Going by the queries that we receive in our inbox, we can safely surmise that investors have been taking full advantage of the Sensex run up prior to the general elections by booking profits. The only problem is that unlike earlier years where the long-term capital gains were tax-free, after the changes brought in by Budget 2018 of reinstating the long-term capital gains tax regime, there is some amount of confusion as to how exactly is the tax applicable. So this week, let us see what the exact nature of change was in the method of computing the long-term capital gains tax and how would it be applicable to current sale transactions.
As per the tax law, tax on long-term capital gains on equity and equity MFs will be levied @10%. There is a basic exemption of Rs. 1 lakh below which there will be no tax. Note that this exemption is cumulative in nature (applicable to all equity related LTCG in aggregate earned during the year and not to individual gains). This LTCG tax has a grandfathering clause (as it is called). This means that to an extent, the tax is prospective and not retrospective. The way it will work is that LTCG on any sale of investments made before 1st of February, 2018 will be split into two. The capital gain earned till 31st of January, 2018 will be exempted from tax. The rest of the gains (from 31st January till date of sale) will attract tax at the flat rate of 10% without indexation. If the sale price is lower than the cost as on 31st of January, 2018, then in effect, there would be no capital gain. The following table details the various scenarios that may emerge. In Scenario I, since the result would be a long-term loss, this loss should be available for set-off against other taxable long-term gain. The point hasn’t been highlighted in the general media.
Also, let us put this tax into perspective. Firstly, the tax (as you can see from the table) is applicable basically only to the difference between sale value (if any) and the cost as on 31st of January. So a major part of the capital gain on past purchases of shares would be exempt in any case. Secondly, there remains the fact that taxes will always be a part of life – in the long run, one cannot escape this reality. So your objective should always be to optimize and maximize post tax income. As you know, in our columns we have always advocated a long term approach. So at a return of say 15% p.a. over 5 years, the capital would basically double (i.e. the return would be 100% over capital). Out of this 100%, 10% would be tax – still leaving 90% profit on the table. It is this 90% that investors should aim for – put into this perspective, the 10% tax is of little significance – definitely not something that you need to change the entire approach and planning for! The reason we are stating this here is that many investors have refrained from entering the market or have sold prematurely on account of the fact that now long term gains are no longer tax-free!
The other measure (not related to the above) that there is substantial confusion about is with respective to taxation of house property as proposed by Budget 2019. As a bi of a background, the basis of calculating income from house property is the rental value. This is the inherent capacity of the property to earn income. Now, property income is perhaps the only income that is charged to tax on a notional basis. This charge is not because of the receipt of any income per se, but is on the inherent potential of the house property to generate income.
So first and foremost, the first property that you buy is exempt from income tax – that is to say, there would be no tax on such property if one lives in the property or has kept the property locked up. The latter scenario may arise if someone resides at a rented place (due to a desire to stay closer to the employment or place of business maybe) or if one stays with one’s parents etc. but yet purchased the property as an investment. This is in so far as the first property is concerned.
However, so far, the second property onwards — even if it had been kept under lock and key, a notional rent value based on the market rental value had to be adopted as your notional income from the second property To put it differently, even if one earns no income whatsoever from the second property, it was taxable as if it had been put on rent. Budget 2019 has brought in the benefits of nil tax hitherto available to only one property to any two properties owned by the taxpayer. So now, any two residential properties owned by the taxpayer, which are not rented out, will nonetheless be tax-free. Tax will be leviable only from the third property onwards. Note that this is only with respect to properties not let out. If any property is actually rented, even if it is the only property belonging to the taxpayer, it would be fully taxable in the normal course. The authors may be contacted at wonderlandconsultants
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