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Finance bill, 2018 – proposal relating to change in taxation of capital gains on equity shares, etc.

February 2, 2018 18503 Views
T.N. Pandey
Ex-Chairman, CBDT

Introduction

Taxation of capital gains is a part of the taxation of income-tax. Any receipt, in order to be taxed under the Income Tax Act, 1961 (Act), should bear income character. The word 'income' is defined in the section 2(24) of the Act by an inclusive definition, which gives it a very wide scope. According to the sub-clause (vi) of section 2(24, 'income' includes inter alia any capital gains chargeable u/s 45. Thus, it is provided in the statute itself that capital gain, which is chargeable u/s 45 of the Act will constitute income within the meaning of section 2(24), which provides statutory legitimacy to the charging of capital gains to tax under the Act.

[1.1] Taxation of capital gains

Section 45 of the Act provides that any profits and gains arising from the transfer of a 'capital asset' shall be chargeable to tax under the head 'capital gains'. Two important terms in this context are 'capital asset' and 'transfer'. In order that chargeable capital gain get generated, there had to be a 'capital asset' and there has to be a transfer of the capital asset. Hence, these terms become important from the angle of taxing capital gains. In the present context, only the concept of 'capital asset' is relevant and the same is explained in the next para.

[2] Concept of 'capital asset'

Capital asset is defined in section 2(24) of the Act to be property of any kind but specifically excluding certain items enumerated in sub-clauses (i) to (vi). The capital assets may be of two types, short-term capital asset and long-term capital asset. Whether a capital asset is former or latter type depends on the period for which that particular asset was held by the assessee before its transfer.

[3] Exemption in case of listed securities, etc. - Section 10(38) of the Act

Clause 38 in section 10 provides for exemption to long-term capital gains arising from sale of equity share in a company or unit of an equity oriented fund or unit of a business trust.

[3.1] Equity oriented fund

Equity oriented fund is defined as a fund -

[i] where the investible funds are invested by way of equity shares in domestic companies to the extent of more than sixty five percent [50% upto to 31.4.2006] of the total proceeds of such fund; and

[ii] which has been set up under a scheme of a Mutual Fund specified under clause (23D).

It is provided that the percentage of equity share holding of the fund shall be computed with reference to the annual average of the monthly averages of the opening and closing figures.

[4] Conditions precedent for exemption

[i] Upto AY 2017-18 - following conditions shall have to be fulfilled in order to avail of the exemption:-

[i] Gain should arise from the transfer (being sale) of a long-term capital asset.

[ii] Such long-term capital asset should be equity share in a company or unit of an equity oriented fund or unit of a business trust [from AY 2015-16].

[iii] The gain should arise from the transaction of sale of equity share in a company or unit of an equity oriented fund or unit of a business trust [from AY 2015-16].

[iv] Such transaction of sale of such equity share or unit should be entered into on or after the date on which Chapter VII of the Finance (No.2) Act, 2004, comes into force. This chapter has came into force from 1.10.2004. [Chapter VII deals with Securities Transaction Tax].

[v] Such transaction of sale should be chargeable to securities transaction tax under Chapter VII of the Finance (No.2) Act, 2004.

[ii From AY 2018-19 - Following conditions shall have to be fulfilled in order to avail of the exemption from the AY 2018-19:-

[i] Gain should arise from the transfer of a long-term capital asset.

[ii] Such long-term capital asset should be equity share in a company or unit of an equity oriented fund or a unit of a business trust.

[iii] The gain should arise from the transaction of sale of equity share in a company or unit of an equity oriented fund or a unit of a business trust.

[iv] Such transaction of sale of such equity share or unit should be entered into on or after the date on which Chapter VII of the Finance (No.2) Act, 2004 comes into force. This chapter has come into force from 1.10.2004. [Chapter VII deals with Securities Transaction Tax].

[v] Such transaction of sale should be chargeable to securities transaction tax under that Chapter.

[vi] The transaction of acquisition of equity shares shall be chargeable to securities transaction tax if equity shares are acquired on or after 1.10.2004 except such type of acquisition that are notified by the Central Govt.

[5] Changes proposed in the Finance Bill, 2018 (applicable from the AY 2019-20)

[A] How the change regarding listed securities, etc., has been explained by the FM

The FM in para 155 of his budget speech under the caption 'Rationalization of Long Term Capital Gains (LTGC) has explained the need for the proposed change in the following manner:-

"Madam Speaker, currently, long term capital gains arising from transfer of listed equity shares, units of equity oriented fund and unit of a business trust are exempt from tax. With the reforms introduced by the Government and incentives given so far, the equity market has become buoyant. The total amount of exempted capital gains from listed shares and units is around Rs.3,67,000 crores as per returns filed for A.Y.17-18. Major part of this gain has accrued to corporates and LLPs. This has also created a bias against manufacturing, leading to more business surpluses being invested in financial assets. The return on investment in equity is already quite attractive even without tax exemption. There is therefore a strong case for bringing long term capital gains from listed equities in the tax net. However, recognising the fact that vibrant equity market is essential for economic growth, I propose only a modest change in the present regime. I propose to tax such long term capital gains exceeding Rs.1 lakh at the rate of 10% without allowing the benefit of any indexation".

[6] Change in the I.T. Act to give effect to the proposal

[A] In section 10(38) (supra) a proviso has been added after the third proviso, which reads as under:-

"Provided also that nothing in this clause shall apply to any income arising from the transfer of long-term capital assert, being an equity share in a company or a unit of an equity oriented fund or a unit of a business trust, made on or after the 1st day of April, 2018".

[B] A new section 112A has been inserted in the Act after the existing section 112 w.e.f. 1.4.2019 i.e. from the AY 2019-20. It is a long section. Its salient aspects are:-

[A] Capital gains arising from long-term capital asset in the nature of listed securities, etc., earlier exempted u/s 10(38) shall be charge able to tax @10%, exceeding Rs.1,00,000/-. This concessional rate of 10% will be applicable on the satisfaction of the following conditions:-

[i] in a case where long term capital asset is in the nature of an equity share in a company , securities transaction tax has been paid on both acquisition and transfer of such capital asset; and

[ii] in a case where long term capital asset is in the nature of a unit of an equity oriented fund or a unit of a business trust, securities transaction tax has been paid on transfer of such capital asset.

[B] Further, sub-section (4) of the new section 112A empowers the Central Government to specify by notification the nature of acquisitions in respect of which the requirement of payment of securities transaction tax shall not apply in the case of equity share in a company. Similarly, the requirement of payment of STT at the time of transfer of long term capital asset, being a unit of equity oriented fund or a unit of business trust, shall not apply if the transfer is undertaken on recognized stock exchange located in any International Financial Services Centre (IFSC) and the consideration of such transfer is received or receivable in foreign currency.

[C] The new section 112A also proposes to provide the following:-

[i] The long term capital gains 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.

[ii] The cost of acquisitions in respect of the long term capital asset acquired by the assessee before the 1st day of February, 2018, shall be deemed to be the higher of -

[a] the actual cost of acquisition of such asset; and

[b] the lower of -

(I) the fair market value of such asset; and

(II) the full value of consideration received or accruing as a result of the transfer of the capital asset.

[ii] "equity oriented fund" has been defined to mean a fund set up under a scheme of a mutual fund specified under clause (23D) of section 10 and,—

[a] In a case where the fund invests in the units of another fund which is traded on a recognized stock exchange,-

(I) A minimum of 90 per cent. of the total proceeds of such funds is invested in the units of such other fund; and

(II) such other fund also invests a minimum of 90% of its total proceeds in the equity shares of domestic companies listed on recognized stock exchange; and

[b] in any other case, a minimum of 65% of the total proceeds of such fund is invested in the equity shares of domestic companies listed on recognized stock exchange.

[iv] Fair market value has been defined to mean -

[a] in a case where the capital asset is listed on any recognized stock exchange, the highest price of the capital asset quoted on such exchange on the 31st day of January, 2018. However, where there is no trading in such asset on such exchange on the 31st day of January, 2018 , the highest price of such asset on such exchange on a date immediately preceding the 31st day of January, 2018 when such asset was traded on such exchange shall be the fair market value; and

[b] in a case where the capital asset is a unit and is not listed on recognized stock exchange, the net asset value of such asset as on the 31st day of January, 2018.

[v] The benefit of deduction under chapter VIA shall be allowed from the gross total income as reduced by such capital gains.

[7] Benefit of grandfathering

This has already been considered in earlier discussion. To make the position more clearer, the observations of the FM in his budget speech in para 155 (supra) are reproduced below:-

"However, all gains up to 31st January, 2018 will be grandfathered. For example, if an equity share is purchased six months before 31st January, 2018 at Rs.100/- and the highest price quoted on 31st January, 2018 in respect of this share is Rs.120/-, there will be no tax on the gain of Rs.20/- if this share is sold after one year from the date of purchase. However, any gain in excess of Rs.20 earned after 31st January, 2018 will be taxed at 10% if this share is sold after 31st July, 2018".

[8] No change in the scheme of taxation of short-term capital gain

"The gains from equity share held upto one year will remain short term capital gain and will continue to be taxed at the rate of 15%".

[9] Revenue gain by change proposed

"In view of grandfathering, this change in capital gain tax will bring marginal revenue gain of about Rs.20,000 crores in the first year. The revenues in subsequent years may be more".

[10] Concluding comments

The proposed change is in right direction and may make some marginal dent in the position of 1% people holding 73% of the total wealth of the country. From, this angle, exemption upto Rs.1,00,000/- could have been avoided. However, in a regime where nearly 99% of the returns are being accepted, the checking of grandfathering benefit to ensure that it is being correctly availed of could be problematic.

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