Many months before the presentation of the Union Budget 2018 on 1 February 2018, newspaper reports had predicted the possibility of re-introduction of tax on long-term capital gains arising from transfer of listed equity shares / units of equity oriented mutual funds / units of business trust (‘specified assets’). These predictions have come true and the Government has indeed withdrawn the tax exemption available to such gains since over a decade under section 10(38) of the Income-tax Act, 1961 (‘the Act’) and proposed to introduce section 112A of the Act which provides for levy of tax of 10% (plus applicable surcharge and cess) on such gains.
A summary of the proposed tax provisions is as under:
|Type of securities||Listed equity shares of a company / equity oriented fund / units of business trust|
|Effective date||Gains arising from qualifying transfers on or after 1 April 2018|
|Nature of gains||Long-term i.e. assets held for more than 12 months|
|Threshold of taxable gains||Gains exceeding INR 100,000|
|Computation of taxable gains||Benefit of cost indexation (for residents) or foreign currency conversion (for non-residents) will not be available.
Accordingly, the computation will broadly be INR sale consideration less INR purchase consideration.
|Grandfathering of gains up to 31 January 2018||The deemed INR purchase consideration will be higher of:
a. Actual cost of acquisition, and
b. Lower of
– Fair market value (i.e. the highest price quoted on a recognized stock exchange on or near 31 January 2018 in case of listed asset or net asset value in case of unlisted units); and
– Full value of consideration received or accruing as a result of the transfer
|Tax rate||10% (plus applicable surcharge and cess)|
|Conditions||Securities Transaction Tax (STT) should have been paid: For equity share – on purchase and sale (as applicable) For unit – on sale|
|Exceptions||Qualifying transfers on IFSC and list of transactions to be notified|
The above mentioned provisions are applicable to all investors i.e. whether resident or non-residents (including Foreign Portfolio Investors [FPIs]). However, non-resident investors would be eligible to apply provisions of the applicable tax treaty with India, subject to furnishing of requisite documents such as Tax Residency Certificate (TRC), Form 10F, etc.
Broadly speaking, the provisions can be pictorially explained as under:
1. What would be the various permutations and combinations for computing deemed cost of acquisition for gains grandfathered upto 31 January 2018?
We have tried to provide a few illustrations below for ease of understanding:
|Particulars||Situation 1||Situation 2||Situation 3||Situation 4|
|A. Actual Purchase Cost||100||100||100||100|
|B. Fair Market Value as on 31 January 2018||90||125||130||120|
|C. Full Value of Consideration||120||85||120||135|
|D. Lower of Band C||90||85||120||120|
|E. Deemed cost of acquisition (Higher of A and D)||100||100||120||120|
|Capital Gains/ (Loss) (C – E)||20
Accordingly, it can be observed in Situation 4 that due to the grandfathering provisions, the taxpayer is protected from taxation on gains accrued up to 31 January 2018 and hence, the taxable gain is only 15 as against actual gain of 35. While in no situation will the taxable gains be higher than the actual gains, the actual loss of the taxpayer will always be available. Accordingly, this is a commendable effort on the part of the government. However, due care will have to be taken by taxpayers to ensure that the computation of deemed cost of acquisition is prepared correctly.
2. Since such gains would now be taxable under section 112A of the Act, would the losses on such specified assets post 1 April 2018 be available for set-off against taxable long-term capital gains / carry forward for set-off in future?
Yes, such losses would now be available for set-off against taxable long-term capital gains / carry forward for set-off for 8 subsequent years. This has also been clarified by the Central Board of Direct Taxes [CBDT] vide responses provided on 4 February 2018.
3. While no deduction of tax (TDS) is required on payment of such taxable gains to a resident investor or Foreign Portfolio Investor (FPI) (section 196D of the Act), would TDS be deductible on payment to other non-resident seller?
Technically, every payment of capital gains to a non-resident (other than a FPI) is liable to TDS under section 195. This is also the position of the CBDT vide responses provided on 4 February 2018. However, considering in normal circumstances the payer of the capital gains would not be aware whether the seller on the stock exchange is a non-resident, the performance of this obligation becomes next to impossible. In fact, this would also be difficult for the tax authorities to monitor and enforce. Accordingly, practical application of such TDS provisions may be difficult for both taxpayers and tax authorities.
4. What would be the transactions which would be exempted from the conditions regarding payment of STT (on sale / purchase, as applicable)?
The CBDT has clarified that the notification issued earlier under section 10(38) of the Act is proposed to be applied for section 112A of the Act as well. It may be noted that to provide tax exemption to genuine cases where STT could not be paid on purchase, CBDT had issued a Notification on 5 June 2017 providing carve outs for transactions:
– approved by Supreme Court, National Company Law Tribunal (NCLT), Securities Exchange Board of India (SEBI) or Reserve Bank of India (RBI);
– where shares were acquired under employee stock option scheme (ESOP) or employee stock purchase scheme (ESPS) framed under SEBI guidelines;
– where shares were acquired by a non-resident in accordance with Foreign Direct Investment (FDI) guidelines; etc.
Accordingly, the CBDT is expected to take into account all comprehensive genuine situations while notifying the transactions which would not be denied concessional tax rate under section 112A due to non-payment of STT (as applicable).
While many issues have been clarified, certain questions / issues still require express clarification:
|1. What would be the position on grandfathering of gains for shares acquired after 1 February 2018 but on conversion of capital instruments bought before 1 February 2018?||Availability of such grandfathering to such gains seems difficult considering the provisions of the law.|
|2. Would an express provision on requirement to pay STT on purchase only if share is acquired on or after 1 October 2004 be introduced (similar to section 10(38) of the Act) even though this has been clarified by the CBDT in its responses of 4 February 2018?||While this express provision is desirable, even in absence of the same, CBDT’s clarification should be enough to apply section 112A of the Act in such cases. Also, the argument of impossibility of performance should be sufficient.|
|3. Can a position be adopted that if a loss arises to the taxpayer due to provisos to section 48 regarding cost indexation (for residents) or foreign currency conversion (for non-residents), then section 112A will not apply considering that computation sections override sections providing rates of tax?||This proposition is already under contemplation in context of section 112 of the Act (long-term capital gains from unlisted securities). Now, the issue is equally relevant in context of section 112A of the Act. While this kind of interpretation is possible based on facts of the case, the risk of litigation with tax authorities would remain.|
Many more issues are expected to arise as and when the provisions are practically applied by professionals / taxpayers in the future. It is hoped that timely resolution of these queries by the CBDT would go a long way in creating an environment of certainty for investors.
In the meantime, it can be concluded that while the investor community is finding the proposal to reintroduce the tax on long-term capital gains of the specified assets to be a bitter pill to swallow, an honest effort has been made by the Government to stick to its promise of not levying retrospective taxes by grandfathering the gains earned up to 31 January 2018.