Capital gains in taxation: What are the major factors driving the long-term and short-term capital gains?

• India’s current capital gains tax regime provides for multiple tax rates and differential treatment based on the holding period and type of assets.
  
  
• A simplified capital gains tax regime can help investors plan their investment/divestment strategies efficiently.
  
  
• Writing exclusively for Business Insider India, the columnists suggest amendments that the government needs to consider in the upcoming Budget to rationalise India’s capital gains tax regime.
  

Capital investment plays an important role in facilitating economic growth, creating employment and encouraging savings. Hence, many countries tax capital gains at a preferential rate.

India too follows a preferential-tax policy for capital gains, e.g., partial exemption on long-term capital gains on sale of listed shares (up to ₹1,00,000 of such gains were fully exempt from tax until 31 March 2019) and lower tax rates for certain types of capital gains.

However, the current capital gains tax regime in India provides for multiple tax rates and differential treatment based on the holding period and type of assets. To bring clarity to the capital gains tax regime, the government should consider simplifying the norms. A simplified capital gains tax regime can help investors plan their investment/divestment strategies efficiently.

Amendments to be considered in Budget FY24 to rationalise India’s capital gains tax regime

The current capital gains tax regime with numerous tax rates and differential tax treatments causes uncertainty and confusion amongst investors. To simplify the tax regime, the following steps can be considered:

• Currently, the assets are classified into long-term and short-term based on their class – for instance listed shares of a company qualify as long-term capital asset if held for more than 12 months, whereas listed units of a business trust qualify as long-term capital asset if held for more than 36 months, resulting in differential treatment for similar class of assets.
  

Hence, the holding period for various types of capital assets can be rationalised.

• There are numerous tax rates for different types of capital assets and their holding period, e.g., the long-term capital gains on listed shares are taxed at 10% whereas, the long-term capital gains on house property are taxed at 20%.
  

Such multiple rates can be reduced to a maximum of 2 to 3 rates.

• To tax only the actual cash gain earned by the investors on sale of capital assets, expenses such as Securities Transaction Tax (STT), legal fees, portfolio management fees, consultation fees, etc., incurred by investors in connection with the purchase and sale of shares can be allowed as expense to compute capital gains.
  

• Long-term capital gains arising from sale of capital assets (other than residential house property) are exempt from tax for individuals and HUFs (Hindu undivided families), if the entire ‘net consideration’ is deposited under Capital Gain Account Scheme. However, in some cases (such as deduction of tax by buyer, receipt of consideration in instalments, etc.), the actual amount available to deposit under the scheme would be less than the ‘net consideration’, resulting in a shortfall.
  

To avoid litigation, clarity should be provided on this aspect.

• Individuals and HUFs are exempt from capital gains tax arising on sale of agricultural land if such gain is invested in another agricultural land within two years of the sale.
  

Like the relief provided for residential house property, the exemption on sale of agricultural land should be available if invested in another agricultural land either one year prior or within two years of sale.

• The capital gains tax regime provides for deemed income consequences for both buyer and seller, where the transfer of assets takes place at a price lower than their fair market value. Hereby, the fair market value is considered as the deemed sale consideration for the seller for computation of capital gains and the difference between the fair market value and the purchase consideration is considered as deemed income in the hands of the buyer.
  

However, there is some ambiguity in the deemed income provisions for certain types of transactions (such as transactions effected pursuant to Insolvency & Bankruptcy Code, 2016, slump sale transactions, conversion of compulsorily convertible instruments, etc). Such transactions can be kept outside the purview of the deemed income provisions.

• To incentivise promoters, most private equity players are increasingly introducing a combination of clauses in the shareholders’ agreement, including consideration payable in a contingent manner based on certain performance milestones. However, there is no clarity on taxation of such contingent consideration.
  

It may be clarified that the contingent consideration should be taxed only in the year in which the same is crystallised.

• Currently, capital gains tax exemption/relief has been provided to some forms of business reorganisation, this relief/exemption can also be extended to other forms of business reorganisation, such as:
  
  
  • Exemption from capital gains arising on conversion of LLP to a company i.e., exemption in the hands of the partners of an LLP on transfer of their interest in the LLP in exchange of shares of a company, aligned with exemption provided to a firm on being succeeded by a company.
    
  • Specific exemption to be provided for merger of an Indian company into a foreign company.
    
  • Similar to the relief provided to a foreign company, relief from capital gains tax too can be provided to the shareholders of the amalgamating foreign company.
    
  • It can be considered to provide tax exemption to intra-group slump sale transactions, subject to a certain lock-in period.
    

Also, clarification needs to be provided on the applicability of grandfathering clause in case of amalgamation/demerger of listed entities, post 31 January 2018.



Given that income from capital gains is a secondary source of income for the majority of the taxpayers, lack of clarity and tedious compliances is cumbersome for such taxpayers. The above amendments/clarifications would help in rationalisation of the capital gains tax regime and improve the vibrancy of capital markets in India.

Utkarsh Trivedi is a Partner at Deloitte India. Shivani Kotadia is a Manager and Shivani Kankaria is a Deputy Manager at the same firm.