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Impact of New Long-Term Capital Gains (LTCG) Tax Regime
Context:
As announced in the Union Budget for 2024-25, new Long-Term Capital Gains (LTCG) Tax regime removes indexation benefits for calculating LTCG tax. It also reduces the tax rate from 20% to 12.5% and for assets purchased before 2001, fair market value as of April 1, 2001, will be considered the cost of acquisition.
Indexation:
- Indexation is a process used in calculating capital gains tax, where the original purchase price of an asset is adjusted for inflation.
- It helps arrive at a more realistic cost of acquisition by revising it upwards based on the inflation rate.
- The adjusted purchase price, known as the indexed cost of acquisition, helps in reducing the apparent capital gains, thereby reducing the tax liability.
- The indexed cost of acquisition is calculated by multiplying the original cost with the Cost Inflation Index (CII) of the year of transfer divided by the CII of the year of acquisition.
- This indexed cost is then used to calculate the taxable long-term capital gains.
Rationale Behind Removal of Indexation Benefit:
- Historically, tax policies in India were designed to direct investments towards specific asset classes by offering tax incentives.
- The current policy approach aims for a more equitable system, treating all asset classes and investors equally.
- This shift is part of the broader vision outlined in the Direct Tax Code.
Direct Tax Code (DTC):
- On August 12, 2009, the initial version of the Direct Taxes Code Bill was introduced.
- In 2017, the government established a task force to develop a new Direct Taxes Code.
- It presented the report to the Finance Minister by 2019.
- It is expected to replace the Income Tax Act of 1961 and other direct tax laws.
- Aim: To simplify, update, consolidate India’s direct tax laws.
- Establish a more transparent and taxpayer-friendly tax system.
- The primary differentiation in the new system is between short-term and long-term investments, with a preference for the latter due to its perceived economic benefits.
- Indexation was initially intended to adjust the cost of acquisition for inflation.
- The new policy considers that investors can better assess their risk tolerance and expected returns without this adjustment.
Impact of Removal of Indexation Benefit:
- Increased Tax Outgo: Without indexation, the original purchase price is used to calculate capital gains, leading to higher taxable profit and tax liability.
- For example: A property bought for ₹50 lakh in 2014-15, sold for ₹1 crore, then indexation would have adjusted the cost to about ₹75.6 lakh, resulting in a ₹24.4 lakh gain taxed at 20%, or roughly ₹4.87 lakh.
- Without indexation, the cost remains ₹50 lakh, so the ₹50 lakh gain is taxed at 12.5%, amounting to ₹6.25 lakh.
- Longer Holding Periods, Higher Taxes: Longer holding periods have led to substantial tax hikes.
- This impact is notably severe in cities like Mumbai and Kolkata, where taxpayers face exceptionally high tax burdens.
- Secondary Property Sales: It could impact secondary property sales, especially for long-held properties with significant gains.
- For example, Property bought in 2001 for ₹100 sold for ₹500 in 2024 would have had a tax of ₹27.4 at 20% under the old rules, but under the new tax rules, it would be ₹50.
- Unrealistic Gains: The gains calculated without considering inflation might not reflect the true appreciation of the asset over time.
- Underreporting of Sale Price: It might also lead sellers to underreport sale price of their properties and take some of the payment in cash to avoid paying higher taxes.
Government’s Stand:
- Simplification of Capital Gains Tax Structure: The government argues that the new regime simplifies the capital gains tax structure.
- The removal of differential tax rates for various assets will benefit both taxpayers and tax authorities.
- Benefits for Real Estate: The government argues that the new regime will be beneficial in most cases, as nominal returns in real estate are generally higher than inflation.
- Therefore, substantial tax savings are expected to a vast majority.
Capital Gains (LTCG) Tax:
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