Long term capital gains on shares-Section 112A

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Long Term Capital Gain on equity shares was exempted u/s 10 (38) till 2017-18. 

However, the above exemption encouraged the diversion of funds from important sectors like manufacturing, infrastructure etc. into capital markets. Also, many taxpayers misused this exemption which resulted in the loss of tax revenue due to abusive practices of certain taxpayers. 

Hence to keep a check over the above issue, CBDT removed the exemption by introducing a new Section 112A with 10% tax on LTCG in excess of Rs 1 Lac on sale of listed equity or equity-related instruments (STT paid).

Section 112A -Applicability 

Capital gain tax under section 112A will be levied provided the below-mentioned conditions are fulfilled:

  1. Sale of equity shares and equity-related instruments like units of a mutual fund and units of a business trust.
  2. The securities should be long-term capital assets i.e having more than 1 year of holding.
  3. Capital gain is exceeding Rs.1 lakh.
  4. The transactions of purchase and sale of equity share are subject to STT (Securities Transaction Tax). In the case of equity-oriented mutual fund units or business trust, the transaction of the sale is liable to STT.

What is the Grandfathering clause in section 112A?

To protect the interests of investors, CBDT introduced grandfathering clauses to ensure that the tax is only prospective in nature, and so the tax is levied only on the gains from the date of levy of such tax. For this, the cost of acquisition of the equity or equity-related securities is to be calculated on the basis of a formula covered in section 112A.

Use the below formula for calculating COA:

  • Value I- Fair Market Value as of 31st Jan 2018 or the Actual Selling Price whichever is lower
  • Value II – Value I or Actual Purchase Price whichever is higher

Long Term Capital Gain = Sales Value – Cost of Acquisition (as per grandfathering rule) – Transfer Expenses

Tax Liability = 10% (LTCG – INR 1 lac)

Illustration for LTCG on shares as per Grandfathering rule

Let us understand with an example

Mr Udit made a lump-sum investment of Rs. 20 lakh in shares of a listed company in June 2005. Its FMV on January 31, 2018, is Rs. 40 lakh. Udit redeems his entire investment in May 2019 for Rs.43 lakh netting a gain of Rs. 23 lakh. However, due to the grandfathering clause, Udit’s taxable gain would be only Rs. 3 lakh.

Udit had made another one-shot investment of Rs. 15 lakh in shares of another listed company in February 2016. The FMV of the investment on January 31, 2018, was Rs. 4 lakh, and he further sold all these shares in June 2019 for a sum of Rs. 10 lakhs. In this transaction, Rahul incurred a loss of Rs. 5 lakh calculated for tax purposes as per the above-mentioned formula.

ABCDEF
Udit’s Investment PortfolioSale priceCostFMV on 31st JanValue I
Lower of A and C
Value II
Cost of acquisition – Higher of B and D

Capital gain (A- E)
143 Lacs20 Lacs40 Lacs40 Lacs40 Lacs3 Lacs
210 Lacs15 Lacs4 Lacs4 Lacs15 Lacs(5 Lacs)
TOTAL53 Lacs35 Lacs44 Lacs44 Lacs55 Lacs(2 Lacs)

Adjustment for Rs. 100,000 exemption

LTCG under section 112A at 10% is to be calculated only on the gains in excess of Rs. 1 Lac.

CBDT has clarified in the FAQ section that the amount of Rs.1 Lac is not to be reduced from the total amount of the capital gains as it automatically gets deducted by the software of the tax calculator. 

Set-off long-term capital loss from long-term capital gain

The loss on the sale of long-term listed equity shares or equity-related instruments is a long-term capital loss. 

Please note that long term loss on capital gains can be set off only against long-term capital gain. In a situation of an investor has incurred losses from some securities and profits from other securities, then the same can be set off against each other. So only net gains become taxable if they exceed Rs 1 Lakh.

Frequently asked questions

How to determine the cost of acquisition for investments acquired on or before 31st Jan 2018?

The COA of the investments purchased before 31st Jan 2018 will be the actual cost. However, if the actual cost is less than the FMV as of 31st Jan, then FMV as of 31st Jan will be considered as COA. Further, if the full value of consideration on transfer is less than the fair market value, then such full value of consideration or the actual cost, whichever is higher, will be deemed to be the cost of acquisition.

How will be FMV of the shares determined?

The FMV will be the highest price of such share or unit quoted on a recognized stock exchange on 31st of January, 2018. However, if there is no trading on 31st Jan 2018, the fair market value will be the highest price quoted on a date immediately preceding 31st of Jan, 2018, on which it has been traded.

In the case of an unlisted unit, the net asset value of such unit on 31st of Jan, 2018 will be the fair market value.

Will the benefit of indexation be available for the cost of acquisition?

As clarification received from the income tax department, the benefit of inflation indexation of the cost of acquisition will not be available for the purpose of calculating LTCG on equity shares or equity-oriented funds.

Is TDS deductible in case of gains by the resident taxpayer?

TDS provisions are not applicable so far on LTCG on equities.

Is TDS deductible in case of gains by the non-resident taxpayer?

TDS at the rate of 10% has to be deducted in case of LTCG payment to a non-resident. The capital gains will be required to be computed in accordance with clause 31 of the Finance Bill, 2018.

What will be the cost of acquisition in the case of bonus shares acquired before 1 st February 2018?

The cost of acquisition of bonus shares acquired before 31st January, 2018 will be determined as per sub-clause (6) of clause 31 of the Finance Bill, 2018. Therefore, the fair market value of the bonus shares as on 31st January, 2018 will be taken as cost of acquisition (except in some typical situations explained in Ans 7), and hence, the gains accrued upto 31st January, 2018 will continue to be exempt. 

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