• UGI USER
  • Jul 29, 2024
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LTCG TAXATION: WITHDRAWAL OF INDEXATION BENEFIT AND CONTROVERSY

Syllabus:

GS 3:

  • Indian Economy and issues relating to Planning
  • Government Budgeting.

Why in the News?

The Union Budget 2024-25 has introduced significant changes to the long-term capital gains (LTCG) tax regime, particularly by withdrawing the indexation benefit. This decision has sparked widespread debate and concern among taxpayers, prompting government clarifications and explanations on its potential impacts.

Source: PB

Introduction and Context:

  • Contentious Decision: The removal of the indexation benefit from the long-term capital gains (LTCG) tax regime has become one of the most debated changes in the Union Budget for 2024-25, causing confusion and concern.
  • Government Clarifications: The government has issued multiple clarifications, asserting that the changes will benefit most taxpayers despite initial apprehensions and misunderstandings.
  • Concept of Indexation: Indexation adjusts the original purchase price of an asset to account for inflation, thus providing a more accurate basis for calculating capital gains.
  • Tax Calculation Impact: Without indexation, gains from long-held assets may appear higher than they are, leading to increased tax liabilities under the same tax rates.
  • Understanding Consequences: The removal of indexation is expected to increase tax outgo for many taxpayers, which has led to widespread debate and concern among various sectors.
About Capital Gains Tax (CGT)

Definition and Examples:

  • Capital gains refer to profits from selling any capital asset.
  • Examples of capital assets include land, buildings, house property, vehicles, patents, trademarks, leasehold rights, machinery, and jewelry.
  • Includes rights in or related to an Indian company and management or control rights.

Taxation of Profits:

  • Capital gains are considered ‘income’ and are subject to taxation, known as CGT.
  • CGT is applied when an asset is transferred between owners.
  • This tax is applicable to both individuals and businesses.

Tax Strategies:

  • Taxpaying individuals can implement tax-efficient financial strategies to reduce their CGT burden.

Types of CGT:

1.  Short-term CGT:

  • Assets held for less than 36 months are considered short-term assets.
  • For immovable properties, the duration is 24 months.
  • Profits from these assets are treated as short-term capital gains and taxed accordingly.

2.  Long-term CGT:

  • Assets held for over 36 months are considered long-term assets.
  • Preference shares, equities, UTI units, securities, equity-based mutual funds, and zero-coupon bonds are long-term if held for over a year.
  • Profits from these assets are treated as long-term capital gains and attract tax accordingly.

What is Indexation?

  • Inflation Adjustment: Indexation involves adjusting the original purchase price of an asset to neutralize the impact of inflation, thus providing a realistic basis for calculating gains or losses.
  • Cost of Acquisition: By revising the cost of acquisition based on inflation, indexation helps in arriving at an accurate value of an asset, reflecting its true worth over the holding period.
  • Realistic Returns: The indexed cost of acquisition allows for more realistic returns compared to absolute gains, which do not account for the inflationary impact.
  • Extended Holding Impact: For assets held over long periods, indexation ensures that the gains are not exaggerated, providing a fair assessment of the asset’s appreciation.
  • Tax Implications: Without

indexation, the tax liability on gains from long-held assets would increase, assuming the tax rates remain unchanged.

Move to Do Away with Indexation Benefit

  • Budget Proposal: The Union Budget for 2024-25 proposes to eliminate the indexation benefit for LTCG on property, gold, and other unlisted assets while reducing the LTCG tax rate to 12.5% from 20%.
  • Pre-2001 Assets: For properties and assets purchased before 2001, the fair market value as of April 1, 2001, will be considered as the cost of acquisition to prevent supernormal taxation on old assets.
  • Simplification Effort: The government argues that this move aims to simplify the capital gains tax structure, making it easier for taxpayers and tax authorities to manage.
  • Differential Tax Rates: Removing differential tax rates for various assets is intended to streamline the tax system, reducing complexity and enhancing transparency.
  • Taxpayer Impact: Despite government assurances, there is significant concern about the potential increase in tax liability for those looking to sell property and other long-held assets.

Frayed Nerves and Efforts to Calm Them

  • Initial Anxiety: The announcement caused widespread apprehension, particularly in the residential real estate sector, with fears of increased LTCG tax liability for property sellers.
  • Government Clarifications: The Finance Ministry and Income Tax Department issued clarifications, stating that the new tax regime would be beneficial in most cases, particularly for the property sector.
  • Nominal Returns vs. Inflation: The government argued that real estate returns are generally higher than inflation, making the new tax rate without indexation beneficial for most taxpayers.
  • Social Media Communication: The Income Tax Department used social media to explain that substantial tax savings are expected for most taxpayers under the new regime.
  • Specific Scenarios: The Department provided specific scenarios where the new regime is beneficial, such as properties held for varying periods and their respective value appreciations.

Pushback and Criticism

  • Industry Concerns: Despite government claims, various industry players and analysts have raised concerns about the potential negative impacts of the new LTCG tax regime without indexation.
  • Secondary Market Impact: There are fears that the absence of indexation may lead to a higher frequency of secondary market real estate sales, as people may prefer not to hold assets for extended periods.
  • Holding Period: Holding a property for a long time with moderate capital value growth could result in higher tax liabilities under the new regime compared to shorter holding periods.
  • Liquidation Ease: The new regime may make it easier to liquidate assets held for shorter periods, benefiting those with capital value appreciation over three to five years.
  • Mixed Reactions: While some see potential benefits in the new regime, others remain skeptical, highlighting the need for careful consideration of long-term implications.

Challenges

  1. Increased Tax Liability: With the withdrawal of the indexation benefit, taxpayers holding long-term assets may face higher tax liabilities, as the inflation-adjusted cost of acquisition is no longer considered.
  2. Market Volatility: The changes in the LTCG tax regime could lead to increased market volatility, as investors may rush to sell long-held assets before the new rules take effect.
  3. Compliance Complexity: Despite the government’s intent to simplify the tax structure, the transition to the new regime may create confusion and compliance challenges for taxpayers and tax professionals.
  4. Economic Disparities: The uniform tax rate without indexation may disproportionately impact middle-class and lower-income investors who rely on long-term investments for wealth accumulation.
  5. Real Estate Market Impact: The real estate sector, particularly residential real estate, may see reduced investment and slower growth due to the higher tax burden on long-term gains.
  6. Investor Sentiment: The changes may negatively affect investor sentiment, leading to a potential reduction in capital inflows and decreased investment in long-term assets.
  7. Legal Disputes: The new tax regime could give rise to legal challenges and disputes, as taxpayers may contest the increased tax burden and seek judicial intervention.
  8. Administrative Burden: The government and tax authorities may face an increased administrative burden in implementing and managing the new tax regime, ensuring compliance and addressing taxpayer concerns.

Way Forward

  1. Public Awareness Campaigns: The government should launch extensive public awareness campaigns to educate taxpayers about the new LTCG tax regime, addressing misconceptions and providing clear guidance.
  2. Phased Implementation: Consider a phased implementation of the new tax regime, allowing taxpayers and the market to adjust gradually and minimizing the risk of market disruptions.
  3. Targeted Relief Measures: Introduce targeted relief measures for middle-class and lower-income investors, such as tax credits or exemptions for specific categories of long-term investments.
  4. Enhanced Support Services: Strengthen support services for taxpayers, including helplines, online resources, and workshops to assist with compliance and understanding of the new tax rules.
  5. Periodic Reviews: Conduct periodic reviews of the new tax regime’s impact on various sectors and taxpayer segments, making adjustments as necessary to address any adverse effects.
  6. Encourage Long-term Investments: Develop policies and incentives that continue to encourage long-term investments, despite the changes in the tax regime, ensuring sustained economic growth.
  7. Stakeholder Engagement: Engage with industry stakeholders, tax professionals, and investor groups to gather feedback and collaboratively address challenges and concerns related to the new regime.
  8. Monitoring and Evaluation: Establish robust monitoring and evaluation mechanisms to assess the effectiveness of the new tax regime, ensuring it meets its objectives without undue burden on taxpayers.

Conclusion:

The removal of the indexation benefit in LTCG taxation has led to mixed reactions. While the government aims to simplify the tax structure and ensure broader benefits, the changes pose challenges that need careful management to balance economic growth, investor sentiment, and tax equity.

Source:Indian Express

Mains Practice Question:

Discuss the implications of the withdrawal of the indexation benefit in long-term capital gains (LTCG) taxation on various stakeholders in India. Suggest measures to mitigate any adverse impacts.

Associated Article:

https://universalinstitutions.com/budget-session-of-parliament/