Direct Taxes Code shock: Short-term can be 2 years

It’s the devil-in-the-detail thing again.
In a move that could spook the stock markets, the revised discussion paper on the Direct Taxes Code (DTC) put out on June 15, 2010, has changed the definition of capital gains on equity and equity mutual funds.

Now, if you buy shares on say April 1, 2011, you would have to hold on to your investment at least till April 1, 2013 —- for a period of two years and one day — to be able to claim a long-term capital gain.

This is because, in the revised discussion paper, long-term capital gain has been defined as an investment held for a period of more than one year from the end of the financial year in which the asset was acquired, said chartered accountant Ameet Patel, partner at Sudit K Parekh & Co.

This is in sharp contrast to the practice under the current disposition, wherein you can book a long-term capital gain by selling the shares anytime after a year of the date of their acquisition, says Sandeep Shanbhag, director, Wonderland Consultants, a tax and financial planning firm. What’s more, these capital gains do not attract any tax now.

“The holding period for long-term capital gains has been changed to anywhere between 12 month 1 day (if you buy stocks on the last day of the financial year i.e. March 31) to 24 months and 1 one day (if you happen to buy stocks on the first day of the financial year (i.e. April 1),” said Patel.

Currently, the holding period is the same for all investors.
On the other hand, the period of short-term capital gains on equity has gone up. If you buy shares on April 1, 2011 and sell on any date before April 1, 2013, your capital gains will be categorised as a short-term capital gains. Such gains will be lumped on to your income for the year and taxed at the marginal rate applicable.
Currently, shares sold within a year or less are categorised as short-term capital gains and taxed at 15%.

This move is bound to hurt speculators who trade in the short-term.

The good part, however, is that the period of holding for long-term capital gains made on sale of property, land and gold will come down.

“There is no distinction between financial assets and other
assets. Therefore, the period of holding would be uniform regardless of whether the asset is immovable property or gold or even equity shares,” said Shanbhag.

Currently for capital gains on assets like gold, land etc to be categorised as long-term, they have to be held as investments for more than three years. The period of holding for capital gains to be categorised as long-term capital gains comes down to as low as one year and one day. Anything shorter than that will be short-term capital gains.

“For non-share assets such as property, etc, where short-term capital gains were taxed for a period of less than 36 months, now it will be under or equal to 12 months,” said Parizad Sirwalla, partner - tax, BSR and Co.

The earlier version of the DTC had done away with the distinction between long-term capital gains and short-term capital gains. All capital gains had to be lumped on to the taxable income for the year and taxed at the top tax rate the tax payer falls into.

The revised discussion paper does away with this and reintroduces the distinction.

The paper also makes the calculation of long-term capital gains on equity a little complicated. Let us say you sell your shares in the stock market for Rs 10,000. You had bought these shares at Rs 4,000 nearly three years back. So you end up making a capital gain of Rs 6,000 (Rs 10,000 - Rs 4,000). Under the current regulations, there would be no tax on this gain. 

As per the revised discussion paper, there will be a deduction allowed on this capital gain and the remaining gain will be lumped on to your income for the year and taxed according to the tax rate in the bracket you fall into.

The revised paper does not specify the deduction rate. But let us say this rate is at 50%. So 50% of Rs 6,000 works out to Rs 3,000. The remaining Rs 3,000 (Rs 6,000 - Rs 3,000) will be added to your income for the year and taxed accordingly. So if you come in the 30% tax bracket, this would mean a tax of Rs 900 (30% of Rs 3,000).

“Whatever will be the capital gains tax, it will be reduced by an ad-hoc deduction. Based on these deductions, in case the marginal tax rate is 30%, it will come down to 15%, if they give an ad-hoc deduction of 50%,” said N C Hegde, tax partner, M&A tax leader at Deloitte.