In response to concerns and criticism over the recent Budget proposal to remove the indexation benefit on long-term capital gains (LTCG) from the sale of unlisted assets, the government has introduced a new provision. Taxpayers will now have the option to choose between two methods for calculating their tax liability on property sales acquired before July 23, 2024. This decision comes as part of the amendments to the Finance Bill.
Understanding the New Tax Options
The two options provided by the government are as follows:
- Pay LTCG Tax at 20% with Indexation Benefit: This allows taxpayers to adjust the original purchase price of an asset for inflation, thereby potentially reducing the taxable capital gain.
- Pay LTCG Tax at 12.5% without Indexation Benefit: This offers a lower tax rate but does not account for inflation, which could result in a higher taxable gain.
Taxpayers are expected to choose the option that results in the lower tax liability.
What is Indexation?
Indexation is a method of adjusting the purchase price of an asset to reflect inflation. By revising the cost of acquisition based on inflation, it neutralizes the inflationary impact on the asset’s value. This adjustment is particularly beneficial for assets held over a long period, as it ensures that the taxable gain reflects true economic gains rather than inflation-driven increases in asset value.
Without indexation, the nominal gains from the sale of an asset might appear significantly higher, leading to a higher tax liability. This might not accurately represent the real profit, especially if inflation has significantly eroded the purchasing power over the holding period.
Implications for Taxpayers
This amendment addresses the concerns raised by taxpayers and financial experts regarding the removal of the indexation benefit. The choice between the two tax rates provides flexibility, allowing taxpayers to select the method that minimizes their tax burden. This change is particularly relevant for those who have held unlisted assets for a long duration, as the impact of inflation can be substantial.
Practical Example
Consider a taxpayer who purchased an unlisted property for ₹10 lakh 15 years ago. Assuming the property is now worth ₹50 lakh, here’s how the two options would work:
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With Indexation (20% Tax Rate):
- If the inflation index has doubled over 15 years, the indexed purchase price would be ₹20 lakh.
- The taxable gain would then be ₹30 lakh (₹50 lakh – ₹20 lakh).
- The tax liability at 20% would be ₹6 lakh.
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Without Indexation (12.5% Tax Rate):
- The taxable gain would be ₹40 lakh (₹50 lakh – ₹10 lakh).
- The tax liability at 12.5% would be ₹5 lakh.
In this scenario, the taxpayer would opt for the second method, as the tax liability is lower.
Long-Term Benefits
This provision aims to provide a fairer tax system by acknowledging the impact of inflation on long-term investments. It encourages investment in unlisted assets by offering a tax-efficient exit strategy. Moreover, it simplifies the decision-making process for taxpayers by providing clear options.
Conclusion
The government’s decision to offer a choice between a 20% tax rate with indexation benefit and a 12.5% rate without it is a significant move to address taxpayer concerns. This amendment to the Finance Bill ensures that taxpayers can make informed decisions and potentially reduce their tax burden on the sale of unlisted assets. By understanding and utilizing the indexation benefit, taxpayers can better manage their long-term investments and navigate the complexities of capital gains taxation.