Capital gains tax, a cornerstone of India’s income tax framework, underwent substantial changes in last year’s Union Budget. While these amendments aimed to simplify provisions and boost tax revenues, they introduced disparities and left some issues unaddressed, prompting calls for further rationalization. Addressing these anomalies is vital to ensure fairness and promote investor confidence.
Key Expectations for Budget 2025
Restoring indexation benefits for the middle-class
The indexation benefit was removed in the Budget 2024 for the calculation of Long-Term Capital Gains (LTCG), which was available for a property, gold and other unlisted assets. This amendment was aimed at streamlining capital gains computation for taxpayers and tax administration; however, the removal of indexation benefits has increased the tax burden on individual investors, particularly the middle class,and in a country like India that has an emotional value attached to home ownership.
Given the fact that home ownership channelises household savings, boosts the real estate and other allied industries, the Finance Minister (FM) must relook at the amendments made last year to fully restore the indexation benefits associated with home ownership.
Rationalising capital gains exemption thresholds
The current capital gains exemption thresholds for reinvestment in specified assets should be increased to better reflect rising property prices and inflation, aligning with the intent laid down in the Memorandum. The FM's attention is specifically drawn to the cap on the cost of new assets of INR 10 crores under the second proviso to section 54F(1) of the Income Tax Act, 1961 (IT Act), which contradicts the Memorandum's intent to limit the maximum deduction and needs to be addressed. Furthermore, it is unclear whether the INR 10 crore deduction limit under sections 54 and 54F is cumulative or independent, causing confusion for individual investors.
Additionally, the holding period for immovable property to qualify as a long-term capital asset is two years, but for claiming exemptions under sections 54 and 54F, the minimum holding period for the new asset remains at three years. To ensure consistency, this holding period should be reduced from three years to two years.
Clarity on period of holding of unlisted shares
Last year’s Union Budget amended section 55(2)(ac) to prescribe a formula for determining Fair Market Value as of 31 January 2018 upon transfer of shares under OFS during the IPO process, for shares referred to in section 112A of the Act. While the Budget has provided the cost of acquisition of such equity shares, there is a need for the FM to clarify the minimum holding period for such shares being treated as a long-term capital asset.
Reassessing recent increase in Short-Term Capital Gains (STCG) tax rates
Last year’s Union Budget increased the STCG tax rate on listed equity shares and equity-oriented mutual funds from 15% to 20%. This increase aimed to boost revenue collections since the present rate was considered very low and the benefit from such a low rate was flowing largely to high net-worth individuals. However, this increase in tax rate may deter investment in equity markets, particularly among individuals and small investors, by reducing post-tax returns and potentially decreasing market participation. This is concerning as domestic investors have been crucial to the Indian capital markets, especially amid significant foreign investor exits.
Therefore, the STCG tax rate for listed equity shares should be reduced, especially for individual investors. Additionally, to counterbalance the impact, a reduction in the Securities Transaction Tax and an increase in the exemption limit for LTCG on equity, currently capped at INR 125,000, should be considered. These measures will help balance revenue generation with fostering an inclusive capital market ecosystem.
Tax on withdrawal from Capital Gains Account Scheme (CGAS)
Section 54F(1) of the IT Act exempts certain capital gains on an investment of net consideration received on transfer, subject to the fulfillment of conditions. The unutilized consideration, if any, must be deposited in the CGAS before the due date of filing the return of income for the previous year in which the long-term capital asset was transferred. Section 54F of the IT Act is silent on when the pre-mature withdrawals shall be taxed,i.e. in the year in which three years from the date of transfer of a long-term asset expire or in the year of the pre-mature withdrawal itself.
As a practice, some banks insist on a tax clearance certificate, which is difficult to obtain. The FM should consider clarifying the year of taxability and removing ambiguity around the taxation of such pre-mature withdrawals.
Conclusion
Faced with high expectations and a slowing economy, the FM has a challenging balancing act ahead. However, if implemented, the above measures will boost capital investments, provide relief to the middle class and small investors, and give a significant thrust to the real estate industry.
(Shaily Gupta is Partner and Aanchal Jain is Associate at Khaitan & Co. The views expressed are personal.)