Budget 2018: The return of tax regime for Long-Term Capital Gains in a new Avatar

The proposal in the Finance Bill 2018 to reintroduce tax on long-term capital gains on shares has created confusion amongst taxpayers and investors. CA Vyomesh Pathak has analyzed the proposed amendments and explained their implications with reference to practical examples

1. Over the past few weeks, even before the Budget session for the year 2018-19 started, there were already rounds of speculations going around that the Government is keen on bringing back the tax regime on the Long Term Capital Gains on sale of shares.

2. Just over a year ago, the Hon’ble Prime Minister Narendra Modi in one of his speech had mentioned that

“Those who profit from financial markets must make a fair contribution to nation-building through taxes. For various reasons, the contribution of tax from those who make money on the markets has been low. To some extent, the low contribution of taxes may also be because of the structure of our tax laws. Low or zero tax rate is given to certain types of financial income. I call upon you to think about the contribution of market participants to the exchequer. We should consider methods for increasing it in a fair, efficient and transparent way.”

3. The above speech made the intentions of the Government very clear that it wants to levy tax on the Long Term Capital Gains (LTCG), considering the fact that Short Term Capital Gains (STCG) is already subject to 15 percent tax, and it is only the LTCG which enjoyed zero tax rate.

4. Therefore, it was just a matter of time that this announcement was coming. Having said the above, there was also another school of thought which believed that this being the last full budget of the Modi Government before the General Elections in 2019, and also that the Stock Market which is currently bullish, may react negatively to such a levy of tax, the Government may not re-introduce the tax levy on LTCG.

5. Amidst the above backdrop, the Finance Minister in his Budget Speech made on 1 February 2018, proposed to levy tax of 10 percent on LTCG on transfer of listed Equity Shares, units of Equity Oriented Funds and also units of Business Trusts. An attempt has been made in the below article to analyse the provisions of the proposed amendments and the implications of the same.

(FM Arun Jaitley explains long term capital gain)

Brief Legislative Background and the current regime of the Capital Gains Taxation in India

6. Finance Act, 2004 introduced the exemption on LTCG with effect from AY 2005-06 by virtue of section 10(38), on the basis of the Kelkar Committee report with a view to attract investments from Foreign Institutional Investors (FII). The LTCG on transfer of Equity Shares or Units of an Equity Oriented Mutual Fund on which Securities Transaction Tax (STT) is paid is currently exempt from tax.

7. In the case of resident tax payers, the LTCG on transfer of any other asset (including shares and securities) other than those covered above is subject to a tax at the rate of 20 percent (subject to indexation benefits).

8. In the case of listed shares and securities on which STT is not paid, an option is available to pay the tax at the rate of 10 percent on LTCG without claiming the indexation benefits. The non-resident tax payers are liable to pay tax on LTCG [which is not exempt u/s 10(38)] at the rate of 10 percent without any indexation benefits.

9. Further, Finance Act, 2017 amended the provisions of section 10(38) by incorporating a provisio to deny exemption on LTCG in case the equity shares if at the time of purchase of the said shares, STT is not chargeable. This amendment intended to curb the malpractices of penny stocks to claim the exemption of LTCG. However, the Central Board of Direct Taxes (CBDT) vide notification dated 5 June 2017 provided few exclusions to this provisio whereby the exemption under section 10(38) will continue in the case of certain acquisitions being genuine transactions which inter alia include acquisition of listed equity shares in a Company- which has been approved by Supreme Court, National Company Law Tribunal (NCLT), Securities Exchange Board of India (SEBI) or Reserve Bank of India (RBI); by a non-resident in accordance with Foreign Direct Investment (FDI) guidelines; acquisition under ESOP or ESPS framed by SEBI; acquisition by mode of specified transfer which are exempt under section 47 etc.

10. As far as STCG is concerned, STCG on 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 percent.

11. Similar taxation regime also exists for the units of Business Trusts i.e. Real Estate Investment Trust (ReIT) and Infrastructure Investment Trust (InvIT).

12. The summary of existing regime of taxability of Capital Gains is tabulated below for ease of reference-

Category of Assessee	Nature of Asset	Nature of Gain	Taxability
Resident/Non-resident	Listed Shares STT paid at the time of sale þ STT paid at the time of purchase þ	LTCG	Exempt u/s 10(38)
	Listed Shares STT paid at the time of sale þ STT paid at the time of purchase ý (covered by exceptions notified by CBDT like ESOPs/bonus etc.)	LTCG
Resident	Listed Shares STT paid at the time of sale þ STT paid at the time of purchase ý (not covered by exceptions notified by CBDT)	LTCG	Section 112- 20% with indexation/10% without indexation (whichever is beneficial) Individual/HUF can utilize the unutilized Basic Exemption Limit
Resident	Listed Shares STT paid at the time of sale ý STT paid at the time of purchase ý (eg. off market transactions like private placements)	LTCG
Non resident	Listed Shares STT paid at the time of sale þ STT paid at the time of purchase ý (not covered by exceptions notified by CBDT)	LTCG	Section 112 – 10% along with benefit of first proviso to Section 48 [Cairn India(Delhi HC)] * If the shares are not of Indian company & benefit under first proviso is not available, then Section 112- 20% with indexation/10% without indexation (whichever is beneficial)
Resident	Zero Coupon Bonds	LTCG	Section 112- 20% with indexation/10% without indexation (whichever is beneficial)
Resident	Unlisted shares	LTCG	Section 112 – 20% with indexation
Non resident	Unlisted shares (including shares of private company)	LTCG	Section 112 – 10% but no benefit of first proviso to Sec. 48
Resident/Non-resident	Listed shares STT paid at the time of sale þ STT paid at the time of purchase þ	STCG	Section 111A – 15%
	Listed shares STT paid at the time of sale þ STT paid at the time of purchase ý	STCG	Section 111A – 15%
	Unlisted shares	STCG	Normal rates

Proposed amendment by the Finance Bill, 2018 for taxation of Long Term Capital Gains

13. The Finance Minister, while presenting the Budget on 1 February 2018 proposed to withdraw the above exemption available under section 10(38) and by inserting a new section 112A under the Act. The proposed new section 112A intends to levy tax at a concessional rate of 10 percent on the LTCG exceeding Rs. 1 lakh on transfer of listed Equity Shares, units of Equity Oriented Funds and also units of Business Trusts computed without any indexation benefit or benefit of computation of capital gains in foreign currency in the case of non-residents (first provisio to section 48).

14. The taxability will trigger prospectively from the Financial Year (FY) 2018-19 corresponding to Assessment Year (AY) 2019-20. Thereby any LTCG exceeding Rs. 1 lakh on the above assets arising on or after 1 April 2018 will attract tax at the rate of 10 percent.

15. It is worth noting that in the case of listed Equity Shares, the benefit of concessional rate is available only when the STT is paid at the time of acquisition as well as transfer of shares.

16. Further, it is also proposed to grandfather the existing investments made upto 31 January 2018. The cost of acquisition in respect of such grandfathered investments shall be deemed to be the higher of-

a. The actual cost of acquisition of such investments; and

b. The lower of-

i. Fair Market Value (‘FMV’) of such investments; and

ii. the Full Value of Consideration received or accruing as a result of the transfer of the capital asset.

17. The FMV has been defined to mean the highest price quoted on the recognised stock exchange on 31 January 2018. In case, there is no trading of the said asset on such stock exchange, the highest price on a day immediately preceding 31 January 2018 shall be considered.

18. Effectively, the tax payer can claim the highest price quoted on the recognised stock exchange on 31 January 2018 as the cost of acquisition and claim the deduction for the same.

19. Please refer the below example for ready reference to understand the computation mechanism for LTCG and tax thereon-

Date of acquisition	1 November 2016
Purchase Price on 1 November 2016	Rs. 100
Highest Price quoted on recognised stock exchange on 31 January 2018	Rs. 180
Date of sale	2 April 2018
Sale Price	Rs. 200
Actual Gain	Rs. 100
Cost of Acquisition as per section 112A [Higher of 100 or (lower of 200 or 180)	Rs. 180
Long Term Capital Gain (LTCG) (200-180)	Rs. 20
Tax on LTCG at the rate of 10 percent (excluding surcharge and cess)	Rs. 2

Also, listed below are few scenarios for calculating LTCG on transfer of listed equity shares for ease of reference-

Particulars	Scenario 1	Scenario 2	Scenario 3	Scenario 4
Purchase Price as on 3 April 2015 (A)	1000	1000	1000	1000
Quoted Price on 31 January 2018 (B)	1800	1200	800	800
Sale Price on 9 May 2018             (C)	2000	1100	900	700
Cost of Acquisition as per section 112A (D) = [Higher of A and (lower of B and C)]	1800	1100	1000	1000
LTCG (E) = (C) minus (D)	200	Nil	(100)	(300)

Few issues / points for consideration and comments thereon-

20. Appended below are few issues / points based on the analysis or queries raised generally.

i. Whether tax is payable for sale of Equity Shares or Units of Equity Oriented Mutual Funds between 1 February 2018 to 31 March 2018?

Based on the reading of the Finance Bill, 2018 and the Memorandum to the same, the amendment is applicable prospectively from AY 2019-20 pertaining to FY 2018-19. Therefore any LTCG arising on or after 1 April 2018 will be subject to tax at the rate of 10 percent and any LTCG arising during the period 1 February 2018 to 31 March 2018 will not be subject to tax.

ii. Whether the benefit of the concessional rate of 10 percent will be available in the case of shares acquired by way of ESOP or as per the scheme approved by NCLT or court etc wherein the STT is not paid at the time of acquisition?

Plain reading of the provisions of the Finance Bill suggest that the concessional rate will be applicable in the case of Equity Shares, only when STT is paid both at the time of acquisition as well as at the time of transfer.

However, it may be worth noting that similar conditions were introduced by Finance Act 2017 for claiming exemption under section 10(38). Subsequently, as mentioned above, CBDT had vide notification dated 5 June 2017 provided few exclusions to this provisio whereby the exemption under section 10(38) will continue in the case the certain acquisition which inter alia include acquisition of listed equity shares in a Company- which has been approved by Supreme Court, National Company Law Tribunal (NCLT), Securities Exchange Board of India (SEBI) or Reserve Bank of India (RBI); by a non-resident in accordance with Foreign Direct Investment (FDI) guidelines; acquisition under ESOP or ESPS framed by SEBI; acquisition by mode of specified transfer which are exempt under section 47 etc.

Considering the fact that section 10(38) is now proposed to be withdrawn, it will be interesting to see if reliance can still be placed on the above notification. It would be appropriate for Government to issue some clarification in this regard for genuine transactions and provide relief to the transactions listed in the earlier notification.

iii. If the LTCG on transfer of listed Equity Shares is say Rs. 150,000, whether only Rs. 50,000 will be charged to tax or entire Rs. 150,000 will be charged to tax?

Section 112A(2)(i) as proposed in the Finance Bill 2018 provides that income-tax shall be calculated on LTCG exceeding one lakh rupees. Therefore, on a reading of the said provisions, it is possible to take a view that only Rs. 50,000 should be charged to tax and not the entire Rs. 150,000.

iv. What is the relevance of the cut-off date of 31 January 2018?

It is proposed to grandfather the investments upto 31 January 2018. Any incremental LTCG over and above the highest quoted price on the recognised stock exchange on 31 January 2018 will be liable to tax, if the transfer takes place on or after 1 April 2018.

Conclusion

21. The exemption was provided to LTCG with a view to invite investments from FIIs and other global investors. Indian Capital Market over the years has yielded great return on investments to the investors. However, the contribution to the tax exchequer has been minimal in view of the aforesaid exemption. If we have to look at global scenario today, no tax on capital gains is a rare scenario, not denying the fact that there are few countries which do provide exemption on capital gains. For instance, if you look at other major countries around the world, Australia, Canada, US and major European countries do have capital gains tax regime and infact many countries also have a higher tax rate as compared to the concessional 10 percent rate proposed in India.

22. Having said the above, the investors and the Market as a whole may not welcome the withdrawal of the exemption on LTCG and it would be interesting to see how the Market reacts in a long run to the said amendment.

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