e. either by 20% with indexation benefit or by 12.5% without indexation, whichever is less. Furthermore, this clause is specifically inserted for the resident individuals and HUFs and not for any other category of assesses such as domestic companies or non-residents.[14]
Step-wise Guide to Calculate Capital Gains: Pre- and Post-Income Tax Act Amendments
Under the IT Act, the immovable assets are categorised into two groups for computing the capital gains, based on their holding period. Among these, a capital asset that is owned for 36 months or more is considered a long-term capital asset and any profit accrued on its sale is considered a long-term capital gain.[15] Further, as per Section 112, the long-term capital gain is taxable @ 20%. In the Budget 2024-25, these values have been amended which means the holding period is reduced from 36 to 24 months and the tax rate from 20% to 12.5% (without indexation).
To calculate the capital gain on assets, the formula given in Section 48 of the IT Act[16] is to be referred, which specifies that income chargeable under the head ‘capital gain’ is liable to be computed by making the following deductions:
Formula of computing Capital Gain/Loss:
| Net Sale Consideration = Sale Consideration – Expenditure of Transfer
Capital Gain/Loss = Net Sale Consideration – (CoA + CoI) |
The Proviso 2 to Section 48 provide for the indexation benefits for long-term capital assets. Thus, it means that the cost of Acquisition and Improvement shall be indexed in the same proportion as the Cost Inflation Index (‘CII’).[19] The adjustment compares the CII for the year in which the asset was transferred with the CII for the year in which it was purchased. Previously, 1986 was considered as the base year, but as per the amendment in Section 55[20] via Finance Act 2017,[21] the base year for the computation of capital gain on asset purchase before 1 April 2001, is now 2001-02. The CII is notified by CBDT every year and till date CBDT has notified CII for the Financial Year 1981-82 to 2024-25.
The formula for computing CII:
| Cost of Inflation Index = Index for the year of sale/ Index in the year of acquisition x CoA |
The Union Budget 2024, has proposed to remove this benefit of indexation on the transfer of any capital asset (long and short) acquired on or after 23 July 2024. So, the mode of computation will remain similar in both short and long-term capital assets.
Let’s look at some scenarios to understand the impact of this amendment on the taxability of the assesses.
Eg: Mr ‘P’ purchases a property for INR 16,00,000/- in the year 2001. Meanwhile, he spent INR 3,00,000/- on renovation and 35,000/- on brokerage and commission. The property was sold in 2024 for INR 90,00,000/-. Let us compute gain both as per the old and new regime.
Given: CII as per Notification No. 44/2024[22] for the Years 2001 and 2024 is 100 and 363 respectively.
| Particulars | Pre-Amendment: Computation | Post-Amendment: Computation |
| Sale Consideration | INR 90,00,000/- | INR 90,00,000/- |
| Cost of Transfers | INR 35,000/- | INR 35,000/- |
| Cost of Acquisition | INR 58,08,000/- [16,00,000 x 363/100] | INR 16,00,000/- |
| Cost of Improvement | INR 10,89,000/- [3,00,000 x 363/100] | INR 3,00,000/- |
| Gain | INR 20,68,000/- | INR 70,65,000/- |
| Tax Rate | 20% | 12.5% |
| Tax | INR 4,13,600/- [20,68,000 x 20%] | INR 8,83,125/- [70,65,000 x 12.5%] |
So, it can be observed that the tax in the post-amendment phase is more.
Let us consider another situation where the sale value of the property is INR 1,80,00,000/-. Then the capital gain and tax would be:
| Particulars | Pre-Amendment: Computation | Post-Amendment: Computation |
|
Sale Consideration |
INR 1,80,00,000/- | INR 1,80,00,000/- |
| Cost of Transfers | INR 35,000/- | INR 35,000/- |
| Cost of Acquisition | INR 58,08,000/- [1,50,00,000 x 363/100] | INR 16,00,000/- |
| Cost of Improvement | INR 10,89,000/- [3,00,000 x 363/100] | INR 3,00,000/- |
| Gain | INR 1,10,68,000/- | INR 1,60,65,000/- |
| Tax Rate | 20% | 12.5% |
| Tax | INR 22,13,600/- [1,10,68,000 x 20%] |
INR 20,08,125/- [1,60,65,000 x 12.5%] |
In this case, the tax is lower in the post-amendment regime. Hence, it can be adduced that based on the percentage rise in the property value, the newly amended provision may be beneficial.
However, there is a need to find a break-even point where we can differentiate when old and new provisions will be beneficial for prospective buyers.
Let us analyse this for the above-mentioned scenario;
- Sale value: y
- Cost of Acquisition: x
- Tax in Old provision will be: 20% (y-x)
- Tax in the New provision will be: 12.5% (y-x)
Now, the break-even point is achieved when both the tax will be equal, let us equate them:
12.5% (y-x) = 20% (y-x)
Upon solving this, we get a relation between y and x i.e. -y = 8x. This exhibits that if the sale consideration is 8 times the cost of acquisition, the assesses would be at break-even. Any consideration below this would lead a assesses in a loss due to the removal of the indexation benefit. Thus, it signifies that the assesses will have to pay less tax in the amended provisions and removal of indexation may prove to be beneficial.
However, in another situation where the purchase year is after 2001-02, a relation between the cost of acquisition and sale consideration can be derived in the same manner. However, the possibility of a new provision being beneficial cannot be ruled out as it depends on a case-to-case basis.
A Way Forward: Effects of Recent Amendments on the Real Estate Sector
Reviewing these major amendments in the capital gain head, it can be understood that these changes have negatively impacted the real estate sector. Various experts add that indexation was an advantageous move taken back in the 90s for those properties whose appreciation is closer to the inflation rates. While, present amendments could encourage short-term investment and simplify the calculation of tax for the administration, at the same time, they could have significant downsides for long-term investments.
In the words of Mr Ritesh Mehta, Senior Director, JLL Ltd.- Real Estate has always been considered a long-term investment where investors hold properties for around 10-15 years, however, now due to such amendments the investors are competing with equity, not from return perspective but from a liquidity perspective. This reflects more churning in real estate assets within 5 years of investment.[23]
Exponentially, these amendments will lead to end-users being long-term investors with higher ticket prices. Following this, in the luxury property market (value above 5 crore), about 95% will remain end-users with only a small portion being investors. In the mid-segment (value between 1-2 crore), roughly 75% will be end-users and 25% investors. Consequently, the affordable housing segment will remain unaffected, as almost all buyers are end-users and capital gain concerns would not arise without sales. However, there will be a minor dent in long-term investments, especially in Tier-II cities, where the absence of an indexation shield might make real estate less stable for new investors.
[1] The Finance (No.2) Bill, 2024, Bill no. 55/2024 dated July 23, 2024.
[2]Memorandum Explaining the Provisions in the Finance Bill, 2024, Government of India, Rationalisation and Simplification of taxation of Capital Gains, p.35, ¶ 3.
[3] Section 45, Income Tax Act 1961.
[4] Section 45(2), Income Tax Act 1961.
[5] Section 2(42A), Income Tax Act 1961.
[6] Section 2(29A), Income Tax Act 1961.
[7] Proviso 1 to Section 48, Income Tax Act 1961.
[8] Poona Electric Supply Co. Ltd. [2008] 174 Taxman 87/306 ITR 392 (SC); CIT v. Shoorji Vallabhdas & Co, [1962] 46 ITR 144; Best Trading and Agencies Ltd. v. Deputy Commissioner of Income Tax, Circle-11(2), Bangalore* [2020] 119 taxmann.com 129 (Karnataka).
[9] Central Board of Direct Taxes, Notification No. 636/1992 dated August 31, 1992.
[10] Arun Shungloo Trust v. CIT [2012] 18 taxmann.com 261/205 Taxman 456.
[11] Memorandum Explaining the Provisions in the Finance Bill, 2024, Government of India, Rationalisation and Simplification of taxation of Capital Gains, p.34, ¶ 1; The Finance (No.2) Bill, 2024, Bill no. 55/2024 dated July 23, 2024, Clause 03, p.25.
[12] Memorandum Explaining the Provisions in the Finance Bill, 2024, Government of India, Rationalisation and Simplification of taxation of Capital Gains, p.35, ¶ 3; The Finance (No.2) Bill, 2024, Bill no. 55/2024 dated July 23, 2024, Clause 20, p.33.
[13] Memorandum Explaining the Provisions in the Finance Bill, 2024, Government of India, Rationalisation and Simplification of taxation of Capital Gains, p.34, ¶ 2.1; The Finance (No.2) Bill, 2024, Bill no. 55/2024 dated July 23, 2024, Clause 31, p.33.
[14] The Finance (No.2) Bill, 2024, Bill no. 55/2024 dated July 23, 2024, Clause 30, p.41.
[15] Section 2(29A), Income Tax Act 1961.
[16] Proviso 2 to Section 48, Income Tax Act 1961.
[17] Section 55(2)(a), Income Tax Act 1961.
[18] Section 55(1)(b), Income Tax Act 1961.
[19] Section 55(2)(b) r/w Section 48 Explanation Cl (v), Income Tax Act 1961.
[20] Section 55, Income Tax Act 1961.
[21] Central Board of Direct Taxes, Notification No. 44/2017 dated June 05, 2017.
[22] Central Board of Direct Taxes, Notification No. 44/2024 dated May 24, 2024.
[23] Souptik Datta, ‘Explainer: Will changes to LTCG tax affect long-term investments in the real estate sector?’, Money Control (Lasted visited August 16, 2024) <https://www.moneycontrol.com/news/business/real-estate/explainer-will-changes-to-ltcg-tax-affect-long-term-investments-in-the-real-estate-sector12796792.html>.
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