REMOVAL OF INDEXATION BENEFIT

Source: IndiaToday

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Context

• The 2024 budget introduced significant changes to how long-term capital gains (LTCG) on property sales are taxed, particularly through the elimination of indexation benefits.

Details

Key Points of Change

• LTCG Tax Rate and Indexation Removal:
  • Properties purchased from 2001 onwards will now incur a 12.5% LTCG tax upon sale.
  • Indexation, which adjusted the purchase price to reflect inflation, has been removed.
• Impact on Tax Calculation:
  • Previously, indexation allowed property sellers to reduce taxable gains by adjusting the purchase price for inflation.
  • Without indexation, the taxable gain is calculated on the original purchase price, potentially leading to higher taxes.

How Indexation Worked

• Cost Inflation Index (CII):
  • The government publishes the CII annually to account for inflation.
  • To adjust the purchase price:

Adjusted Purchase Price=(Original Purchase Price×CII of Sale Year/CII of Purchase Year)

• Example Calculation:
• Assume a property was purchased for ₹5 crore in 2001. Under the old system, the indexed cost of acquisition was calculated using the CII. This adjusted cost was then used to determine capital gains, taxed at 20%.
• Under the new system:
• The LTCG is calculated on the original purchase price.
• The tax rate is reduced to 12.5%, but without the benefit of inflation adjustment.
  

Impact Analysis

• Short-Term Holders: Investors holding property for less than 10 years with moderate appreciation (less than 10% per annum) will face a higher tax burden.
• Long-Term Holders: For properties held over 10 years with high appreciation (over 10% per annum), the tax impact may be neutral or slightly beneficial.

Expert Opinions

• Concerns:
  • Real estate investors, particularly those with long-term holdings, may face higher taxes due to the removal of indexation.
  • The sector could see a short-term bearish outlook and potential increases in cash transactions.
• Support: Some experts believe the reduction in the LTCG tax rate to 12.5% could encourage more liquidity in property transactions and align the tax treatment across asset classes.
• Government’s Perspective:
• The Finance Ministry aims to simplify the tax system and lower the average tax burden.
• The changes are designed to streamline capital gains calculations, benefiting the middle class and encouraging investment.

Conclusion

The removal of indexation benefits alongside the reduction of the LTCG tax rate to 12.5% represents a significant shift in property taxation. While intended to simplify the tax process and encourage market activity, it poses potential challenges for long-term property investors, who may face increased tax liabilities.

Sources:

IndiaToday

PRACTICE QUESTION Q: Discuss the current framework of capital gains tax in India. Analyze the impact of recent amendments in the Finance Act, 2024, on different categories of investors and assets. What measures can be taken to balance the need for revenue generation with the goal of fostering a favorable investment climate? (250 Words)