[Guest Post] Budget 2018 – Taxing times for Capital Gains

The post has been contributed by Mr. Girish Vanvari , National Head of Tax at KPMG. He is a Chartered Accountant (Gold Medalist). His experience includes advising on many of the largest M&A deals and restructuring transactions in India on a year-to-year basis. In this post, Mr. Girish Vanvari  discusses the changes introduced to the Capital Gains Tax regime under Budget 2018-19.

Taxation of Long Term Capital Gains (‘LTCG’) on sale of equity shares over a recognized stock exchange has been a topic of contentious debate for a long time.  The Finance Act 2004, brought about a radical change to capital gain taxation regime with the introduction of the Securities Transaction Tax (‘STT’) and the exemption to LTCG on transfer of listed shares and units of equity oriented mutual funds. These beneficial provisions were welcomed by the market participants and the successive governments did not amend the same thereby providing largely a stable capital gain tax regime. However, it was observed that these provisions also gave rise to tax evasion through innovative penny stock scams that were discovered by the IT department and were also leading to a significant erosion of tax base resulting in revenue loss. It was also contended that the extant regime was inherently biased against the manufacturing sector and encouraged diversion of investment in financial assets.

Considering the aforesaid, the FM finally bit the bullet in the recent Budget by introducing changes to the capital gain tax regime.The Finance Bill, 2018 proposes to withdraw the Section 10(38) exemption with effect from financial year beginning 1st April, 2018 and levy tax at 10% on such LTCG exceeding one lakh rupees.

Accordingly,a new section is proposed to be introduced which provides that the rate of 10% will be applicable on the LTCG if the long-term capital asset is in the nature of equity share in a company or equity oriented fund or a unit of a business trust and STT has been paid on both acquisition and transfer of such capital asset.

The proposed Section also provides for computing the tax on LTCG in respect of the above capital assets. Unlike other provisions where the benefit of indexation on the cost of acquisition and cost of improvement are available for computing tax on LTCG, the same will not be available while computing tax under the proposed section. Also the cost of acquisition in respect of long-term capital assets acquired by the assesse before 1st February, 2018 shall be higher of the following:-

  1. The actual cost of acquisition of such assets; and
  2. The lower of:-
    1. The fair market value (‘FMV’) of such assets
    2. The full value of consideration received or accruing as a result of the transfer of the capital asset

The FMV in case of capital asset if listed on any recognized stock exchange would be the highest price quoted on such exchange as on 31st January, 2018 and the highest price on a date immediately preceding 31st January, 2018 in case there was no trading in such capital asset on such exchange on 31st January, 2018. The FMV in case of capital asset is a unit and is not listed on recognized stock exchange, would be the net asset value as on 31st January, 2018.

Also to bring parity between the domestic tax payers and the Foreign Institutional Investor amendments to that extent has also been proposed in Section 115AD of the Act and provide for same tax rates.

Closing remarks:

Whilst the Budget proposes to introduce LTCG tax, the same does not abolish STT. Co-existence of the STT, as well as the LTCG tax, is a move that surprised many given that one of the rationale to introduce the STT was to substitute the government’s revenue loss arising on account of the LTCG tax exemption and is a move that the government may relook.

Also, the government has done well to bring out FAQ’s that provide the methodology to compute capital gains in specific scenarios.

However there are still some open areas that would need to be addressed, e.g. there could be circumstances where the historic price as on 31st January, 2018 may not be available for substitution in certain merger/demerger scenarios where the issuer company is originally not listed as on such date. Further, since the proposed law requires that the transferor should have held such shares as on 31st January, 2018, there could be scenarios wherein these shares were held by way of convertible instruments or were inherited post such date. The manner of taxability in such scenarios should be clarified.

At the macro level, whilst the move may have taken some sheen off equity investments in the listed space, it would be interesting to see if it could materially impact inflows into the capital markets in times to come.

(The aforesaid article was co-authored by Mr. Krishnan TA and Mr. Jabir Lakdawala who are Associate Director and Manager respectively in the Deal Advisory M&A Tax team KPMG India.)

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