Changes in respect of LTCG in respect of FY 2018-19 ( AY 2019-20)

Changes in respect of Long Term Capital Gain in respect of FY 2018-19 ( AY 2019-20)

Introduction

With Union Budget 2018, Hon’ble Finance Minister Arun Jaitley has sought to rationalize long-term capital gains (LTCG) from listed equity shares, units of quits of equity oriented mutual funds and units of business trust.

Current Scenario:

“With the reforms introduced by the government and incentives given so far, the equity market has become buoyant. The total amount of exempted capital gains from listed shares and units is around Rs. 3,67,000 crores as per returns filed for A.Y.17-18.” said FM in the Budget speech. Most Importantly, major part of this gain has accrued to corporates and LLPs. In business terms, this means all surpluses and profits are being invested in financial assets such as equity shares and mutual. This might look a good benefit, but another side of the coin is that the same funds, if not invested, would have been used for manufacturing.

With Union Budget 2018, It is proposed to tax such long-term capital gains exceeding Rs. 1 lakh at the rate of 10% without allowing the benefit of any indexation.

 However, all gains up to 31st January, 2018 will be grandfathered. In other words, long-terms capital gains made on investments up to January 31, 2018, will not be taxed. Also, the existing short-term capital gains tax, applicable on profits made on investments below one year, remains the same at 15 percent.

The finance minister also introduced a 10 percent tax on distributed income by equity-oriented mutual funds at the rate of 10 percent. As this will create, a level playing field across growth-oriented funds and dividend distributing funds.

The gains from equity share held up to one year will remain short-term capital gain and will continue to be taxed at the rate of 15%. “In view of grandfathering, this change in capital gain tax will bring marginal revenue gain of about Rs. 20,000 crores in the first year. The revenues in subsequent years may be more” said FM justifying the amendment in the taxation regime.

Budget 2018 has proposed to delete Section 10(38) of the Income-tax Act, 1961, which has so far, provided for an exemption from tax, 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. This section was initially introduced vide Finance Act, 2004 with effect from AY 2005-06, on the basis of the Kelkar Committee report to attract investments from Foreign Institutional Investors (FII).  However, Short Term Capital Gains (STCG) on the transfer of Equity Shares or Units of an Equity Oriented Mutual Fund on which Securities Transaction Tax (STT) is paid, is currently taxable at the rate of 15% and this position remains untouched in the budget too.

The taxation rules in regards to LTCG and STCG on business trusts i.e. Real Estate Investment Trust (REIT) and Infrastructure Investment Trust (InvIT) are similar to what has been stated above.

Proposal of introduction of Section 112A

In Budget 2018, with the withdrawal of Sec 10(38), there is a proposal of a parallel introduction of Section 112A to tax LTCG on sale of

• Equity shares,
• Units of equity oriented funds or
• Units if business trusts

at a concessional rate of 10% on the gains in excess of Rs. 1 lakh without providing the benefits of indexation or the benefit of computation of capital gains in foreign currency in the case of non-residents.

Applicability

The provisions of this section will apply from the Financial Year (FY) 2018-19 i.e. AY 2019-20. This otherwise means, any transfer carried out after 1 April 2018, resulting in LTCG in excess of Rs 1 lakh will attract tax at the rate of 10 percent.

Proposal to grandfather investments made up to 31 January 2018

There is also a proposal to grandfather investments made on or before 31 January 2018. To explain this further, a method of determining the Cost of Acquisition (“COA”) of such investments has been specifically laid down according to which the COA of such investments shall be deemed to be the higher of-

1. The actual COA of such investments; and

2. The lower of-

• Fair Market Value (‘FMV’) of such investments; and
• the Full Value of Consideration received or accruing as a result of the transfer of the capital asset i.e. the Sale Price

Further, the FMV would be the highest price quoted on the recognized stock exchange on 31 January 2018. In case there is no trading of the said asset in such stock exchange, the highest price on a day immediately preceding 31 January 2018 shall be considered to be the FMV. In effect, the taxpayer can claim the highest price quoted on the recognized stock exchange on 31 January 2018 as the COA and claim the deduction for the same.

The computation mechanism has been further explained by way of the following example under various scenarios:

Particulars	Scenario A	Scenario B	Scenario C	Scenario D
Purchase Price on 1/1/2017	100	100	100	100
FMV on 31/1/2018	200	200	50	200
Sale Price 1/4/2018 (X)	250	150	150	50
COA (based on prescribed method of computation) (Y)	200	150	100	100
Capital Gains / (Loss) (X-Y)	50	Nil	50	(50)

Given below is further analysis of the LTCG implications of the certain other scenarios which will help understand the proposed amendment better:

Sl No	Scenario	Tax Implications
1	Purchase and sale before 31/1/2018	Exempt under Section 10(38)
2	Purchase before 31/1/2018 Sale after 31/1/2018 but before 1/4/2018	Exempt under Section 10(38)
3	Purchase before 31/1/2018 Sale on or after 1/4/2018	LTCG taxable Gains accrued before 31/1/2018 exempt Capital Gains computed in the manner as discussed above
4	Purchase after 31/1/2018 Sale on or after 1/4/2018	LTCG taxable Capital Gains computed in the manner as discussed above

 Note: The above table has been prepared with a presumption that all gains are long term.  

 LTCG on transfer of bonus and rights shares acquired on or before 31 January 2018

The LTCG for these shares will be arrived at by considering the FMV on 31 January 2018 as the COA of such shares thereby exempting gains until 31 January 2018 from tax.

Carry forward of Long-Term Capital Losses (“LTCL”) on sale of such shares

The income tax department has vide its FAQs issued dated 4 February 2018, inter alia clarified that LTCL from a transfer made on or after 1 April 2018 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 LTCGs and unabsorbed LTCL can be carried forward to subsequent eight years for set-off against LTCG.

Following are the few examples how this change will work and impact on the investors:

If you bought a share for Rs 100 and have held it for more than 12 months (to qualify for LTCG) ; and say the fair market value of the asset on 31.01.2018 is Rs 150 and you sell it for Rs 180 on 1.5.2018 then the cost of acquisition of this share would be Rs 150. You would (for tax purposes) have realised LTCG of Rs 180 minus Rs 150 i.e. Rs 30.

If you sold the share for Rs 110 on 1.5.2018 then your cost of acquisition would be Rs 110.

If you sold the share for Rs 90 on 1.5.2018 then your cost of acquisition would be Rs 100.

For shares or equity MF units bought after 31.1.2018, capital gain would be computed as = Selling price – actual cost of acquisition (without indexation).

2. Indexation of the cost of acquisition (determined as per above formula) will not be allowed. Setting off cost of transfer or improvement of the share/unit will also not be allowed.

3. Therefore, cost of acquisition is determined as per formula explained above, this cost will be subtracted from the sale value and the LTCG will be arrived at.

4. This LTCG will be taxed at 10% for all listed equity shares where STT is paid on purchase and sale and at 10% for units of equity oriented MFs where STT is paid on the sale of these units . As STT is paid/deducted if you sell your equity MF units back to the MF or on the stock exchange the new LTCG regime would apply to these.

This means that the LTCG tax regime would be unchanged for unlisted equity shares where STT is not paid on purchase or sale.

Impact: 

The impact is not as bad as first glance because of provision which allows the cost of acquisition to be taken as the market value on 31.1.2018 (as per formula above). This is because this provision in a sense indexes the actual cost of acquisition up to this date despite removing the indexation of the actual cost of acquisition, she says. This reduces the amount of capital gains that would face the 10% tax. Essentially for a person selling after 31.3.2018, only the actual gains after 31.1.2018 would be taxed, she adds. However, obviously a 10% tax has been levied on the capital gains calculated as above which was not there earlier.

1. An equity share is acquired on 1st of January, 2017 at Rs. 100, its fair market value is Rs. 200 on 31st of January, 2018 and it is sold on 1st of April, 2018 at Rs. 250. As the actual cost of acquisition is less than the fair market value as on 31st of January, 2018, the fair market value of Rs. 200 will be taken as the cost of acquisition and the long-term capital gain will be Rs. 50 (Rs. 250 – Rs. 200).

2. An equity share is acquired on 1st of January, 2017 at Rs. 100, its fair market value is Rs. 200 on 31st of January, 2018 and it is sold on 1st of April, 2018 at Rs. 150. In this case, the actual cost of acquisition is less than the fair market value as on 31st of January, 2018. However, the sale value is also less than the fair market value as on 31st of January, 2018. Accordingly, the sale value of Rs. 150 will be taken as the cost of acquisition and the long-term capital gain will be NIL (Rs. 150 – Rs. 150).

3. An equity share is acquired on 1st of January, 2017 at Rs. 100, its fair market value is Rs. 50 on 31st of January, 2018 and it is sold on 1st of April, 2018 at Rs. 150. In this case, the fair market value as on 31st of January, 2018 is less than the actual cost of acquisition, and therefore, the actual cost of Rs. 100 will be taken as actual cost of acquisition and the long-term capital gain will be Rs. 50 (Rs. 150 – Rs. 100).

4. An equity share is acquired on 1st of January, 2017 at Rs. 100, its fair market value is Rs. 200 on 31st of January, 2018 and it is sold on 1st of April, 2018 at Rs. 50. In this case, the actual cost of acquisition is less than the fair market value as on 31st January, 2018. The sale value is less than the fair market value as on 31st of January, 2018 and also the actual cost of acquisition. Therefore, the actual cost of Rs. 100 will be taken as the cost of acquisition in this case. Hence, the long-term capital loss will be Rs. 50 (Rs. 50 – Rs. 100) in this case.

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