Decoding LTCG tax

Decoding LTCG tax

The reinstatement of the long-term capital gains (LTCGs) tax on listed securities has been creating a market buzz for quite some time now, especially after Prime Minister Narendra Modi publicly stated that "those who profit from financial markets must make a fair contribution to nation-building through taxes".

Accordingly, it was speculated that there would be levy of tax on LTCGs in the 2017 Budget. However, provisions with respect to taxation of LTCGs were largely left untouched.

However, in the Finance Bill 2018, the finance minister has reintroduced the LTCGs tax with the intention to bring tax parity among investor groups and other taxpayers.

Existing provisions

As per the provisions of Section 10 (38) of the Income Tax Act, 1961 (the Act), capital gains arising on transfer of long-term capital asset (i.e. capital asset held for more than 12 months) being listed equity shares or unit of equity-oriented fund or unit of a business trust is tax-exempt, provided Securities Transaction Tax (STT) has been paid on such transfer.

The aforesaid exemption was introduced in 2005 to attract investments and the revenue loss for the same was made up by imposition of STT.

It was also said that since the ultimate source of LTCGs is corporate profit and dividends, which are already taxed, therefore tax on LTCG derived from such tax paid income would potentially amount to double taxation.

However, the above regime inherently resulted in some kind of bias towards the investment sector, encouraging investment in financial assets as opposed to real (manufacturing) sector.

Further, LTCGs being completely exempt in India resulted in significant erosion of the tax base, amounting to huge revenue loss. The Finance Bill, 2018, had amended the provisions of Section 112A of the ITA, thereby levying tax on LTCGs arising on transfer of listed equity shares, equity-oriented units or units of a business trust.

As per the recently introduced provisions, LTCGs on transfer of equity share or unit of equity-oriented fund or unit of business trust shall be taxable at 10% (without the benefit of indexation), where such capital gains exceed Rs 1 lakh, subject to following conditions:

n In case of equity shares - STT has been paid at the time of acquisition, as well as transfer of the capital asset.

n In case of unit of equity-oriented fund/business trust - STT has been paid at the time of transfer of the capital asset.

The payment of STT shall not be required:-

n If the equity shares are acquired in a manner as notified by the government.

n If the transfer is undertaken on a recognised stock exchange located at any International Financial Service Centre (IFSC) and the consideration for the same is in foreign currency

The above amendments shall be effective from April 1, 2018. Further, all LTCGs arising on or before January 31, 2018, shall be grandfathered and not subject to any capital gains tax. Thus, for the purposes of computation of LTCGs, the cost of acquisition of capital assets acquired before February 1, 2018, shall be higher of the following:

n Actual cost of acquisition

n Lower of FMV or full-value consideration arising on such transfer

n FMV for the above purposes shall be highest price quoted on January 31, 2018, on the recognised stock exchange in case of listed securities. In case of unlisted units, it shall be net asset value (NAV) of the asset as on January 31, 2018.

Further, in case of non-resident sellers, the tax payable on LTCGs shall be subject to withholding tax in India at 10%, and the tax withholding obligation shall be vested on the buyer. However, in case of on-the-market trading of shares/units, there would be practical challenges in complying with the tax withholding obligations due to ambiguity surrounding the identity of the buyer.

Conclusion

Since 1991, both the Indian economy and the stock market wealth (value of transactions) have magnified in real terms. However, the contribution of the stock market to the Indian treasury has been less than commensurate.

As per the income tax returns filed for financial year 2017-18, the loss to the government treasury due to capital gains tax exemption is approximately Rs 3,67,000 crore. Reintroduction of the LTCGs tax should enable the government to plug out this tax loss and deliver higher tax revenues.While the aforesaid amendment, along with other corrective measures, would help the Indian government recoup the revenue loss one will have to wait and watch to calibrate the impact of this announcement on the investment climate including on listed entities.

(Talreja is Partner at Deloitte India, while Bhane is Deputy Manager at Deloitte Haskins and Sells)

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