Tax on capital gains has always been a concerning matter for the Government as well as taxpayers. Firstly because of the transaction values generally being high and secondly frequency of the transactions being low.
The Government has time and again tried to streamline the provisions with regards to the taxation of capital gains, added to this jurisprudence from the Hon'ble Courts in India.
This year the Government, has brought in an amendment to streamline the tax rates to 12.5% for long term capital gains and 20% of reducing the tax rate on long term capital gains on all assets, except for listed securities and unlisted bonds & debentures, tax rates stand reduced from 20% to 12.5%. This would benefit owners where value accretion to asset price is significantly high and quick, whereas in other case, due to withdrawal of cost of inflation indexation benefit, tax outflow could be higher even with reduced tax rate where asset appreciation is slow and nominal.
The above reduction in tax rates also makes corporate restructuring more tax efficient and could be seen as an opportunity to set right the corporate structures with the objective of value consolidations and tax efficiency. There is a direct net effective benefit/gain of approximately 9% (inclusive of surcharge and education cess) i.e., approximately 40% reduction in tax cost, in the pre-budget and post budget tax regime. This could also lead to spur in private equity and venture capital transactions by making restructuring exercise, typically needed before such fund raise, cheaper.
The above may also be seen positively by the non-residents (as the amended tax rates apply to both residents and non-residents) in whose case another significant benefit is allowing the benefit of rupee depreciation on unlisted shares and securities. This recently has become a contentious issue between the non-resident taxpayers and the Revenue with Courts giving verdicts on either side (Cairns being on the taxpayer's side while Legatum Ventures Ltd being on the other side). Considering usual currency fluctuation loss of 2-3% on yearly basis, tax saved on allowance of this loss could be higher than additional tax to be paid on account of increase in tax rates from 10% to 12.5%.
Further, the amendment with regard to listed shares and securities may lead to excess taxes in the hands of promoters holding on to their shares to be monetised under the Offer for Sale ('OFS') at the time of Initial Public Offering (IPO). The effective difference inclusive of Surcharge and Education Cess is 3%. So, for e.g., in a scenario where the capital gains on sale of shares under OFS is INR 100 Crores, the tax outlay shall be approx. INR 15 Crores against INR 12 Crores earlier. Though this may not be a make-or-break deal for the promoter, given the IRR earned on such shares is also significantly high.
The same also seems to leave an additional amount in the hands of the sellers of real estate, which they can then deploy in other investment opportunities (like in stocks, etc.) or even to invest in own business. Given the reduced tax rate, the taxpayers may also consider avoiding taking the benefit of exemption under Section 54 and 54F (i.e., investing in another residential house property), which may also help stabilise real estate prices. It may be noted that the Government in its post budget presentation has clarified that the benefit of indexation shall continue to remain for immoveable properties acquired prior to April 2001, i.e., for long held properties.
The amendment is also a welcome move wherein the cost of acquisition of the asset is Nil or negligible, for example, the shares exercised on account of ESOP's granted in early-stage startups. This could also be used as a tool for tax planning by holding the shares for 24 months, as there is a direct benefit of reduction of tax rate by 9% in such cases.
The Government has also given a benefit in terms of reduction of corporate tax rate on foreign companies from 40% to 35%, while no corresponding benefit has been given in terms of gross basis incomes, particularly FTS and Royalty, wherein the tax rate stands at 20%. Though this may not be very relevant or significant for foreign companies, as the tax rate in most DTAA's is less than 20%.
Another stir is on the buy-back, making it less attractive by putting the gross amount received under the definition of 'dividend' with allowing for the cost of shares so extinguished as a capital loss, which may or may not be set off depending on the taxpayer having incomes under the head capital gains. Though the intent seems clear, as the same was being used as a tool of tax-planning by most corporates and shareholders wherein a Buy-back tax of 23.30% on the net amount (amount paid by the company less received by the company) was paid out on such buy-back, this may encourage the tendency of non-resident shareholders to getting the returns through management cross-charge, FTS, Royalty, etc., and eventually leading to more litigation rather than simplifying it. Though corporates may consider using window available till 30th September 2024 to undertake buy back process for profit distribution to shareholders.
All in all, there have been positive amendments especially on the reduction of tax rates on long term capital gains and the corporate tax rate on foreign companies. I believe that reduced and simplified tax structure on capital gains could mean higher investment activity in general and also reduction in speculative activities given higher tax arbitrage in holding the asset for longer duration.
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