Budget 2018: Double clampdown of LTCG, is it fair?

In the Budget 2018, the Finance Minister has Re-Introduced taxability of Long Term Capital Gain on equities shares and equity oriented mutual fund (herein after referred as LTCGE) @ 10%. This proposal has raised many questions, some people are even calling this move as double taxation. Government named its move as rationalization of LTCGE, whereas the affected people named it as 'Double Jeopardy'.

A. The Government Rationale

The government rationale behind putting the LTCGE segment to 10% tax is buoyancy in the equity market which has been a result of reforms, incentives & exemptions given so far.  As per latest data of PIB (Public information Bureau) total amount of exempted capital gains from listed shares and units is around Rs. 3,67,000 crore which mostly accrued to corporates and LLPs. The prevailing exemption has also created a bias against manufacturing by attracting more business to invest in capital market instead putting it in manufacturing sector, real estate and other areas of conventional capital inflow. Therefore to save the 'small' taxpayers the Finance Minister  has proposed to tax such LTCGE exceeding Rs. 1 lakh @ 10%, without indexation benefit, simultaneously he also grandfathered all gains up to 31st January, 2018. He also proposed to introduce a tax on distributed income by equity oriented mutual funds @ 10%, to provide a level field across growth oriented funds and dividend distributing funds. Consequently the government will achieve the following by taxing LTCGE:

• It will bring marginal revenue gain of about Rs. 20,000 crore in first year, in view of grandfathering. Later on this will increase significantly due to diminishing effect of grandfathering.
• This move will now motivate businesses to invest in manufacturing sector, real estate which is seen as the sectors that can accommodate the vast work force of India.

B. People's Reaction

People at the dalal street felt like their worst night mare came true on the budget day as the Finance Minister proposed long term capital gains tax on equities. The reaction could have been much worse if he would not have placated people with grandfathering. The reaction was evident from steep fall in the Sensex & Nifty observed on 1st & 2nd February 2018 of around 1000 points. The government immediately came in action and released a statement that the fall was because of Global Cues & not because of taxing LTCGE.  The affected people are of the view that they are being taxed twice first by way of STT & now by way of taxing LTCGE also. Investors in a listed company will now suffer taxation on multiple fronts - corporate tax paid by their company, then dividend distribution tax paid by their company, then direct incidence of tax in the form of STT when they buy the stock, tax on large cumulative dividends received and now even LTCG tax on exit from their investments (without indexation). Many Tax experts are of the view that the government should have at least abolish with securities transaction tax (STT) on listed shares and withdrawn the dividend distribution tax.

C. Technicality Of Amendments Related To Taxation Of LTCGE

Following Amendments were introduced

1. Amendment to Existing Section 10(38)

In Section 10(38) 4th Proviso is added which provides that exemption provided Section 10(38) will not be available to any income arising from of Long Term Capital Asset, being an Equity Share in a company or a unit of an Equity Oriented Fund or a unit of a business trust, if the transfer is made on or after 01/04/2018.

2. Insertion of New Section 112A

The new section of taxing LTCGE is inserted simultaneously which provided that the long term capital gains arising from transfer of a long term capital asset being an equity share in a company or a unit of an equity oriented fund or a unit of a business trust shall be taxed @ 10% if such capital gains exceeding Rs. 1 lakh subject to condition that STT has been paid on both acquisition and transfer of such capital asset (with certain exceptions provided therein). Section 112A also provides that LTCGE will be computed without giving effect to the first and second provisos to section 48, i.e. inflation indexation in respect of cost of acquisitions and cost of improvement, if any, and the benefit of computation of capital gains in foreign currency in the case of a non-resident, will not be allowed.

Section 112A also provided for the grandfathering provisions by prescribing the benefitted cost of acquisitions in respect of the long term capital asset acquired by the assessee before the 1st day of February, 2018 so as to ease the burden of tax on assessee. The same can be understood with the help of the example given in the table below. 

Section 112A is similar to erstwhile section 10(38), the Section 112A is reproduced below:

Section 112A- Tax on long-term capital gains in certain cases with effect from 01/04/2019:

 (1) Notwithstanding anything contained in section 112, the tax payable by an assessee on his TI shall be determined in accordance with the provisions of sub-section (2), if—

(i) TI includes any income chargeable under head 'CG';

(ii) CG arise from transfer of a LTCA being an ES in a company or a unit of an EOF or a unit of a business trust;

(iii) STT under Chapter VII of the Finance (No.2) Act, 2004 has,-

(a) in a case where LTCA is in nature of an ES in a company, been paid on acquisition and transfer of such capital asset; or

(b) in a case where LTCA is in nature of a unit of an EOF or a unit of a business trust, been paid on transfer of such capital asset.

(2) The tax payable by the assessee on the total income referred to in sub-section (1) shall be the aggregate of—

(i) the amount of income-tax calculated on such LTCG exceeding  Rs. 1 lakh @ 10%.; and

(ii) the amount of income-tax payable on the balance amount of the total income as if such balance amount were the total income of the assessee:

Provided that in case of an individual or a HUF, being a resident, where TI as reduced by such LTCG is below maximum amount which is not chargeable to income-tax, then, LTCG, for the purposes of clause (i), shall be reduced by amount by which TI income as so reduced falls short of maximum amount which is not chargeable to income-tax.

(3) The condition specified in 112A(1)(iii) shall not apply to a transfer undertaken on a recognised stock exchange located in any IFSC and where the consideration for such transfer is received or receivable in foreign currency.

(4) CG may, by notification in OG, specify nature of acquisition in respect of which provisions of 112A(1)(iii)(a) shall not apply.

(5) The capital gains u/s 112A(1) shall be computed without giving effect to provisions of 1st & 2nd provisos to section 48.

(6) The cost of acquisition for purposes of computing CG referred to in 112A(1) in respect of LTCA acquired by assessee before 1/02/2018, shall be deemed to be higher of-

(i) the actual cost of acquisition of such asset; and
(ii) the lower of -

(a) FMV of such asset; and
(b) full value of consideration received or accruing as a result of transfer of capital asset.

(7)Where GTI of an assessee includes any LTCG referred to 112A(1), the deduction under Chapter VI-A shall be allowed from GTI as reduced by such capital gains.

(8) Where TI of an assessee includes any LTCG referred to in 112A(1), rebate u/s 87A shall be allowed from income-tax on TI as reduced by tax payable on such CG.

Explanation. - For the purposes of this section,-

(a) 'EOF' means a fund set up under a scheme of a MF specified u/s 10(23D) and,-

(i) in a case where fund invests in the units of another fund which is traded on a RSE,-

(A) a minimum of 90% of total proceeds of such fund is invested in units of such other fund; and
(B) such other fund also invests a minimum of 90% of its total proceeds in ES of domestic companies listed on a RSE; and

(ii) in any other case, a minimum of 65% of total proceeds of such fund is invested in ES of domestic companies listed on a RSE:

Provided that the percentage of equity shareholding or unit held in respect of the fund, as the case may be, shall be computed with reference to the annual average of the monthly averages of the opening and closing figures;

(b) 'FMV' means,-

(i) in a case where capital asset is listed on any RSE, highest price of capital asset quoted on such exchange on 31/1/2018:

Provided that where there is no trading in such asset on such exchange on 31/1/2018, highest price of such asset on such exchange on a date immediately preceding 31/1/2018 when such asset was traded on such exchange shall be FMV;

(ii) in a case where capital asset is a unit and is not listed on a RSE, net asset value of such asset as on 31/1/2018;

(c) 'IFSC' shall have meaning assigned to it in clause (q) of section 2 of the SEZ Act, 2005;
(d) 'RSE' shall have meaning assigned to it in clause (ii) of Explanation 1 to clause (5) of section 43.'

3. Amendment in Section 115R by way of substitution

Section 115R provides for Tax on distributed income to unit holders, sub-section (2) thereof provides that any amount of income distributed by the specified company or a Mutual Fund to its unit holders shall be chargeable to tax and such specified company or Mutual Fund shall be liable to pay additional income-tax on such distributed income at prescribed rates. Earlier provisions of this sub section were not applied on income distributed to a unit holder of equity oriented funds in respect of any distribution made from such funds. However, the proposed provisions in the budget made these provision applicable on income distributed to a unit holder of equity oriented funds in respect of any distribution made from such funds and consequently equity oriented funds shall be liable to pay additional tax on such distributed income at the rate of  10%

4. Some Key Points

• Tax treatment of accrued gains upto 31st January 2018 = As the fair market value on 31st January, 2018 will be taken as cost of acquisition (except in some typical situations explained in the above table), the gains accrued upto 31st January, 2018 will continue to be exempted.
• Tax treatment of transfer of share or unit between 1st February 2018 to 31st March 2018 = The new tax regime will be applicable to transfer made on or after 1st April, 2018, the transfer made between 1st February, 2018 and 31st March, 2018 will be eligible for exemption under clause (38) of section 10 of the Act.
• Ordinarily, under section 195 of the Act, tax is required to be deducted on payments made to non-residents, at the rates prescribed in Part-II of the First Schedule to the Finance Act. The rate of deduction in the case of capital gains is also provided therein. In terms of the said provisions, tax at the rate of 10 per cent, will be deducted from payment of long-term capital gains to a non-resident tax payer (other than a Foreign Institutional Investor).
• Cost of acquisition in the case of bonus shares or right shares acquired before 1st February 2018 = The cost of acquisition of bonus shares acquired before 31st January, 2018 will be determined as per Section 112A(6). Therefore, the fair market value of the bonus shares as on 31st January, 2018 will be taken as cost of acquisition (except in some typical situations shown in table above).

D. Conclusion

• Government has decided not to roll back the proposed amendments with respect to taxation of Long Term Capital Gain. This will result into more short term trades as no one would prefer to keep their funds blocked for 1 year just to save additional 5% of the tax. The investor of capital market will become the forced trader of capital market.
• This proves to be a win-win situation for government. More funds will be there in the government's kitty either by way of STT coupled with tax on STCG or by way of STT coupled with slightly lower tax on LTCG.
• People can now only have hope that increased revenue of government by way of 'Double Clampdown' in the form of LTCG Tax & STT will be utilized in an efficient and effective manner and will not land into another scam.

Note - The Author is a Chartered Accountant and can be reached at Hemant.sharma53@gmail.com. The information contained in this write up is general in nature and does not take into account reader's personal situation, this should not be construed as professional legal advice. Reader should consider whether the information is appropriate to his/her needs, and where appropriate, seek professional advice from a Chartered Accountant.