The Indian stock markets have flourished in the past decade with investors earning huge tax-free profits – thanks to the prevailing long term capital gains exemption on Indian listed equity shares. Stockholders prefer investing in stock market as the investments have relatively shorter payback period and effectively quicker yields, as compared to other avenues of investments in India.
In the present regime, transactions of purchase and sale of equity shares or equity-oriented mutual funds which are traded on the recognized stock exchange are liable to security transaction tax (STT). Sale of such shares/units of mutual fund will result in capital gains/loss. Any capital gain arising on transfer of such long term investments are exempt under section 10(38) of the Income-tax Act, 1961 (‘the Act’). Thus, investment in listed equity shares and units of equity-oriented mutual fund for a duration of more than 1 year was a very tax effective investment option for many investors.
As per the budget speech, basis the return of income for AY 2017-18, the total amount of exempted capital gains from listed shares and units is INR 3,67,000 crores (approx.). In order to minimize the said economic distortions and curb erosion of tax base, the Hon’ble Finance Minister has proposed to withdraw the said tax exemption under section 10(38) of the Act with respect to such long term gains made on or after 1st April 2018.
Further, a new section 112A in the Act is proposed to be introduced to deal with the taxability of capital gains arising on transfer of such long-term capital assets. It provides that long-term capital gains exceeding INR 1 Lakh, 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 10%. The aforesaid amendment will come into effect from 1 April, 2019 and will, accordingly, apply in relation to the assessment year 2019-20 and subsequent assessment years.
Section 112A further provides that the long term capital gains will be computed without giving effect to the first and second proviso to section 48 of the Act, i.e. the benefit of inflation indexation in respect of cost of acquisitions and cost of improvement and the benefit of computation of capital gains in foreign currency in the case of a non-resident, if any, will not be allowed. Further, in order to claim the concessional rate of 10%, securities transaction tax should have been paid on the acquisition and transfer of equity shares and on transfer of unit of equity oriented fund or unit of business trust.
The newly inserted section further states that the cost of acquisition in respect of the long term capital asset acquired before the 1 February 2018, shall be deemed to be the higher of –
a) the actual cost of acquisition of such asset; and
b) the lower of –
(I) the fair market value of such asset; and
(II) the full value of consideration received or accruing as a result of the transfer of the capital asset.
Below is the illustration for better understanding
| Particulars | Illustration 1
(Sold before 31 March 2018) |
Illustration 2
(Sold post 1 April 2018) |
Illustration 3
(Sold post 1 April 2018) |
| Purchase price (on 1 January 2017)—A | 100 | 100 | 100 |
| Sale Price—B | 175 | 175 | 175 |
| Highest price as on 31 January 2018 on stock exchange as on 31 January 2018 (in case where unit is not listed on recognized stock exchange – NAV as on 31 January 2018 to be considered) – C | 150 | 150 | 200 |
| Deemed cost of acquisition (Higher of A or (Lower of B or C)) – D | 150 | 150 | 175 |
| LTCG as on 31 Jan 2018 (C-A) – E | 50 | 50 | 100 |
| LTCG post 31 Jan 2018 (B-C or D ) | 25 | 25 | -25 |
| Total LTCG | 75 | 75 | 75 |
| Exempt u/s 10(38) LTCG (C-A) | 75 | N.A. | N.A. |
| Taxable LTCG u/s 112A (B-C) | N.A. | 25 | Nil |
| Tax on LTCG @ 10% | Nil | 2.5 | Nil |
| Reasons | Withdrawal of section 10(38) exemption and introduction of section 112A is w.e.f 1 April 2018 i.e. AY 2019-20. As LTCG has arisen before 1 April 2018, the same shall be exempt under section 10(38) | Profits accrued till 31 January 2018 shall be exempt i.e. 50 (150 – 100) as per section 112A. Profits post 31 January 2018 shall be taxable at the rate of 10% | Profits accrued till 31 January 2018 is exempt i.e. 100 (200 – 100). Profits post 31 January 2018 shall be taxable at the rate of 10%. However, there is no profits post 31 January 2018 |
The exemption w.r.t LTCG was introduced in the year 2004 when the securities transaction tax was levied on transactions through stock market. However, in 2016 and 2017, there were amendments in the tax treaties with Mauritius and Singapore wherein capital gains taxation was re-introduced for the investments that were routed through such jurisdictions. Thus, the new provision of section 112A will be in line with the provisions under amended treaties with Mauritius and Singapore. Further, in spite of the exemption being withdrawn, the levy of securities transaction tax continues in case of such transactions.
In addition to the above, withdrawal of section 10(38) has also resulted into taxability of LTCG in the hands of Foreign Institutional Investors (FIIs) under section 115AD. Section 115AD states that FIIs shall be taxed at the rate of 10% on capital gains arising on transfer of certain securities. However, on a co-joined reading of section 115AD and 10(38), the current regime exempted the long term capital gains arising from transfer of long term capital asset being equity shares of a company or a unit of equity oriented fund or a unit of business trusts. Thus, due to withdrawal of capital gains tax exemption as per section 10(38), such long term capital gain shall also become taxable in the hands of FIIs. Here, the Finance Bill and the Memorandum is silent on the exemption granted for investments made prior to 1 February 2018 for FII investments, thus clarifications from CBDT would be much awaited in this regard.
The withdrawal of exemption for long-term capital gains will have an impact on investments made by the FIIs post 31 March 2017 especially from jurisdictions such as Mauritius, Singapore, and earmarked for sale post 31st March 2018 since for such investments now there is neither a tax benefit under the Act nor under the relevant tax treaty. However, such FIIs can claim foreign tax credits in their country of residence for the taxes paid in India. Although, the Finance Minister states the introduction of LTCG is a modest move, the reaction from the equity market does not echo the said thought. It is little surprising that when various countries are putting in conscious efforts to attract foreign investments led by the US, the Indian Government chose to cling on to less tax friendly measures such as that these.
Information for the editor for reference purposes only
Zainab Bookwala is a Manager and Risha Gandhi is a Deputy Manager with Deloitte Haskins & Sells LLP. The views expressed herein are personal and not that of the firm.
