Decoding the new Long Term Capital Gains Tax on Equities

The writer is a Delhi based Certified Financial Planner CFPCM, conferred upon by the
Financial Planning Standards Board. If you are an Indian resident looking for a financial plan prepared according to your needs & goals, write to her at shruti(AT)richesawait.com

Until financial year 2017-18, Long Term Capital Gain (LTCG) tax on equity or equity oriented mutual funds was Nil, i.e. if investors sold their shares or equity oriented mutual fund units after holding them for more than a year, they paid zero LTCG tax. All the gains (no matter the amount) were theirs to keep without fear of the taxman.

However, in this year’s budget, the government has changed the rules and has introduced an LTCG tax of 10% (without indexation) on gains made above 1,00,000 per annum, starting from April 1st 2018.

To understand the implication of this new LTCG tax, you need to understand some key points and features:

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  • Valid from 1st April 2018
    This new tax is valid from the starting of this financial year. This means that all the redemptions done till 31st March 2017 were tax free. You only have to pay tax if you sell your shares or units during this financial year.
  • No tax on gains of upto 1,00,000
    You only have to pay tax if your total gains in a year exceed the amount of 1,00,000. Moreover, you will be taxed on the excess amount only and not the entire amount. For example, say you sold a share after holding it for 2 years and made a profit of ₹50,000 on it in FY 2018-19. In the same year you also sold some equity mutual funds which you bought an year ago and gained ₹70,000 from this sale. This means that your total capital gains during FY 2018-19 was ₹1,20,000. Now as per the new LTCG tax, gains upto ₹1,00,000 are exempt which means that you will be taxed only on the remaining ₹20,000 @ 10%. So your total tax liability is of ₹2,000.
  • No Indexation benefit
    You will be taxed on total gains arising from redemption, inflation will not be taken into consideration. So, no indexation benefit on LTCG on equity, unlike the benefit you receive in case of LTCG tax on sale of units from debt mutual funds.

Since most investors invested in equities scheme keeping in mind the relaxed tax regime and in order to safeguard their earlier returns, the Indian government has introduced a Grandfathering clause.

This clause is the exemption granted to existing investors for the gains made by them before the new tax came into force. Government has said that gains made in equity oriented mutual fund schemes till January 31st 2018, will be grandfathered or exempted. There will be no LTCG tax on estimated profits on mutual funds till then.

Keeping in mind this grandfathering clause the following method will be used for calculating LTCG.

The cost of acquisition of share or unit bought before 1st February 2018 will be calculated as (a) or (b), whichever is higher:
a) The cost of acquisition of the asset
b) The market value of the asset (as on January 31st 2018) OR The sale value received when the share or unit is sold, whichever is lower

Let’s understand what this means.
To calculate LTCG  you need to deduct the purchase price (cost of acquisition) from the selling price. The cost of acquisition is usually the cost of the asset. However, as per the grandfathering clause, if the cost is less than its market value as on January 31st 2018, the market value itself will be deemed as the cost of acquisition. But if the sale value is less than the market value, then sale value will be deemed as the cost of acquisition.

The following scenarios will help you understand this point more effectively:

Scenario 1
An equity mutual fund unit was bought on 20th December 2016 at ₹100, and its market value on January 31st 2018 is ₹200. Now say you sell this unit on April 10th 2018 at ₹250. In this case the cost of acquisition is less than the January market value, therefore, the latter (₹200) will be taken as the purchase price and the LTCG will be ₹50.

Scenario 2
An equity mutual fund unit was bought on 20th December 2016 at ₹100, and its market value on January 31st 2018 is ₹200. Now say you sell this unit on April 10th 2018 at ₹150. In this case the market value in January is not only higher than the purchase price but is also higher than the sale value. Therefore, the sale value of ₹150 will be taken as the cost of acquisition too and the LTCG will be zero (₹150 – ₹150)

Scenario 3
An equity mutual fund unit was bought on 20th December 2016 at ₹100, and its market value on January 31st 2018 is ₹50. Now say you sell this unit on April 10th 2018 at ₹150. In this case since the sale price is higher than the January market value, this will be the amount used for computing LTCG. So LTCG will be ₹50 (₹150 – ₹100).

Keep in mind that this grandfathering clause is only valid for purchases made before 1st February 2018.
If you bought an asset on or after 1st February 2018 then actual purchase price will be used for calculating LTCG.

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