Simplification of the income tax law has been at the forefront of the government’s agenda. The government has been vocal in its intent of phasing out deductions, exemptions, allowances etc. in favor of a simpler tax regime. Over the years, the government has phased out tax benefits and reduced average tax rates for corporates and individuals.

In line with this intent, the Finance (No. 2) Act, 2024 (‘Finance Act’) has made a host of changes to the Income-tax Act, 1961 (‘IT Act’) to rationalize the provisions relating to capital gains tax. Amendments have been made to simplify the characterization of long-term assets, computation of gains and application of tax rates. The proposed amendments inter alia, will have a significant impact on taxpayers transferring their capital assets on or after July 23, 2024.

The present article aims to summarize these amendments and highlight key aspects that warrant taxpayers’ attention.

Presently, any profits or gains arising from the transfer of capital assets (being immovable property) is chargeable to income-tax under the head ‘Capital Gains’ and are taxable in the year of transfer [Section 45, IT Act.]. The income chargeable under the head ‘Capital Gain’ can be classified under two heads, namely (1) long-term capital gains, or (2) short-term capital gains, depending on the period of holding. [Immovable property being land or building or both held for 24 months or more are classified as long-term capital asset under third proviso to Section 2(42A) of the IT Act]

Under the existing provisions, the long-term capital gains from the transfer of immovable property are computed by reducing the indexed cost of acquisition [Cost of acquisition x (Cost Inflation Index (‘CII’) of the year of transfer / CII of the year of acquisition of the capital asset)], indexed cost of improvement [Cost of improvement x (CII of year of year of transfer/ CII of year in which improvement of capital asset took place)], and expenses connected with the transfer from the full value of consideration [Section 48, IT Act]. The same is taxed at the rate of 20 per cent (excluding surcharge and cess) in the hands of the resident-transferor [Section 112(1) of the IT Act].

The benefit of ‘indexation’ was purported to offset accrued capital gains against the inflation rate during the holding period by making an upward adjustment to the cost of acquisition of the asset. This effectively resulted in lowering the effective tax incidence on the taxpayers.

The Finance Act has made following changes in respect of the transfer of immovable property effected on or after July 23, 2024:

• Firstly, reduced the tax rate on long-term capital gains from 20 per cent to 12.5 per cent;

• Secondly, the benefit of indexation from long-term capital gains computation has been withdrawn;

There is just one caveat to the afore-stated position. Taxation of long-term gains derived by a resident individual or HUF from transfer of land and building, acquired prior to July 23, 2024, has been capped at amount of income tax as would have been payable prior to these amendments. This grandfathering benefit will ensure that the taxpayers who had acquired land and/ or building prior to July 23, 2024 don’t end up paying higher taxes because of the amendments.

The overall impact of the proposed amendment can be understood with the help of the following illustration:

Let us assume Mr. A (resident individual) acquired a piece of land in FY 2012-13 for INR 5,00,000, which was later sold on July 24, 2024 for the following sale consideration:

o   Scenario 1: INR 75,00,000

o   Scenario 2: INR 8,00,000

The new regime is beneficial to Mr. A as tax rates are lower whereas the old regime is beneficial to Mr. A as carry forward of losses was possible.

While the government’s stated intent is to rationalize and simplify the capital gains taxation regime, the taxpayers transferring immovable properties on or after July 23, 2024, may face the following challenges:

• No carry forward or set-off of de facto capital loss on sale of immovable property considering inflation and time-value of money: As evident from the illustration above (Scenario 2), there may be cases wherein a taxpayer is incurring a loss after reducing the indexed cost of acquisition from full value of consideration under the erstwhile provisions.

  With the removal of the indexation benefit, taxpayers will no longer be entitled to carry forward or set off such losses. Thus, the grandfathering provision does not necessarily place the taxpayers on the same footing as before in relation to land and/ or building acquired before July 23, 2024.

• Higher re-investment for claiming capital gains tax exemption: Section 54 of the IT Act grants exemption to long-term capital gain arising from the transfer of a residential house, subject to the condition that the capital gain amount is invested in a new residential house within the specified period. With the removal of the indexation benefit, an individual or HUF intending to claim this exemption in respect of a residential house acquired on or after July 23, 2023 would be required to invest a higher amount in the new asset.

• No grandfathering benefit for leasehold rights: It is provided that the taxation on transfer of immovable property (being land or building or both) acquired before July 23, 2024 will be capped at the tax rates as applicable prior to the amendment.

However, the provision is silent on other categories of rights which are directly associated with immovable property, such as leasehold rights. In certain cases, the phrase immovable property being ‘land’ and/ or ‘building’ has been interpreted not to cover rights associated with such immovable property, such as leasehold rights. Accordingly, taxpayers transferring such rights (say, leasehold right or development rights) should carefully evaluate their tax liability in light of the proposed amendments.

The amendments to capital gains taxation will diversely impact the taxpayers. The reduction in tax rates for long-term gains may have the impact of significantly reducing the capital gains tax rate in respect of certain assets such as unlisted shares where there has been a significant increase in the valuation with a relatively lower investment. Nevertheless, the elimination of indexation benefits would likely result in increased capital gains, necessitating a larger investment in assets like residential properties to mitigate the tax burden. Accordingly, taxpayers undertaking real estate transactions need to closely examine their capital gains tax liability on a case-to-case basis.

About the authors: Karanjot Singh is a Partner, Devashish Jain is a Principal Associate and Kanika Jain is an Associate at Lakshmikumaran and Sridharan attorneys.

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