For representative purposes.
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The story so far: Finance Minister Nirmala Sitharaman’s announcement in the Union Budget about doing away with indexation for computing long-term capital gains (LTCG) tax has not drawn much enthusiasm. She had proposed that long-term gains on all financial and non-financial assets would now be taxed at 12.5% instead of a tiered structure, albeit abandoning indexation. A memorandum explaining the provisions of the Finance Bill (2024), stated that this was to “ease computation of capital gains for the taxpayer and tax administration”.

What purpose does indexation serve?

Imagine, an individual buys a house for ₹10 lakh in 2001. For reasons such as inflation and/or a vibrant property market, they are able to sell the same property in 2021 at ₹75 lakh. Here, it may appear that they gained ₹65 lakh and should be taxed accordingly.

However, the figure does not consider the price levels prevailing at the time of sale with that of purchase. This is where the Cost Inflation Index (CII) comes in. Indexation ensures that taxpayers are taxed on real gains than gains at prevailing prices, which are a result of general increase in prices, and not economic growth, during the course.

In the stated example, the CII for 2021 (that is, 317) would be divided by that for the base year 2001 (100) to derive a number. It would then be multiplied with the purchase price (that is, ₹10 lakh). Thus, the indexed cost becomes ₹31.7 lakhs and the individual’s taxable gain is revised downwards to ₹43.3 lakhs. At the erstwhile 20% rate, they would now be required to pay a long-term capital gains tax of approximately ₹8.7 lakhs. With the new system however, the ₹65 lakh would be taxed at a lower 12.5%. Thus, a tax liability of ₹8.13 lakh.

What is the issue?

Abhijit Mukhopadhyay, consulting economist at the Secretariat explained to The Hindu that the eventual tax liability is broadly determined by two factors, that is, the rate on return and the subjected time-period.

In this light, it is essential to note that not all assets may experience the same exponential growth as in the example above. This could be because of a flat market or a temporary period of slump. This is primarily where the indexation turns out to be more favourable. To illustrate, let us say that in 2021 instead of ₹75 lakh, the house is sold for ₹40 lakh. When adjusted with indexation, the tax liability is ₹1.66 lakh against ₹3.75 lakh without indexation.

Furthermore, a BankBazaar study, basing an assessment from the RBI’s House Price Index, observed that without indexation, LTCG tax went up about three times on properties purchased after 2010. Keeping its base year as FY 2010-11, the study noted a “severe loss of tax savings” especially in the years from 2016-17. “From zero tax liability across the board, we see significant liabilities arising for these years (since 2016-17),” the study found. The Income Tax department, however, estimates that real estate returns (12-16% per annum) are much higher than indexation for inflation (4-5%), depending on the period of holding. Therefore, it predicts “substantial tax savings” to a “vast majority” of taxpayers.

According to Mr Mukhopadhyay, an individual stands to benefit more from the revised provisions if they sell the assets expeditiously (say, 3-4 years) instead of holding it for a longer-time period (say, 10 years or more). Furthermore, he explained that with the change, real-estate investment trusts (REITs) and infrastructure funds stand to suffer because they “do not have the same high rate of returns as an equity market”. With respect to bonds, Anil Talreja, Partner at Deloitte India, held that feedback has been “a bit muted” given the lack of indexation. “Hence this may impact the popularity of the instrument,” he said.

What does this mean for assets?

According to Mr. Talreja, whilst the removal of indexation is “adding dampness” to the overall sentiment, the reduction of the base rate of tax was providing “balance to the dampness”. He explains, “A lot depends on the nature of the asset, the time when the asset was purchased (during the price boom or otherwise). Based on this, it would continue to lead to different reactions from various sections of the society.”

For real estate, Mr Mukhopadhyay observes that those looking to buy a second house for the purpose of investment may potentially refrain from doing so. “They would have to sell if off quickly to profit from the revised provisions,” he explains. The paradigm however is potentially minimised, according to him, for those who intend to buy a house to reside themselves. Pertinent to note here, the Income Tax department clarified that for assets acquired before April 1, 2001, the individual would have the option to choose between fair market value as on that date (April 1, 2001) and the actual cost of acquiring the asset as the basis to compute the capital gain on sale. This paves the way for an indexation cushion for pre-2001 acquisitions.

The other set of concerns as also pointed out by AAP MP Raghav Chadha in the Rajya Sabha, entail potential sale of properties at circle rates (minimum price at which a real estate is to be sold) only. Undervaluing the real estate helps furbish lower capital gains, thus, lesser taxation. Further, Mr Chadha also warned about increased black money transactions in the sector — another means to hide gains.

The Union Budget for 2024-25, in my view, has certainly drawn up a detailed roadmap and laid foundations for ‘Amrit Kaal‘ to pursue the goal of a ‘Viksit Bharat’. The government has articulated well its planning to foster long-term growth drivers for sustainable development, improvement in productivity, and creating opportunities for all.

The Budget envisages sustained efforts on the nine priorities for generating ample opportunities for all covering improvement in productivity in agriculture, employment, skilling, manufacturing & services, urban development and infrastructure and energy security, innovation, research, etc.

Although there is nothing much to incentivise the market and investors due to increase in securities transaction tax (STT), additional capital gains tax, buyback taxation, no change in taxation for high income group segment, etc., I do not foresee a big shakeup as there cannot be gains without pains. In earlier Budgets, there were initiatives such as taxing of dividends in the hands of recipients, removal of tax exemption for long-term capital gains.

One other important aspect covering taxation, in my view, could be bringing down of the tax rate for foreign companies to 35% from 40%. The related part to this could be read with the Budget proposal for simplification to improve FDI, nudge prioritisation, and promote opportunities for using Indian rupee as a currency for overseas investments.

The notable provisions cover massive efforts for raising productivity in agriculture sector through research, developing the climate resilient and high-yielding varieties, initiatives to achieve self-sufficiency in pulses and oil seeds, implementation of the Digital Public Infrastructure (DPI) in agriculture for coverage of farmers and their lands in three years. The announcement to bring National Cooperation Policy to foster growth of the rural economy and generation of employment in this segment is also a welcome move. A provision of ₹1.52 lakh crore for these initiatives is significant.

Generation of employment for youth is quite challenging. The Budget has unveiled the initiatives to generate employment opportunities through employment-linked incentives based on enrolment in the EPFO with a focus on recognition of first-time employees, and support to employees and employers. The government is also planning a new centrally-sponsored scheme for skilling in collaboration with State governments and industry.

The Budget measures like Skill Loan Scheme, subsidised education loans of higher amount, supporting economic activities of craftsmen, artisans, SC, ST and woman entrepreneurs, and street vendors will go a long way in improving the all-round , all- pervasive and all-inclusive development of farmers, youth, women and poor.

For supporting promotion of manufacturing and services, the Budget contains proposals to set up industrial parks with complete infrastructure in or near 100 cities, in partnership with the States and private sector, reforms in shipping Industry, Critical Mineral Mission for domestic production, recycling of critical minerals, and overseas acquisition of critical mineral assets, digital public infrastructure.

In the area of urban development, the Budget has planned various initiatives such as creative brownfield redevelopment of existing cities, transit-oriented development for 14 large cities, subsidies for urban housing, bankable project for water supply, sewage treatment and solid waste management projects and services for 100 large cities, development of 100 weekly haats or street food hubs in select cities and lowering duties for properties purchased by women.

Infrastructure development needs significant investment and fiscal support. As announced in the Interim budget, there has been a proposal to provide ₹11.11 lakh crore for capital expenditure that amounts to 3.4% of the country’s GDP.

The Budget includes a proposal to formulate a policy document on appropriate energy transition pathways for resource-efficient economic growth, a policy for promoting pumped storage projects for electricity storage and integration of the growing share of renewable energy, plan to develop newer technologies for nuclear energy. The government will also provide the required fiscal support development of indigenous technology for Advanced Ultra Super Critical (AUSC) thermal power plants.

The most significant aspect of the Budget is fiscal management, which is worth taking into account the deficit placed at 4.9% of GDP for 2024-25 and the aim of the FM to bring it down to 4.5% next fiscal and a commitment to staying the course. Overall, the Budget shows that the government is continuing to pursue the path of fiscal consolidation and prudence while keeping the growth in its line of sight.

(Ashok Hinduja, Chairman, Hinduja Group of Companies (India))