The Ministry of Finance of the Government of India presented its 2018-2019 budget on February 1, 2018. The new budget, which still needs to be approved by the Indian Parliament but is almost certain to pass, would update the current capital gains tax regime to include capital assets held long-term, which were previously not subject to the regime.
Provisions of the budget, scheduled to go into effect April 1, 2018, would subject long-term capital gains in excess of the listed exemption (100,000 Indian rupees, about $1,500 U.S. dollars) to a tax of 10% (plus a Surcharge and Education Cess) on capital gains arising from the transfer of long-term capital assets. This new rule would be in addition to the current capital gains tax in India, causing some considerations for foreign investors in Indian securities as it is transitioned into place.
Current Capital Gain Tax Treatment
Today, equity shares of a listed Indian security only see a capital gains tax if held for less than 12 months. These short-term capital gains are taxed at a rate of 15% (plus a Surcharge and Education Cess). Long-term capital gains from these assets held for 12 months or more have been exempted from tax in India since 2004.
Changes to Capital Gain Tax Treatment in the New Budget
The government believes that exempting long-term capital gains from tax has resulted in 1) revenue loss for the government and 2) bias against the manufacturing industry in India. Therefore, the budget proposes a 10% flat tax rate to be applied to capital assets held for 12 months or more, limiting the exclusion to only 100,000 Indian rupees. No changes would be made to the short-term capital gains tax already in place. The definition of capital assets for this purpose includes equity shares in a company listed on a recognized Indian stock exchange.
Provisions in the budget would provide relief in the form of a cost basis step up for assets held on January 31, 2018. A capital asset would carry its original cost as the cost basis — unless on January 31, 2018, the fair market value (FMV) of the asset is greater than its original cost. In this case, the higher FMV would be used as its cost basis going forward for purposes of the long-term capital gain computation. This step up in basis would not affect the holding period, which continues from the original date of purchase, and is meant to relieve the appreciated value of assets held prior to the new rule going into effect.
Long-term capital appreciation prior to January 31, 2018, would remain untaxed and require no basis adjustment. During the transition period after January 31, 2018, but prior to April 1, 2018, long-term capital gains would continue to be tax-free — even though cost basis would be fixed for purposes of the new long-term capital gains tax calculation on January 31, 2018.
Starting April 1, 2018, capital gains from the sale of assets held for 12 months or more would be taxed at 10%. The gain would be calculated based on the basis step up that occurred on January 31, 2018, and would include the new exemption cap of 100,000 Indian rupees (approximately $1,500). The new long-term capital rate also would be subject to applicable benefits pursuant to the tax treaty. The tax would not be withheld at the source of the capital gain and, therefore, would require reporting and payment to the Indian Income Tax Department.
It appears that losses on the sale of capital assets could be netted against capital gains if the losses are recognized after March 31, 2018. Further, prior year short-term capital losses would be available to offset against the long-term capital gains recognized after March 31, 2018. Any long-term capital losses recognized prior to this date would not be allowed to offset long-term capital gains subject to the new tax.
ASC 740 Implications
The addition of a capital gains tax on long-term capital assets would require funds that hold such assets to consider accruing a tax liability on their balance sheet.
Considerations for Sale of Appreciated Assets
To minimize potential tax liability from appreciated holdings, unrealized long-term capital gains can be recognized tax-free if sold prior to April 1, 2018. As noted with the inclusion of the required basis step up for capital assets held before January 31, 2018, any unrealized gains prior to this date would remain tax-free. Assets that appreciate in value after January 31, 2018, would be taxed at the 10% rate unless sold before April 1, 2018. Therefore, there will still be a window of opportunity to recognize long-term capital gains from these assets tax-free.
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