ARTICLE
17 October 2024

Indexation Benefit – The Devil Is In The Details

J
JSA

Contributor

JSA is a leading national law firm in India with over 600 professionals operating out of 7 offices located in: Ahmedabad, Bengaluru, Chennai, Gurugram, Hyderabad, Mumbai and New Delhi. Our practice is organised along service lines and sector specialisation that provides legal services to top Indian corporates, Fortune 500 companies, multinational banks and financial institutions, governmental and statutory authorities and multilateral and bilateral institutions.
The finance bill presented in July 2024 has proposed doing away with the indexation benefit for properties purchased after 2001, while reducing the long-term capital gains tax from 20% to 12.5%.
India Tax

The finance bill presented in July 2024 has proposed doing away with the indexation benefit for properties purchased after 2001, while reducing the long-term capital gains tax from 20% to 12.5%. This has stirred quite a bit of anxiety and debate.

Indexation benefit provided a sort of revaluation of the property to account for inflation between the date of purchase and the date of sale.

Let us say a property bought in 2005 was sold in 2023. If the property were purchased for INR 1,000,000, it would be valued at approximately INR 3,000,000 in 2023 due to indexation. If the sale price of such property were INR 4,000,000, the long-term capital gains tax would have been INR 200,000 (with indexation, and computed at 20% of INR 1,000,000). Assuming no indexation benefit, the long-term capital gains tax would be INR 375,000 (computed at 12.5% of INR 3,000,000). Here the indexation benefit results in lower tax.

Now say another property bought in 2018 was sold in 2023. If the property were purchased for INR 2,000,000, it would be valued at approximately INR 2,400,000 in 2023 due to indexation. If the sale price of such property were INR 4,000,000, the long-term capital gains tax would have been approximately INR 320,000 (with indexation and computed at 20% of INR 1,600,000). Assuming no indexation benefit, the long-term capital gains tax would be INR 250,000 (if computed at 12.5% of INR 2,000,000). Here the indexation benefit results in higher tax.

It would therefore appear that the indexation provision is beneficial in certain cases despite the new lower tax rate of 12.5%, but not beneficial in certain other cases. The devil is therefore in the details, and the computation and consequences will be specific to the facts of each case.

The government's position is that the lower rate without indexation benefit will be beneficial to all. Accordingly, like in the case of tax filings where an assessee can opt for the new tax regime or choose to continue with the old regime, a similar approach could have been taken for this matter as well. The assessee could have been given the option to choose the higher tax rate of 20% with indexation benefit or the lower tax rate of 12.5% without indexation benefit. The indexation benefit could have been eventually done away with based on a statistical analysis after a few years if almost all assessees were to opt for the lower tax rate of 12.5% without indexation benefit.

Post the budget, the income tax department has also clarified that the cost of acquisition of properties purchased before 2001 will be their fair market value as of April 1, 2001 (which cannot exceed the guideline/ stamp duty value) or the original acquisition cost.

We are moving ahead with the idea of digital India, encouraging reduction in cash transactions, and that only banking channels be utilised reflecting the full value of the transaction. Given this, a higher effective tax liability should not lead to property transactions being recorded at a lower guidance value/ circle rate with a cash component. This would be two steps backwards on an overall basis, for a well-intended one step forward with the intent to simplify tax computation. Not to mention, if property transactions are recorded at lower rates, it would also affect the stamp duty revenue of states. The collateral damage should not have a more negative overall effect than the stated specific positive of simpler tax computation.

Although it may not affect the real estate sector or transactions in the long term, it will require a mindset change.

The tax payer may have felt happier with being able to choose between the two options. Alternatively, the provision could have been introduced and made effective prospectively. The larger concern and disappointment seem to be because the effect of the change becomes applicable even for past transactions.

Property is a very personal and key asset for individuals. A mere possibility for an ordinary person that he may suffer more tax does not seem to bode well. As for now, if questioned as to whether the proposal is a positive one or a negative one, the answer is going to be "well, it depends!"

Originally published by ET Edge – Insight.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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