CA Ketan Vajani
While presenting the budget for the year 2023- 24, the Hon’ble Finance Minister has made a genuine attempt to keep a large segment of the citizens happy with some concessions, albeit somewhat deceptive, in so far as tax rates and surcharge are concerned under the new regime. The things, however, are not that simple as they appear and one will have to evaluate the options under different regimes to decide the better course of action. While rate of tax and surcharge etc. is more relevant for common man, it is primarily a question of arithmetic. We as students of tax laws need to focus more on various other amendments which has effect of changing certain known principles and will make it necessary for us to understand thoroughly so that we can in turn guide our clients in the correct manner.
In this article, we will deal with some of such amendments proposed in the area of capital gains and also capital receipts. The amendments made in this area are though appearing to be small, there are few significant issues that are going to emerge in the years to come and therefore it will be worth for us to study these amendments with greater care. With that idea at mind, let’s start looking at few of such amendments in this very important area of tax laws :
Capital Gains on Market Linked Debentures
Existing provisions
In present securities market, various hybrid products of investments are available. Market
linked debentures are one of such hybrid products. Market Linked Debenture (MLD) are listed on stock exchanges. These securities are though issued as a debt security, they differ with plain vanilla debt securities in as much as their performance is linked to the equity markets and therefore the rate of return is also variable, as compared to fixed rate of return for a debt security.
Under the existing provisions of section 112 of the Act, the long term capital gains on transfer of a listed security suffers tax @ 10% without indexation. Further, the period of holding prescribed for such a security to be classified as long term capital asset is 12 months.
Proposed amendment
Clause 24 of the Finance Bill seeks to insert a new section 50AA in the Act. The newly proposed section proposes to lay down special provision for computation of capital gains in case of Market Linked Debentures. The section seeks to provide that the full value of consideration received or accruing as a result of transfer or redemption or maturity of MLD as reduced by the cost of acquisition thereof and the expenditure incurred wholly or exclusively in connection with transfer or redemption of such MLD shall be treated as capital gains arising from transfer of a short term capital asset notwithstanding the provisions of section 2(42A) and section 48 of the Act. The proviso to the section provides that no deduction shall be allowed in respect of STT paid for such Market Linked Debentures.
The Explanation to the section defines the term “Market Linked Debenture” to mean a security by whatever name called, which has an underlying principal component in the form of a debt security and where the returns are linked to the market returns on other underlying securities or indices and includes any security classified or regulated as a market linked debenture by the Security and Exchange Board of India.
Effective Date
The proposed section 50AA will be inserted with effect from 1-4-2024 i.e. assessment year 2024-25 and onwards.
Comment
The provisions of section 50AA will become operative with effect from assessment year 2024-25 de-hors the date of the assessee acquiring such MLDs. Unfortunately there is no provision for grandfathering of the debentures acquired prior to the insertion of the proposed section 50AA. Accordingly, even the MLDs already acquired by the assessee will also be governed by the newly proposed section 50AA if the transfer takes place on or after 1st April, 2023. As such, though the amendment is not retrospective, the same is certainly retro-active in operation.
Conversion of Gold to Electronic Gold Receipt and vice versa
In our country we have a fascination towards
gold for centuries. Almost all families, however small their financial standing might be, will possess some amount of gold in the house for sure. The government had accordingly thought it fit to have a regulated Gold Exchange and the SEBI has been made the regulator for the same. SEBI has come out with a detailed regulatory framework for spot trading in gold on existing stock exchanges and has devised Electronic Gold Receipts (EGR) as an instrument for this.
The objective of the government is to promote the concept of Electronic Gold as against
physical gold to be held as a form of investment. The scheme permits conversion of physical gold to electronic gold and also shifting back to the physical gold whenever thought fit. However, there is no clarity as regards the tax effect on conversion of physical gold to electronic gold and vice versa. The Finance Bill seeks to make amendments to section 47, section 49 and section 2(42A) for the above purpose.
Existing provisions
Section 47 of the Income-tax Act lists down the transactions which will not be regarded as transfer and therefore will be out of purview of capital gains tax. Section 49 of the Act provides for cost of acquisition with reference to the modes of acquisitions dealt in the section. Clause (42A) of section define the term : “short term capital asset”. Explanation to the said clause lists down for inclusion and exclusion of periods specified therein under various different situations for determining the period for which a capital asset is held by an assessee.
Proposed amendments
Clause 21 of the Finance Bill 2023 seeks to insert an additional clause in section 47 of the Act so as to provide that any transfer of a capital asset, being conversion of gold into Electronic Gold Receipt (EGR) issued by a Vault Manager or conversion of such EGR into gold will not be regarded as a transfer. For the purpose of this clause, the terms Electronic Gold Receipt and Vault Manager shall have the meaning as given to the respective term in SEBI regulations. This amendment will in effect make the conversion of gold into EGR and also conversion of EGR into physical gold as tax neutral.
Clause 23 of the Finance Bill 2023 seeks to insert sub-section (10) in section 49 of the Act. The proposed sub-section 10 seeks to provide that where an Electronic Gold Receipt issued by a Vault Manager became the property of the person as consideration for transfer of the gold, the cost of acquisition of the gold in the hands of the person in whose name EGR is issued shall
be deemed to be the cost of acquisition of the EGR. Similarly, where gold is released against an EGR, the cost of acquisition of the EGR shall be deemed to be cost of acquisition of such gold.
Clause – 3 (d) of the Finance Bill 2023 seeks to insert an additional clause, namely clause (hi) in the Explanation to clause 42A of section 2 of the Act. As per the proposed amendment, the period for which gold was held by the assessee prior to conversion into EGR will be included in determining the period of holding of the EGR. Similarly where gold is released in respect of an EGR, the period for which such EGR was held by the assessee prior to its conversion into gold shall be included for determining the period of holding.
Effective Date
All these amendments are proposed to be made with effect from 1-4-2024 and shall therefore apply for assessment year 2024-25 and subsequent years.
Comment
The amendment to section 2(42A) permits to include the period of holding of the original asset in case of gold while computing the period of EGR and also the period of holding of EGR for computing the period of holding for gold released in respect of EGR. However, there can be a case where the assessee was owning gold originally say for example since 2015. This was converted into EGR in April 2022 and was again converted back to physical gold in April 2024. The assessee sells physical gold in May 2024. On this facts, the period of holding of gold will include period of holding of EGR
i.e. period from April 2022 to April 2024. But the section does not permit to include the period between the years 2015 to 2022, while computing the period of holding. Accordingly, though technically the assessee is transferring gold in May 2024, which was originally acquired in 2015 and therefore the same is a long term capital gain, the language of section will make it difficult and will result in the same being
termed as short term capital gains. It seems that this is perhaps an unintended hardship hopefully the same shall be remedied while the Finance Bill is finally enacted.
Limiting the roll over benefit for exemptions under section 54 and section 54F of the Act
Existing provisions
Section 54 of the Act provides for deduction of long term capital gains on transfer of a residential house where the assessee invests the capital gains on such transfer for purchase or construction of another residential house subject to certain conditions and timelines as prescribed in the section. Similarly section 54F provides for deduction from long term capital gains arising on transfer of any capital asset, other than a residential house, where the assessee invests the amount of net consideration for purchase or construction of a residential house, again subject to various conditions and timelines as prescribed in the section. At present there is no upper limit prescribed and the assessee can avail the benefit of exemptions for any amount of investment made under both the sections without any monetary restrictions.
Sub-section (2) of section 54 provides for investment of the capital gains that remain unappropriated till the due date of Return of Income u/s. 139(1) in the capital gain account scheme with notified banks or institutions. Similarly sub-section (4) of section 54F provide for the investment of the net consideration that remain unappropriated till the due date of Return of Income u/s. 139(1) of the Act in such account.
Proposed amendments
Clause 25 of the Finance Bill seeks to amend section 54 of the Income-tax Act by inserting third proviso to sub-section (1) of section 54. The proposed third proviso seeks to provide that where the cost of new asset exceeds Rs. 10 Crores, the amount exceeding Rs. 10 Crores
shall not be taken into account for the purpose of the section. Clause 30 of the Finance Bill seeks to amend section 54F by inserting the second proviso to sub-section (1) of section 54F on similar lines.
Both the above clauses also seek to amend sub- section (2) to section 54 and sub-section (4) to section 54F so as to provide that the provisions of these sub-sections for the deposit in the Capital Gain Account Scheme shall apply only to capital gains or net consideration as the case may be upto Rs. 10 Crores.
Effective date
Both the above sections are proposed to be amended with effect from 1-4-2024 i.e. assessment year 2024-25.
Purpose of Amendments
As per the Memorandum explaining the provisions, the primary objective of both these sections was to mitigate the acute shortage of housing and to give impetus to house building activity. However, it has been observed that claims of huge deductions are made by high net-worth assessees under these provisions by purchasing very expensive residential houses which defeats the very purpose of these sections. The amendments are proposed in order to prevent this.
Effect of the amendments
On account of the above amendments, if an assessee invests more than Rs. 10 Crores in a residential house, the amount in excess of Rs. 10 Crores will not be considered as the cost of new asset. As such, say if an assessee purchases a residential house for Rs. 12 Crores, the amendments provide that the additional amount of Rs. 2 Crore will be ignored while computing the deductions under both the sections.
In so far as section 54 is concerned, there arises an unintended hardship in a case where the assessee transfer the new asset within the
period of 3 years from the date of its acquisition. The provisions of section 54(1) provide that while computing the capital gains in respect of the new asset arising from its transfer within a period of three years, the cost shall be considered as Nil in a case where some portion of capital gains was charged on transfer of the original asset. Further, in a case where the entire amount of capital asset for the original asset was available as deduction, the section provides that if in such case the new asset is transferred within a period of three years, the cost of acquisition shall be reduced by the amount of capital gains, which is not charged on account of deduction at the time of transfer of the original asset.
This mechanism provided in section 54 has not been amended and therefore it creates a situation where the assessee will suffer double disallowance. This can be better explained with the help of an example.
Let us assume a situation where the assessee has earned long term capital gains of Rs. 15 Crores on transfer of old asset. The assessee invests an amount of Rs. 12 Crores in the new residential house and is therefore eligible for deduction of Rs. 12 Crores under the present provisions. Accordingly the difference of Rs. 3 Crores is subjected to tax in the year of transfer of the original asset. Now assuming further that the new asset is transferred within a period of three years from its acquisition say for same amount Rs. 12 Crores. The section provides that for the purpose of computing capital gains on transfer of the new asset, the cost will be assumed to be Nil and therefore the entire amount of Rs. 12 crores will be treated as capital gains. This amount of Rs. 12 Crores is nothing but the withdrawal of deduction allowed earlier at the time of transfer of original asset.
As against this, under the proposed amended provisions, the assessee will be eligible to exemption of only Rs. 10 Crores as the cost of the new asset is capped at Rs. 10 Crores.
Therefore, in the year of transfer of original asset, the assessee will be subjected to long term capital gains of Rs. 5 Crores. Now in the subsequent year, when the new asset is transferred for Rs.12 Crores, the section provides that the cost shall be taken at Nil. Accordingly the entire 12 crore will be subjected to tax. Here it can be seen that though the assessee had got the deduction of only Rs. 10 Crores in the year of transfer of original asset, the amount brought to tax in the year of transfer of the new asset is Rs. 12 Crores and therefore the assessee suffers double disallowance to the extent of Rs. 2 Crores.
It appears that the above implication is again an unintended implication and is arising on account of the mechanism provided for the transfer of the new asset within a period of three years. With the deduction being capped at Rs. 10 Crore, a back-up amendment is also required to provide that where the deduction is restricted to Rs. 10 Crores in accordance with the proposed third proviso, the cost of acquisition at the time of the transfer of the new provision will be the actual cost of acquisition as reduced by Rs. 10 Crores. If such an amendment is also brought in the same will meet the ends of justice and the assessee would not suffer double disallowance as brought out hereinabove. Hopefully, this will be considered and suitable back-up amendments will be made at the stage of enactment of the Bill.
Rationalisation of exempt receipts under Life Insurance Policies
Existing provisions
Clause 10D of section 10 provides that in computing the total income of any person, any sum received under a life insurance policy, including the sum allocated by way of bonus on such policy subject to certain exceptions as listed in the clause. The fourth proviso to the clause provide that the exemption will not be available in relation to any unit linked insurance policies issued on or after 1-2-2021 if the amount
of premium payable for any of the previous year during the term of such policy exceeds Rs. 2,50,000/-. The fifth proviso provides that in case of multiple unit linked policies issued on or after 1-2-2021, the exemption will be available only in relation to those policies where the aggregate amount of premium on such policies do not exceed Rs. 2,50,000/-.
Proposed Amendments
Clause – 5(c) of the Finance Bill seeks to insert two additional provisos to clause 10D of section 10 of the Act. The sixth proviso proposes to provide that nothing contained in the clause shall apply with respect to any life insurance policy, other than a unit linked insurance policy (which is already carved out by virtue of the fourth proviso), issued on or after 1-4-2023 if the amount of premium payable for any of the previous year during the term of such policy exceeds Rs. 5 Lakhs.
While the sixth proviso deals with individual policies, the seventh proviso proposed to be inserted is in respect of multiple policies with high premiums. The seventh proviso accordingly seeks to provide that if the premium is payable by a person for more than one life insurance policy, other than a unit linked insurance policy (already carved out by the fifth proviso) issued on or after 1-4-23, the provisions of this clause shall apply only in relation to such policies where the aggregate amount of premium in any of the financial year does not exceed Rs. 5 Lakhs.
Let’s take an example to understand this better. Say if an individual subscribes to three different policies issued after 1-4-2023 and the annual premium for policy 1 is Rs. 3,00,000/- and for policies 2 and 3 are Rs. 2,00,000/- each. In such a case, the total premium will be Rs. 7,00,000/- and therefore by applying the seventh proviso the individual will be eligible to claim exemption in relation to policy – 1 and either policy 2 or policy 3. Accordingly one of the policies will result in a non-exempt receipt in
the case of the individual. In absence of any provision to the contrary, the individual should be able to select as to whether he wishes to claim exemption for policy 2 or policy 3.
The present sixth proviso to the clause will be eighth proviso to the clause and the same seeks to provide that the provisions of fourth, fifth, sixth and seventh proviso shall not apply to any sum received on the death of a person. Accordingly, the insurance claim received by a legal heir / nominee of a deceased insured, the exemption will continue to be available without any limit on the amount of premium on the policy.
Taxable under Income from other Sources
Clause – 32 of the Finance Bill seeks to insert clause (xiii) in section 56(2) so as to provide that any sum received, including the amount allocated by way of bonus in relation to such policies issued on or after 1-4-2023, in excess of the aggregate of premium paid during the term of such policy, and not claimed as deduction under any other provisions of the Act, will be taxed under section 56(2) i.e. as Income from other sources. The manner of computation for the same will be prescribed.
Similarly Clause – 3 (b) of the Finance Bill seeks to insert an additional clause in the definition of Income u/s. 2(24) to include amount received u/s. 56(2)(xiii) as income.
Effective Date
All the above amendments are proposed to be effective from assessment year 2024-25 onwards.
Reason for amendment
The objective of providing for exemption u/s. 10(10D) has been to further the welfare objective by subsidizing the risk premium for an individual’s life and providing benefit to small and genuine cases of life insurance coverage. Over the period of years, several different insurance policies have been designed by insurance companies which has the element of both risk coverage and investment embedded into it. Several high net worth individuals are subscribing to such policies and availing the exemption in respect of the sum received under such insurance policies. The amendments are proposed in order to prevent deny the exemption in such cases where the primary purpose is that of investment and risk coverage is incidental.
Comment
Considering the fact that the high premium policies have been considered as a mode of investment by the government, it would have been more appropriate to tax the same under the head of capital gains rather than as income from other sources. This would have been in accordance with the principle that property of any kind is a capital asset and alienation of such property would result in capital gains. This would have permitted the assessee to take the advantage of indexation for long term investment and also exemptions like section 54F.
Cost of Acquisition in case of certain assets
Existing provisions
Section 55 of the Act inter-alia provide that in relation to a capital asset being a goodwill of a business or profession or a trade mark or brand name associated with a business or profession or a right to manufacture, produce or process any article or thing, or right to carry on any business or profession etc. the cost of acquisition or cost of improvement shall be considered in the manner specified in the said section. This also includes cases where the cost of acquisition and cost of improvement of various assets are to be treated as Nil.
Proposed amendment
Clause 31 of the Finance Bill seeks to amend section 55 of the Act so as to provide that the cost of acquisition and cost of improvement of a capital asset being any intangible asset or any
other right, other than those mentioned in the said sub-clause or clause, as the case may be, shall be Nil.
Effective Date
The above amendment is proposed to be made with effect from 1-4-2024 and accordingly it will apply from assessment year 2024-25 and onwards.
Reason for amendment
As per the Memorandum explaining the provisions, there are certain assets like intangible assets or any sort of right for which no consideration has been paid for acquisition. The cost of acquisition of such assets is not clearly defined as ‘Nil” in the existing provision. This has led to many legal disputes and the courts have held that for taxability under capital gains there has to be a definite cost of acquisition or it should be deemed to be Nil under the Act. Since presently there is no specific provision which states that the cost of such assets is nil, the chargeability of capital gains from transfer of such assets has not found favour with the Courts. The amendments are therefore proposed to define the term cost of acquisition and cost of improvement of such assets as Nil.
Comments
Section 48 of the Income-tax Act provide that the income chargeable under the head “Capital Gains” shall be computed by deducting from the full value of the consideration received or accruing as a result of transfer of the capital asset (a) expenditure in connection with the transfer and (b) the cost of acquisition of the asset and the cost of any improvement thereto. As such, the two important limbs for computation of income under the head of capital gains are (i) full value of consideration on account of transfer of the capital asset and
(ii) cost of acquisition and cost of improvement of the capital asset.
Courts have held that in a situation where either of the two limbs are missing, the computation
mechanism as provided in section 48 of the Act will fail and in such case the charging section
i.e. section 45 cannot be given effect to. This will result in the capital receipt going down without any levy of tax. The Hon’ble Supreme Court in the case of CIT v. B. C. Srinivasa Setty (1981) 128 ITR 294 (SC) has observed as under :
“None of the provisions pertaining to the head “Capital gains” suggests that they include an asset in the acquisition of which no cost at all can be conceived. Yet there are assets which are acquired by way of production in which no cost element can be identified or envisaged. It is apparent that the goodwill generated in a new business has been so regarded. In such a case, when the asset is sold and the consideration is brought to tax, what is charged is the capital value of the asset and not any profit or gain.
If the goodwill generated in a new business is regarded as acquired at a cost and subsequently passes to an assessee in any of the modes specified in section 49(1), it will become necessary to determine the cost of acquisition to the previous owner. Moreover, in a new business it is not possible to determine the date on which the goodwill comes into existence. The date of acquisition of asset is a material factor in applying the computation provision pertaining to capital gains. Having regard to the nature of goodwill, it will be impossible to determine its cost of acquisition. Nor can sub-section (3) of section 55 be invoked because the date of acquisition by the previous owner will remain unknown.
Therefore, the goodwill generated in a newly commenced business cannot be described as an “asset” within the term of section 45, and, therefore, its transfer is not subject to income-tax under the head “Capital gains”.
On account of this judgment, the amendments were made in the Act from time to time so as to provide that the cost of acquisition in relation to certain assets will be deemed to be Nil. Despite of various items being added in the list of such Nil cost assets, many items had still been left out of the purview of section 55 and the Courts
have continue to hold that no capital gain arises in the cases of transfer of such assets.
In the case of PNB Finance Ltd. v. CIT (2008) 307 ITR 75 (SC), it has been held that the cost of acquisition in relation to the compensation for nationalization of bank is not possible to be determined and therefore no capital gain arise. Similarly the Bombay High Court in the case of CIT v. Sambhaji Nagar Co. Op. Hsg. Soc. Ltd. (2015) 370 ITR 325 (Bom) has held that TDR attached to land owned by co-op. housing society does not have any cost of acquisition and therefore there is no capital gains arising on transfer of such TDR.
There are many such other judgments and decisions of the Tribunal where the assessee has been able to successfully argue that no capital gains arise on account of there being no cost of acquisition in relation to different capital assets. With this amendment, this argument of the assessee will no more be relevant and in the cases of transfer of intangible asset of any type or any other similar rights, the cost of acquisition will be treated as Nil and capital gains will accordingly be computed.
Amendment in section 45(5A) in line with section 194-IC
Existing provisions
Under the existing provisions of section 45(5A) of the Act, capital gain arising to an individual or HUF from transfer of a land or building or both under a Joint Development Agreement is chargeable to income tax as income of the previous year in which the Certificate of Completion for the whole or part of the project is issued by the competent authority. The sub- section (5A) also provides that the full value of consideration for the purpose of section 48 shall mean the stamp duty value of his share in the constructed area as increased by consideration received in cash, if any, in respect of the specified agreement.
Proposed amendment
Clause – 20 of the Finance Bill seeks to amend the sub-section (5A) of section 45 so as to provide that the full value of consideration for the purpose of section 48 shall mean the stamp duty value of his share in the constructed area as increased by consideration received in cash or by a cheque or draft or by any other mode, in respect of the specified agreement.
Effective Date
The amendment is sought to be made with effect from assessment year 2024-25
Purpose
According to the Memorandum explaining the provisions, the taxpayers are inferring the provisions to mean that any amount of consideration received in a mode other than cash i.e. cheque or electronic payment modes would not be included in the consideration for the purpose of computing capital gains. This interpretation is not in accordance with the intention of law and the same is evident from the provisions of section 194-IC of the Act which provide for deduction of TDS in respect of the specified agreements. The amendment is proposed to align the provisions of section 194-IC with section 45(5A) of the Act.
Conclusion
I express my heartfelt gratitude to the All India Federation of Tax Practitioners to provide me this excellent opportunity to share some of my thoughts in this very important part of the amendments proposed by the Finance Bill 2023. This opportunity has made me go through the proposed amendments in greater detail and accordingly quenched my thirst for education in the best possible manner.