TAG: GS 3: ECONOMY
THE CONTEXT: The Union Budget for 2024-25 has introduced significant changes to the long-term capital gains (LTCG) tax regime, particularly by withdrawing the indexation benefit.
EXPLANATION:
- This decision has sparked extensive debate and concern among taxpayers and industry stakeholders.
- Here, we delve into the concept of indexation, the implications of its removal, and the government’s rationale behind this policy shift.
What is Indexation?
- Indexation adjusts the original purchase price of an asset to account for inflation, thereby providing a more accurate measure of the asset’s real value over time.
- This adjustment helps in calculating the indexed cost of acquisition, which reflects the inflationary impact on the asset’s value.
- For example, if an asset was purchased for $100,000 and held for ten years, during which inflation averaged 4% annually, the indexed cost of acquisition would increase to approximately $148,000.
- This higher base reduces the apparent capital gain when the asset is sold, thus lowering the tax liability.
- Without indexation, long-term gains might appear inflated, especially for assets held over extended periods.
- This happens because the inflationary decrease in money’s value isn’t considered, leading to a higher nominal gain and consequently, higher taxes.
- Indexation ensures that taxpayers are taxed on real gains rather than nominal gains.
Policy Changes and Their Implications
- Government’s New Policy
- The 2024-25 Union Budget, presented by Finance Minister, removes the indexation benefit for calculating LTCG on property, gold, and other unlisted assets.
- Concurrently, the LTCG tax rate has been reduced from 20% to 12.5%.
- For properties and other assets acquired before 2001, the fair market value as of April 1, 2001, will serve as the acquisition cost.
- This approach is consistent with the previous regime.
- Government’s Justification
- The government argues that this change simplifies the capital gains tax structure and benefits most taxpayers.
- The differential tax rates for various asset classes are eliminated, creating a uniform tax regime.
- According to the government, the nominal returns on real estate, typically between 12-16% per annum, far exceed the inflation rate, making the new regime advantageous for most taxpayers.
- Addressing Concerns and Confusion
- The announcement initially caused confusion, particularly in the real estate sector.
- Fears arose that the removal of indexation would lead to a significant increase in LTCG tax liability for property sellers.
- In response, the Finance Ministry and Income Tax Department issued clarifications, asserting that the new regime would be beneficial in most scenarios.
- The government highlighted that the new tax rate without indexation would be favorable when the value appreciation is substantial.
- For instance, a property held for five years would benefit from the new regime if its value increased by 1.7 times or more.
- Similarly, for a property held for ten years, the new regime would be advantageous if its value increased by 2.4 times or more.
- For properties purchased in 2009-10, the regime would be beneficial if the value increased by 4.9 times or more.
- Additionally, the rollover benefits remain unchanged, allowing exemptions if the capital gains are reinvested in specified instruments or residential real estate.
Stakeholder Reactions and Concerns
- Industry and Market Reactions
- Various industry players and analysts have expressed concerns about the new regime.
- They fear it might lead to an increase in secondary market real estate sales, as property owners might prefer not to hold assets for extended periods.
- Director at JLL India noted that properties held for a long time with annual capital value growth around 10-12% would incur higher taxes under the new regime.
- In contrast, shorter holding periods (3-5 years) might see easier liquidation and favorable capital value appreciation.
- Potential for Black Money
- There are apprehensions that the new regime might encourage the use of cash in property transactions.
- Sellers might undervalue transactions on paper to reduce their tax liability, potentially leading to a resurgence of black money in real estate.
- Lack of Grandfathering
- Critics have also pointed out the absence of grandfathering for purchases made over the past 24 years.
- Grandfathering would allow the old rules to apply up to a certain date, protecting taxpayers from abrupt changes.
- In this context, it would mean extending the indexation benefit until the new regime takes effect in July 2024.
- Such a measure could have used the current fair market value as the base for assets acquired before 2001, easing the transition for taxpayers.
- The government, however, contends that the reduction in the LTCG tax rate by 7.5 percentage points offsets the benefits that grandfathering would have provided.
What is Capital Gains Tax in India?
- Any profit or gain that arises from the sale of a ‘capital asset’ is known as ‘income from capital gains’.
- Such capital gains are taxable in the year in which the transfer of the capital asset takes place. This is called capital gains tax.
- There are two types of Capital Gains: short-term capital gains(STCG) and long-term capital gains(LTCG).