The Union Budget 2024-25 has completely overhauled the capital gains tax framework. Some measures may hurt badly. Homeowners will no longer get the indexation benefit on sale of property, while gains on sale of stocks and equity funds will now attract a higher tax. However, the Budget offers some sops as well. The exemption limit on gains from equities has been hiked, while a previous anomaly in taxation of certain non-equity funds has been removed. Let’s dive deeper to find out what this means for you.
Removal of indexation
The gamechanger is the elimination of indexation benefit from the capital gains taxation framework. This has been accompanied by a cut in long-term capital gains (LTCG) tax rate from 20% to 12.5%. This will have an impact on property owners, as well as gold buyers, in varying degrees. Indexation offsets accrued capital gains against inflation rate during the holding period, which lowers the effective tax incidence in many cases. This offset benefit has been removed by the Budget, so the entire gains will be taxed, but at a lower rate of 12.5%, instead of 20% earlier. The Finance Ministry has clarified that assets bought before 1 April 2001 will continue to get the indexation benefit.
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Removal of indexation and lower LTCG will affect property sellers differently
Some sellers could end up paying more, while others could get away with a lower tax.
How this affects you will depend entirely on the period of holding and the gains accrued. Shishir Baijal, Chairman and Managing Director, Knight Frank India, remarks, “If the property’s value has increased more than the inflation rate, the new 12.5% tax rate is expected to be more advantageous for real estate sellers, compared to the previous 20% tax rate after adjusting for indexation.”
If a property bought for Rs.25 lakh in 2003 is sold today for Rs.1.5 crore, the capital gain is Rs.1.25 crore. Under existing rules, the indexed cost of the property would come to Rs.86.43 lakh, which means the taxable capital gains would be only Rs.63.57 lakh. At 20%, the seller would pay a tax of Rs.12.71 lakh on these gains. Under the proposed rules, the entire capital gains of Rs.1.25 crore would be taxed at 12.5%, resulting in a higher tax liability of Rs.15.62 lakh. The seller will end up shelling out Rs.2.9 lakh more as tax.
Why we need lower taxes on capital gains
Now, suppose that a property bought for Rs.75 lakh in 2018 is sold for Rs.1.5 crore today. Under the existing rules, the tax would be Rs.10.55 lakh on the indexed capital gains of Rs.52.76 lakh. However, the seller will pay a lower tax of Rs.9.37 lakh as per the proposed change.
Some reckon that the removal of indexation benefit is not a dampener. Amit Goyal, Managing Director, India Sotheby’s International Realty, asserts, “For real estate transactions, bringing down the LTCG tax from 20% to 12.5% is a welcome step, even if it comes with the removal of indexation benefit. It will encourage more liquidity in property transactions.” Amol Joshi, Founder, PlanRupee Investment Services, points out that many property sellers typically end up buying another property, which allows them to offset the capital gains from sale. So these sellers will not miss the indexation benefit. However, some concede this is likely to weigh on homeowners’ decision to sell property. Nilesh Sharma, President & Executive Director, SAMCO Securities, remarks, “The removal of indexation benefit for LTCG will slow down the resale of residential flats or lands. It may also increase the proportion of cash in real estate deals, which will be counterproductive.”
Hike in capital gains tax
In another unexpected move, the Budget has proposed to hike the tax on shortterm and long-term gains from equities. Short-term gains on equities will now be taxed at 20%, sharply up from 15% earlier. Meanwhile, long-term gains will attract a 12.5% tax, up from 10%. This higher tax will eat into the gains from shares and equity-oriented funds. The Budget has extended some relief by increasing the tax exemption on LTCG from Rs.1 lakh to Rs.1.25 lakh in a financial year. Joshi says, “The higher tax burden from hike in capital gains tax is partially offset by the increase in exemption limit.” Further, the securities transaction tax (STT) on trading in futures and options segment is set to be hiked to 0.02% and 0.1%, respectively. This will raise the cost for those engaging in trading activity.
How capital gains tax rates will change
The Budget proposes to change the rates and remove some previous anomalies in taxation of assets.
Clearly, even as the Budget has hiked capital gains tax on both long-term and short-term gains, it has nudged investors towards longer-term holding and discouraged speculative activity. After the tax change, the gap between short-term and long-term capital gains tax rate has widened from 5% to 7.5%. Despite the hike in LTCG tax rate, the wider gap relative to STCG tax rate and higher exemption makes longer-term holdings more attractive for investors. Investors in equity arbitrage funds, who typically hold for less than a year, will feel the pinch of the hike in short-term capital gains tax rate to 20%, reckons Joshi.
Investors may have to adjust their investing and trading strategies accordingly. Vaibhav Porwal, Co-founder, Dezerv, says, “The widening gap between STCG and LTCG rates is a clear incentive for longerterm holdings, which aligns with our view of creating sustainable wealth.” Shlok Srivastav, Cofounder & COO, Appreciate, reckons this is like killing two birds with one stone. “For serious long-term investors, the increase from 10% to 12.5% would hardly make a dent in the larger accounting of gains. At the same time, it will nudge investors into entering the Indian markets with a reasonably long-term outlook and encourage them to step up as actual stakeholders in the Indian growth story,” he says.
With the concurrent hike in STT on futures and options, the government clearly wants to discourage short-term trading activity. Porwal asserts, “This will undoubtedly impact the profitability of frequent traders. However, we encourage investors to look beyond immediate market reactions and consider the long-term benefits of a tax structure that promotes patient capital.”
Parity in taxation
The rationalisation of capital gains tax regime has also ushered parity in taxation across asset classes. For qualification as a long-term capital asset, the period of holding for listed financial assets is proposed to be fixed at one year, and for others (unlisted financial assets and all non-financial assets), to two years. For instance, the holding period for REITs is now reduced to 12 months, from 36 months, to qualify as long-term asset, on a par with equities. Similarly, the holding period for LTCG in real estate, gold and international funds is now the same for all at two years. Further, long-term capital gains across listed and unlisted equities are proposed to be taxed at a uniform rate of 12.5%, doing away with the current differential tax rates of 10% and 20%, respectively. Manoj Purohit, Partner & Leader, Financial Services Tax, Tax & Regulatory Services, BDO India, says, “The harmonisation of the period of holding for capital assets will bring the much-needed clarity and simplification in computing the tax aligned with common tax rates for financial assets.” Shantanu Bhargava, Managing Director, Head of Discretionary Investment Services, Waterfield Advisors, asserts, “The tax simplification introduced in this year’s Union Budget levels the playing field for other asset classes, such as unlisted shares, gold, international equity/debt FoF, and real estate.”
The Budget has also removed an anomaly in taxation of gold mutual funds, gold ETFs, fund of funds, and international equity funds. After the change in last year’s Budget, these funds were being treated as debt funds from the taxation perspective, where gains were taxed at the slab rate regardless of holding period. Now, investors in these assets will get the benefit of the new LTCG, and will pay 12.5% tax, if the holding period is more than 24 months. Meanwhile, the mutual funds that were holding between 35-65% in equities, and the rest in debt or other asset classes, will no longer get indexation benefit. Some investors had taken to funds in categories like multi-asset funds and balanced hybrid funds purely from the tax perspective.
Bhargava feels this rationalisation will help investors be tax-informed, rather than tax-driven. “At the industry level, we have observed that in the past 15 months, a large swathe of investors has made tax-driven portfolio allocations, in which they have allocated to riskier products due to changes in taxation of vanilla debt mutual funds, possibly without carefully assessing and understanding the risks by including such riskier products.”
Further, it must be noted that unlisted bonds and debentures, debt mutual funds and market-linked debentures, irrespective of the holding period, will attract tax on capital gains at the applicable rates. Purohit observes, “Bringing unlisted debentures and unlisted bonds under the ambit of Section 50AA of the Act will increase the tax burden for the investors as the proposed tax would be on applicable rates.”
