Defer capital gains dos till DTC becomes law

The draft Direct Taxes Code (DTC) circulated for comments in August 2009 had proposed drastic changes in the area of computation of capital gains.

Some of the proposals have been modified by the revised discussion paper on DTC.

In this article, I will discuss the existing provisions, provisions proposed in the original DTC, and compare them with the changes proposed in the revised DTC in respect of taxation of capital gains and with special reference to transactions in shares and securities.

Holding period
First let us take the basis of classification of assets.

The present provisions contained in the Income-Tax Act classify assets as short-term or long-term.

As per the existing provisions of Income-Tax, an asset is considered long-term if you have held it for more than 36 months as on the date of its transfer.

However, in respect of shares of a company, units of UTI or other mutual funds and zero coupon bonds, these are treated as long-term if you have held them for a period of more than 12 months. Presently, the long-term capital gains are charged at concessional rates of tax or are completely exempt in some cases, like listed equity shares.

Any asset, which does not qualify as long-term, is presently treated as short-term and is taxed accordingly. Generally, the short term capital gain is charged at normal rates except in case of listed securities and units of equity oriented units where the rate applicable is 15%.

The draft of DTC as well as the revised DTC have done away with the distinction between short-term assets and long-term assets, though both have indirectly recognised this distinction between assets based on the fact whether these are held for more than 12 months or not.

The revised DTC does not have two criteria for such differentiation, unlike in the present tax laws where the criteria for being recognized as a long-term asset are different for shares in a company, listed securities and units of mutual funds, etc, where presently the holding period requirement is more than 12 months.

Moreover under the draft DTC and the revised DTC, the holding period is proposed to be calculated differently. It is proposed to be linked from the end of the financial year in which the assets were acquired as against the existing provisions where the holding period is counted back from the date of the transfer.

One consequence of this radical provision will be that a lot of assets will become long-term on the same date and may cause an uncalled for volatility in the markets during the initial days of the financial year, specifically in the prices of shares on the stock exchange, as people will rush to sell assets where 12 months have been completed and book capital gains on April 1 each year.

This method of counting the holding period may give some absurd results. There may be a difference of just one day between the holding period of two different assets and yet one may be eligible for special treatment and the other asset may be deprived of such treatment.

For example, an asset acquired on March 31, 2009 will be entitled for indexed benefit if sold on or after April 1, 2010. However, if the same asset is acquired on the very next day, i.e. April 1, 2009, and sold on April 1, 2010, it will not be entitled for indexation benefits. For availing indexation benefits, you will have to hold this asset till April 1, 2011.

Tax treatment of equity shares and units of equity oriented funds
As per the existing provisions, your capital gain income is classified into two parts: incomes arising on transfer of equity shares and units of equity-oriented fund on which securities transaction tax has been paid and all other assets.

If the holding period is of more than 12 months, the capital gain is fully exempt from tax in case of the first category of assets. However, in case the asset was held for 12 months or less, then the same is taxed at a flat rate of 15%.

The original DTC did not propose to differentiate between equity shares and units of equity oriented funds but proposed to treat these assets at par with other assets.

However, the proposed revised DTC proposes to differentiate between these assets. The revised code proposes to grant a flat deduction in respect of equity shares and units of equity oriented fund so as to reduce the amount of such capital gains, which will be charged at normal rates. It is felt that deduction to be allowed here will be based on the number of years for which the original asset was held. This will compensate for the tenure of holding of the assessee.

Tax treatment of other assets
Presently, all assets other than the listed equity shares and units of equity oriented funds are eligible for the benefits of indexation. The indexation is done by multiplying the cost of the assets by a multiplying factor derived with the cost inflation index of the year when you had purchased the asset and the cost inflation index of the year in which you sold the asset.

Presently, if the asset was acquired by you before April 1, 1981, you have the option of taking the market value of the assets as on that date as your cost and indexing it accordingly, keeping the base year as 1981. The original DTC as well as the revised DTC propose to forward this date of April 1, 1981 to April 1, 2000 for the purpose of cost substitution.

The capital gain obtained after deducting the indexed cost from the net sale price is the indexed long-term capital gain. Presently, you have to pay tax at the rate of 20% on such indexed gains. However, in case of listed securities, units or zero coupon bonds, your tax liability is capped at 10% of un-indexed gains. No such
differential is proposed either in the draft DTC or the revised DTC as the capital gains after indexation are proposed to be included in your total income and taxed accordingly.

To conclude here, my suggestion is that investors should not take any step right now based on the proposals made in the revised DTC as this may undergo some changes before being placed in Parliament or after having been placed but before being enacted into law.

The writer is CFO, ApnaPaisa.com, a price comparison engine for loans, insurance and investments. He can be reached
at balwant.jain@apnapaisa.com.