Side Effects of Indexation Removal for long-term capital gain

Removal of indexation while calculating long-term capital gain is the most discussed proposal in the Finance (No.2) Bill 2024 presented on 23rd July, 2024.

Existing Provision before Union budget 2024

Section 48 of Income Tax Act, 1961 provides the mechanism of computation of capital gain by deducting expenditure incurred wholly and exclusively in connection with such transfer, the cost of acquisition of the asset and the cost of any improvement thereto from full consideration.

However, where long-term capital gain arises from the transfer of a long-term capital asset (other than arising from transfer of capital asset being shares in, or debentures of, an Indian company acquired using foreign currency by non-resident), the capital gain will be calculated by deducting expenditure incurred wholly and exclusively in connection with such transfer, the indexed cost of acquisition of the asset and the indexed cost of any improvement thereto from full consideration.

Amendment Proposed in Union budget 2024

Clause 20 of Finance (No.2) Bill, 2024 propose to restrict the benefit of indexed cost of acquisition and indexed cost of any improvement for the transfers which take place before 23-07-2024 only and simultaneously reduced the tax rate on long term capital gains to 12.50% from present 20% for transfers on or after 23-07-2024.

This caused major hardship particularly for long term capital gain arising from transfer of land and building or both. Various representations and concerns were expressed regarding the same.

Subsequent  Proposed Amendment related to Indexation of Capital Assets 

Considering those representations the Government granted a relief by making a provision in Section 112 of Income Tax Act, 1961 that in respect of capital gain on capital asset being land and building by resident individual or resident HUF, if the tax payable @12.50% on capital gain calculated without indexation, exceeds the tax payable @20% on capital gain calculated with indexation, the excess will be ignored.

Example 1

If Resident Individual sold a residential house in August 2024 for Rs.1 crore which was purchased by him in FY 2010-11 for Rs.25 lakh.

As tax payable as per old provision is lower, the excess of Rs.0.24 lakh (Rs.9.37 lakh minus Rs.9.13 lakh) will be ignored and assesse will need to pay capital gain tax of Rs.9.13 lakh only.

Issues

1) The amendment in Budget provides comparison of tax on capital gain @12.50% with tax on capital gain calculated as per provisions as they stood before amendment done by Finance (No.2) Bill, 2024.

Where the taxpayer wish to avail the exemption u/s 54 or 54EC but the taxpayer utilize or invest part of the amount, the deduction is restricted to utilized or invested amount.

Considering the example given above,

As tax payable as per old provision is lower, assessee will not have to pay any tax.

A clarification is needed from the Government regarding the calculation in such case as it may result into no tax is paid even if assessee has not invested entire capital gain calculated as per new provision.

2) In case the taxpayer has made transfer of house properties more than one during the same financial year, the calculation becomes more complex.

Example 2

The taxpayer also sold another house property in addition to the above mentioned in the example-1 given above in September 2024 for Rs.25 lakh which was purchased by him prior to 1^st April 2001 and its FMV as on 01-04-2001 is Rs.1 lakh.

As tax payable as per new provision is lower, assessee will have to pay 3.00 Lakh tax.

As the taxpayer sold two properties after 23-07-2024 which were acquired prior to 23-07-2024, the tax calculation as per provision of Section 112 to be calculated as under –

So as tax payable as per new provisions is less assessee will pay tax of 12.37 Lakh

In above calculation if we treat capital gain tax payable for each property separately then assessee will have to pay tax as follows –

Hence total tax payable if capital gain tax payable for each property is considered separately results to Rs.12.13 Lakh.

If calculation of tax payable is computed as per provision of section 112 then tax payable will come to Rs.12.37 whereas if tax is calculated for each property separately then tax payable is Rs.12.13 Lakh.

A clarification is also needed from the Government regarding the calculation method in such cases.

Other Practical Issues

It’s not only tax payable which taxpayer needs to consider, certain other major implications also triggered due to removal of indexation while calculating long term capital gains. The main concerns are listed below

A) Increase in investment amount u/s 54 and 54EC

Section 54 of Income Tax Act, 1961 grants exemption from capital gain to individual and HUF, if the capital gain arises from the transfer of a long-term capital asset, being buildings or lands appurtenant thereto and being a residential house is utilized by the assessee for acquisition of one residential house within specified period.

Similarly, Section 54EC of Income Tax Act, 1961 grants exemption from capital gain to assessee, if the capital gain arising from the transfer of a long-term capital asset, being land or buildings or both is invested in the long-term specified asset within a period of six months after the date of such transfer.

Due to removal of indexation, the capital gain will be calculated as difference between sale consideration and cost of acquisition and cost of improvement instead of indexed cost of acquisition and indexed cost of improvement. Accordingly capital gain will be more without indexation and as both these section requires utilization of capital gain, the amount to be utilized or invested will be more.

Considering the example-1 given above, as the capital gain without indexation is Rs.75 lakh, he needs to utilize or invest Rs.75 lakh as against Rs.45.66 lakh, if indexation benefit was available, amounting to Rs.29.34 lakh more to be utilized or invested.

B) Increase in total income may attract Surcharge

The Total Income of the taxpayer will increase due to additional amount of Capital gain included while calculating Total Income which can make the assesse liable to Surcharge and even higher rate of surcharge.

Considering the example-1 given above, if his other income was just Rs.3 lakh, with the capital gain as per the old calculation with indexation, his total income will be worked out to be Rs.48.66 lakh.

However, with the capital gain as per new calculation without indexation his total income will be worked out to be Rs.78 lakh.

As the total income works out to be more than 50 lakh, he will be liable to pay Surcharge @10% on total tax payable including tax on normal income and tax on capital gains.

C) Requirement of providing Asset and Liabilities in Return

The income tax return requires details of assets and liabilities if total income exceeds Rs.50 lakh and thus in such case as above, requirement to provide the details of assets and liabilities will be an additional compliance.

Conclusion-

The amendment has given relief in case of tax payable but still certain issues for taxpayer remains since the relief is not given the way Capital Gain is calculated but by way of tax payable thereon.

The views expressed in this article are author’s personal view as per his understanding of the provisions as they prevail today and it should not be construed as tax advice.

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Author –

CA Sunil Dandekar

7^th August 2024.