Capital Gains To Index or Not To

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The Tax Publishers Income Tax--Capital Gains To Index or Not To Srivatsan Ranganathan Hamlet's famous soliloquy was 'to be or not to be is not the question..'. The removal of indexation for capital gains throws open some interesting economic/financial facets as highlighted by the author in this eponymous Hamlet titled write up. 1. The indexation conundrum Finance Act (2), 2024 removed indexation on almost all categories of long-term capital assets with a carve out of indexation benefit only available for immovable properties acquired prior to 22-7-2024 and sold after this date that too only for the purpose of payment of capital gains tax. This carve out exception is only available for residents/not ordinarily residents (individual and HUF's) so that they can avail the best of both worlds viz. computing the capital gains without indexation or with indexation and pay capital gains tax lower of both these computations. This indexation benefit is however not be available if the resident/not ordinarily resident decides to reinvest or claim carry forward or set-off provisions. Thus, there arises a thinking what will be the economic trade-off look like between indexation and no indexation in the law look like which is what is dealt in this write up. 2. Assumptions For simplicity, I have taken the sale price as 300 and cost of acquisition as 100 in all the scenarios. Asset doubling period roughly ranges 8-10 years, so with 2000-01 as the base to 2025-26 the sale price normally has to be 300-400 though there can be exceptional properties that might have appreciated much more as well due to rapid urbanization or property being very unique with its premium/distress value. It is also known that the faster a capital asset appreciates beyond 8 times (100/12.5 = 8) then capital gains without indexation will be beneficial than the capital gains with indexation. Below example will also help demonstrate the effect of capital loss scenarios arising out of indexation impact. There is no cost of improvement considered as well to keep understanding simple. No surcharge or cess are also considered in these capital gains calculations (only the bare rates of 12.5% or 20% is taken in the scenarios). Sale is assumed to happen during financial year 2025-26 and the asset is a long-term capital asset say an immovable property. From the below tabulation, one can understand that there are three zones viz. (a) Zone 1 where the real income is worse off where there is a capital loss due to only application of indexation benefit. This was almost similar to granting a notional loss as the index is a market factor imputed methodology to compute capital gains. One can say that many assessees might have been benefitted by being in this Zone 1 and offsetting their real income loss by encashing gains elsewhere on other assets either in that very same year or in subsequent 8 years. This notional loss offsetting was irksome for the revenue definitely as cases of planned evasion always came to the fore as the moot question in most of those cases and it is also factual is that revenue got snubbed due to operation of law. SUBSCRIBE FOR FULL CONTENT

The Tax Publishers

Income Tax--Capital Gains

To Index or Not To

Srivatsan Ranganathan

Hamlet's famous soliloquy was 'to be or not to be is not the question..'. The removal of indexation for capital gains throws open some interesting economic/financial facets as highlighted by the author in this eponymous Hamlet titled write up.

1. The indexation conundrum

Finance Act (2), 2024 removed indexation on almost all categories of long-term capital assets with a carve out of indexation benefit only available for immovable properties acquired prior to 22-7-2024 and sold after this date that too only for the purpose of payment of capital gains tax. This carve out exception is only available for residents/not ordinarily residents (individual and HUF's) so that they can avail the best of both worlds viz. computing the capital gains without indexation or with indexation and pay capital gains tax lower of both these computations. This indexation benefit is however not be available if the resident/not ordinarily resident decides to reinvest or claim carry forward or set-off provisions. Thus, there arises a thinking what will be the economic trade-off look like between indexation and no indexation in the law look like which is what is dealt in this write up.

2. Assumptions

For simplicity, I have taken the sale price as 300 and cost of acquisition as 100 in all the scenarios. Asset doubling period roughly ranges 8-10 years, so with 2000-01 as the base to 2025-26 the sale price normally has to be 300-400 though there can be exceptional properties that might have appreciated much more as well due to rapid urbanization or property being very unique with its premium/distress value.

It is also known that the faster a capital asset appreciates beyond 8 times (100/12.5 = 8) then capital gains without indexation will be beneficial than the capital gains with indexation.

Below example will also help demonstrate the effect of capital loss scenarios arising out of indexation impact.

There is no cost of improvement considered as well to keep understanding simple. No surcharge or cess are also considered in these capital gains calculations (only the bare rates of 12.5% or 20% is taken in the scenarios). Sale is assumed to happen during financial year 2025-26 and the asset is a long-term capital asset say an immovable property.

From the below tabulation, one can understand that there are three zones viz.

(a) Zone 1 where the real income is worse off where there is a capital loss due to only application of indexation benefit. This was almost similar to granting a notional loss as the index is a market factor imputed methodology to compute capital gains. One can say that many assessees might have been benefitted by being in this Zone 1 and offsetting their real income loss by encashing gains elsewhere on other assets either in that very same year or in subsequent 8 years. This notional loss offsetting was irksome for the revenue definitely as cases of planned evasion always came to the fore as the moot question in most of those cases and it is also factual is that revenue got snubbed due to operation of law.