The Union Budget for the financial year 2024-25 introduced significant changes to India’s long-term capital gains (LTCG) tax regime. These changes have sparked discussions among investors, financial experts, and economists alike. The government made notable adjustments, including reducing the tax rate on long-term capital gains and reinstating the crucial indexation provisions. This article provides a comprehensive overview of the LTCG tax, the concept of indexation, and the implications of the new budgetary changes.
What is Long-Term Capital Gain (LTCG)?
A Long-Term Capital Gain arises when you sell a capital asset after holding it for a specified period:
- Real Estate: Holding period more than 24 months.
- Equity and Equity Mutual Funds: Holding period more than 12 months.
The profit you earn after this holding period is classified as LTCG and is subject to taxation under Indian law.
Understanding Capital Gains Before 2018
Before diving into the recent changes, it’s crucial to understand a key provision related to LTCG taxation. Until 2018, long-term capital gains from the sale of equity shares and equity mutual funds were entirely exempt from tax. However, the 2018 Union Budget changed this, introducing a 10% tax on LTCG exceeding ₹1 lakh per annum. To protect the gains accumulated before this change, the government introduced a “grandfathering” provision.
Grandfathering Provision:
- Gains accrued up to January 31, 2018, were exempt from LTCG tax.
- Any gains made after this date were subject to the new 10% LTCG tax, but only on the gains that exceeded the highest price of the asset as of January 31, 2018.
Example:
- Purchase Price (2015): ₹1,00,000
- Price on January 31, 2018: ₹1,50,000
- Sale Price (2023): ₹2,50,000
Taxable LTCG:
[ \text{Taxable LTCG} = 2,50,000 – 1,50,000 = ₹1,00,000 ]
In this case, the gain from ₹1,00,000 to ₹1,50,000 is “grandfathered” and remains tax-free.
Inflation, Indexation, and Long-Term Capital Gains
Inflation refers to the general rise in prices over time, eroding the purchasing power of money. To ensure that investors are not unfairly taxed on gains that merely reflect inflation, the government uses a technique called indexation.
Indexation adjusts the purchase price of an asset for inflation, reducing the taxable gain. The government uses the Cost Inflation Index (CII) for this purpose.
Indexed Cost of Acquisition:
[ \text{Indexed Cost of Acquisition} = \frac{\text{CII of the year of sale}}{\text{CII of the year of purchase}} \times \text{Actual Cost of Acquisition} ]
Example Calculation of LTCG with Indexation
Let’s consider an example to see how indexation works:
- Year of Purchase: 2010
- Purchase Price: ₹10,00,000
- Year of Sale: 2023
- Sale Price: ₹25,00,000
- CII in 2010: 167
- CII in 2023: 331
Indexed Cost of Acquisition:
[ \text{Indexed Cost} = \frac{331}{167} \times 10,00,000 = ₹19,82,035 ]
Long-Term Capital Gain (after indexation):
[ \text{LTCG} = 25,00,000 – 19,82,035 = ₹5,17,965 ]
Without indexation, the capital gain would have been ₹15,00,000, resulting in a higher tax burden. Indexation brings it down to ₹5,17,965.
Key Changes in the Budget 2024-25
In the 2024-25 Union Budget, the government made the following key changes:
- Reduction in LTCG Tax Rate: The tax rate on LTCG was reduced to incentivize long-term investments.
- Removal and Reinstatement of Indexation Provisions: Initially, the government removed the indexation benefit, which would have significantly increased the tax burden on long-term investors. However, after widespread concern from the public and experts, the government reinstated the indexation provisions. This reinstatement was crucial as it ensures that only the real gain, accounting for inflation, is taxed, thus providing relief to long-term investors.
Impact of the Changes
The reinstatement of indexation, coupled with the reduction in LTCG tax rates, is expected to boost long-term investments in real estate, equity, and other capital assets. Investors are likely to find these changes favorable, as they align with the principles of fair taxation, considering inflationary effects and protecting the real value of gains.
Conclusion
The 2024-25 budgetary changes in the long-term capital gains tax regime reflect the government’s intent to encourage long-term investments while ensuring a fair tax system. The reinstatement of indexation provisions is a welcome move, balancing the need for revenue with the importance of protecting investors from the eroding effects of inflation. For those invested in long-term assets, these changes provide clarity and a sense of fairness, which is crucial for sustained economic growth.
Investors should stay informed and consult with financial advisors to navigate these changes effectively, ensuring that they maximize their benefits while complying with the new tax rules.
