Budget’17 shifted indexation calculation base to 2001. Who gains?

Although the Budget did not propose any major changes on the tax front, the move to shift the base year for computation of indexed cost of acquisition of an asset could have an impact for investors. However, the impact would differ across assets that enjoy indexation benefit on long term capital gains real estate, unlisted shares, gold and bond funds. Here’s a look at the possible impact on your tax burden going forward.

WHY INDEXATION HELPS
Indexation refers to the adjustment in purchase price of an investment for the inflation rate during the period for which it was held. This inflated cost is considered as the purchase price while computing the gains arising from sale of the asset from the taxation perspective.
This benefit is available after holding period of two years in case of property sale, and after three years in case of sale of unlisted shares, gold and debt funds. The Cost of Inflation Index notified by the Income-tax Department every year is used to compute this indexed cost of any asset.
For instance, assume you bought a property in June 2005 at a price of Rs 40 lakh and sold it for Rs 1 crore in December last year. While your actual capital gains stand at Rs 60 lakh, you are allowed to index the acquisition cost as per the rate of inflation during this time to arrive at the inflation adjusted capital gains.
Considering that the CII for the year of purchase (2005-06) as notified by the tax authorities is 497 and that for the year of sale, 2016-17, stands at 1125, the indexed cost of the property comes to around Rs 90.54 lakh (Rs 40 lakh *1125/497). This translates into lower capital gains of roughly Rs 9.46 lakh on the sale. The investor will be taxed at 20% on Rs 9.46 lakh resulting in a liability of Rs 1.89 lakh. Without indexation benefit, the liability would be Rs 12 lakh (20% of Rs 60 lakh).
Till now, capital gain was calculated with 1981 as the base year. This means that the purchase price of an asset bought before April 1, 1981 could be calculated on the basis of the fair market value of 1981. Now on, the purchase price will be calculated based on the fair market value of 2001. Accordingly, capital gains on assets acquired before 1 April, 2001 will also be calculated using fair market value as on 2001. This will accordingly change the computation of capital gains, but with varying results. Keep in mind that investors have the option of considering either the fair market value or the cost of acquisition for computing capital gains. Choosing the higher value would result in lower tax.

PROPERTY OWNERS GAIN…
Experts reckon that it is mostly the property owners who would benefit from this revision in base year. This is because the inflation rate in property market between 1981 and 2001 is not captured in the current index. For one, between 1981 and 2001, the index has jumped four times from 100 to 406 whereas property prices have surged 10 times in the same period. The shift in base year will help align the index with the actual rise in property rates, and help investors get the full benefit of indexation.
The actual rate of inflation in property rates in those days was much higher than that provided in the current index. Since the inflation rate is more in sync with market rates now, shifting the base year to 2001 will help capture the inflated cost of acquisition much better, lowering the capital gains and by extension, the tax burden, says Sudhir Kaushik, CFO, Taxspanner. Save tax beyond 80C, Optimize Tax Now!
Rahul Manjrekar, partner, tax & regulatory services, KPMG, says bthe readjustment will be more representative of the market value, so the indexed cost is likely to be much higher. Since this will help investors deduct a higher amount from the sale price, the capital gains will be lowered to that extent.b Kuldip Kumar, partnerpersonal tax, PwC India, says: bIf your property is located in a region where the appreciation is higher than the CII figure, then the revised base year should cover the appreciation better than previously.b Essentially, the price appreciation between the date of acquisition and April 1, 2001 becomes tax free in hand of the investor. However, the actual impact will depend on the index values notified by the tax department.

…OTHERS MAY GAIN SOMEWHAT
For those holding on to inherited shares or gold bought many years ago, any gains up to April 1, 2001 becomes tax free.
However, the shift in base year will not have much material impact for those holding gold, say experts. This is because gold prices held steady till the beginning of the millenium, with much of the gold price appreciation taking place only after 2007-08. However, those holding unlisted shares, on which no securities transaction tax has been paid, may benefit due to lower capital gains tax incidence, says Vidya Bala, head, mutual fund research, FundsIndia.
If the price of gold or shares rose between your date of purchase and April 1, 2001, you can consider the fair market value as on 1 April, 2001 as your acquisition price to enjoy lower tax burden. If not, you can consider the actual purchase price as cost of acquisition. But it is unlikely that any bond fund investors will be holding on to their units acquired before 2001.

NOW AND BEFORE
HOW A PROPERTY SELLER COULD GAIN OR LOSE AFTER SHIFT IN BASE YEAR
Purchase price (Rs): 1,000,000
Sale price (Rs): 7,500,000
Purchase date: April 1, 1995
Date of sale: September 30, 2016
CII (1995-96): 281
CII (2001-02): 426
CII (2016-17): 1125

CURRENT SCENARIO
Base year: 1981
Indexed cost of acquisition: 4,003,559
Long term capital gain/loss: 3,496,441
Tax liability (20% of capital gain): 699,288
FMV IS FAIR MARKET VALUE

BUT AS PER CII, THE PROPERTY PRICE HAS GONE UP TO Rs 15.16 LAKH IN 2001-02. NOW, THERE CAN BE TWO SCENARIOS IF BASE YEAR IS TAKEN AS 2001
SCENARIO 1
FMV in 2001-02 Rs 20 lakh (>Rs 15.16 lakh)
5,281,690
2,218,310
443,662
TAX LIABILITY IS LOWER
SCENARIO 2
FMV in 2001-02 Rs 12 lakh ( 3,169,014
4,330,986
866,197
TAX LIABILITY HAS INCREASED
[button style=”btn-danger btn-lg” type=”link” target=”true” title=”Optimize Tax Now!” link=”https://www.taxspanner.com/optimize-tax/” linkrel=””]
 
(As Published in ET Wealth on Feb 13, 2017)