Taxation Laws Act
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This article is written by Sanjana Santhosh, a law student at Christ (Deemed to be University), Bengaluru. The article explains the concepts and intricacies of Section 112-A of the Income Tax Act, 1961.

This article has been published by Sneha Mahawar.

Introduction

Equity trading income is taxed differently depending on whether the gains were realised over a long or short period of time. Long-Term Capital Gains (LTCG) on shares and securities for which Securities Transaction Tax (STT) is paid were excluded until the conclusion of the 2018–19 financial year in accordance with Section 10(38) of the Income Tax Act, 1961. This provision was in place until the end of the fiscal year. However, due to changes made in Budget 2018, the Section 10(38) exception no longer exists. In addition, long-term capital gains derived from the sale of equity shares, equity mutual funds, and units of business trust that are in excess of Rs. 1 lac for a financial year are now subject to a 10% income tax in accordance with the newly enacted Section 112A of the Income Tax Act. These gains must be reported on tax returns. LTCG was determined as a result of Section 112A which was inserted by the Finance Act, 2018. This rate applies to gains on certain assets that have been held for an extended period of time. This article examines the application of Section 112A of the Income Tax Act, including a detailed analysis of each of the components that constitute tax computation under this section.

What is a capital gain

A capital gain is a profit that an investor makes when they sell a capital asset for a price that is higher than the price at which they purchased the item. According to the Income Tax Act, taxable income includes capital gains. When an assessee sells land that has been used for agricultural purposes, for example, they are eligible for a capital gains tax exemption because this is a unique condition that only applies to this type of transaction. The term “Capital Gains” refers to the profits or gains that result from the transfer of a capital asset. These profits or gains are subject to taxation under the heading “Capital Gains.”

It is possible but not certain that the asset is connected in some way to the assessee’s line of work or enterprise. Examples include land, vehicles, residential property, commercial property, machinery, jewellery, and buildings, among others. Included on this list are individuals who have rights in or in relation to an Indian firm.  

Types of capital gain

Gains on investment can often be broken down into the following categories based on the duration the investor has been in possession of the asset:

  1. Short-term capital gain: The profits generated from selling an asset that was purchased less than one year ago are considered short-term capital gains. For example, a sale of an asset that takes place less than 12 months after the asset was initially purchased is regarded as having short-term capital gains. These earnings are taxed differently from long-term capital gains. However, the duration of ownership for various kinds of assets may vary greatly from one another. When it comes to an inheritance, the idea of capital gains does not apply because there is no transaction that includes a sale of the inherited property. However, the inheritor will be responsible for paying income tax on the profit made from the sale of the inherited property once it has been sold.
  2. Long-term capital gain: Long-term capital gains are the term given to the profit made from the sale of an asset that has been held for more than three years and six months. The previous holding period of 12 months for immovable properties was increased to 24 months as of the 31st of March, 2017. However, this rule does not apply to movable assets such as jewellery or debt-oriented mutual funds, among other types of investments. In addition, certain assets are regarded as short-term capital assets if the duration of time spent hanging onto them is less than a year. The following is a list of assets that are taken into account in accordance with the rule that was presented earlier:
  • Shares of ownership in any company that is traded on a stock exchange that is officially recognised in India.
  • Securities such as bonds, debentures, and other similar debt obligations are listed on any of India’s stock exchanges.
  • Unit Trust of India (UTI) units, irrespective of whether they are quoted or not quoted. 
  • Gain on capital invested in equity-oriented mutual funds, regardless of whether or not the funds are quoted. 
  • Bonds with no coupon interest.

If any of the assets stated above are retained for an amount of time greater than one year, then they are categorised as long-term capital assets.

What is a long-term capital gain 

Only gains on investments held for more than one year are subject to taxation under Section 112A. In order to be subject to taxation under Section 112A, the duration of keeping the property must be longer than one year. The tax rate is 10% on any amount that is greater than the exemption threshold of Rs 1 lakh. Therefore, long-term capital gains that fall under the purview of Section 112A are exempt from taxation up to a limit of one lakh rupees each fiscal year. Gains that are greater than one lakh rupees are subject to taxation at a rate of ten percent, plus education cess and any relevant surcharge.

For instance, if a taxpayer’s yearly (net) long-term capital gain according to Section 112A is Rs. 1,50,000, then the tax of 10% according to Section 112A is calculated based on Rs. 50,000. (Rs. 1,50,000 – Rs. 1,00,00).

A resident individual or HUF whose total income, after deducting the long-term capital gains, is less than the basic exemption level; in this case, the long-term capital gains are subject to a reduction equal to the gap in income.

For illustration purposes, we will assume that a taxpayer has a total income of Rs 400,000 and that their net long-term capital gains under Section 112A are Rs 200,000. After deducting the value of the capital gains, the remaining income is a little over two thousand rupees, which is less than the basic exemption level. 50,000 rupees is the amount that the lowered total income is short of in order to fall below the basic exemption level (Rs 2,50,000 – Rs 2,00,000). The gains on long-term investments that are subject to taxation will amount to Rs 1,50,000. (Rs 2,00,000 – Rs 50,000).

A long-term capital loss would be incurred if there was a loss incurred upon the sale of long-term listed equity shares or units, as described above. Only a long-term capital gain can be deducted against a short-term investment loss. In the event that one has losses from some securities but gains from others, he will be able to deduct the losses from the gains using the set-off method. The only time taxes are applied to net gains is when such gains are greater than Rs 1,000,000.

Calculating long-term capital gain

  1. When computing the long-term capital gain tax outlined in Section 112A, the first and second proviso to Section 48, also known as the benefit of indexed cost of acquisition and cost of improvement, are not allowed to be taken into account. 

Indexation aids in reflecting the true market worth of an asset by accounting for inflation’s declining effect on purchasing power. It is common practice to refer to the purchase price of an asset as its “indexed cost of acquisition” when selling the asset. The term “cost of improvement” refers to the sum an assessee spends to enhance or replace an existing capital asset.

  1. Also, when Section 112A applies, Non-Resident Indians (NRIs) cannot take use of the advantages of indexation or calculating capital gain in a foreign currency. Only in cases where Section 112A applies does this regulation operate.
  2. The cost of acquisition for assets that were acquired prior to February 1, 2018, shall be the higher of the following: the actual cost of acquisition, the lower of the fair market value of such assets and the full value of the consideration received or accruing as a result of the transfer of the capital asset. In other words, the cost of acquisition shall be the greater of these two amounts.
  3. The method that should be utilised to determine the fair market value is as follows:
  4. The following formula should be used to determine the fair market value of any capital assets that were listed on a recognised stock exchange as of January 31st, 2018: The highest price that a capital asset was quoted at on a recognised stock exchange as of the 31st of January 2018 is the price that will be used to determine the fair market value of any capital assets that were listed on a stock exchange as of the 31st of January 2018.

If there is no trading of the capital asset on the 31st of January 2018, the asset’s fair market value will be determined by the highest price that was ever quoted for the asset on a date that was immediately prior to the 31st of January 2018 and was the day on which it was last traded.

  1. If the capital asset for which the fair market value is sought is a unit, but the unit was not listed on a recognised stock exchange as of January 31, 2018, then the fair market value of such capital asset shall be the net asset value of such capital asset as of January 31, 2018.
  2. In all other cases, the fair market value of an asset shall be determined by the amount that, in the case of an equity share that was not listed on a stock exchange as of January 31, 2018, but which was listed on a stock exchange on the date of transfer, bears to the cost of acquisition the same proportion as the cost inflation index for F.Y. 2017-18 bears to the cost inflation index for the first year in which the asset was held or the year beginning on April 1, 2001, whichever is later. This sum is equivalent to the purchasing price.
  3. In accordance with the terms of Section 112A, deductions claimed under Sections 80C to 80U and/or rebates claimed under Section 87A cannot be applied against the capital gain taxed as a result of those Sections.

Tax Computation on long-term capital gain under Section 112A

The factors below will be used to determine the amount of tax due on the long-term capital gain if the aforementioned four requirements are met:

Long-term capital gain in excess of Rs. 1 lakh taxable at 10% 

  • Gain on the sale of an asset held for more than a year is exempt from taxation if the amount is less than Rs. 1 lakh 
  • If the gain is more than Rs. 1 lakh, the additional sum will be subject to taxation at a rate of 10% (+ surcharge + 4% health and education cess).
  • Whether the assessee is a corporation or an individual, the rate of 10% remains the same.

Benefits of exemption limit in some cases 

The exemption limit is advantageous owing to the provision in Section 112A (2). Only citizens or HUFs with a permanent address in the country can receive this perk (may be ordinarily resident or not ordinarily resident).

Further, this advantage is only accessible if the individual’s adjusted gross income (after deducting the long-term capital gain indicated in condition 2) is less than the exemption level.

What does Section 112A of the Income Tax Act say 

An assessor must pay income tax on capital gains from long-term capital assets as described in Section 2 (29A) of the IT Act, 1961 at the rate of 10% under Section 112A if the value of the gains is more than INR 1,000,000. If the assessor has determined that he or she is liable for this tax and the conditions in this section are met, then this tax is due. Shares, debentures, and business trust units are all included in the scope of this clause, as are other securities that may or may not be listed.

Section 112A does not apply to the deductions provided by Chapter VI-A. If the conditions in Section 10(38) aren’t met, the exceptions of that provision will not apply.

Before the amendment of Section 112A

A long-term capital gain tax exemption was in place for the transfer of equity shares, units of equity-oriented funds, and units of business trust prior to Assessment Year 2018-2019 under the terms of Section 10(38).

After the amendment of Section 112A

Since April 1, 2018, income from the sale of equity shares, units in equity-oriented funds, and units in a business trust is exempt from taxation under the requirements of Section 10 (38). Income taxed as a result of the sale of equity shares, units in equity-oriented funds, or units in a business trust must comply with the provisions of Section 112A beginning on April 1, 2018.

Exceptions to Section 112A

Some of the areas that are exempted from the application of Section 112A are:

  1. There is no tax imposed on profits made from mutual fund investments.
  2. If Section 112 applies, then Section 112A is not relevant.
  3. Non-Resident Indians are not eligible for this offer (NRIs)
  4. Shares that are not subject to Securities Transaction Tax (STT) when they are transferred do not have to be listed on a stock exchange in order to qualify, and the International Financial Service Centre (IFSC) is one location that qualifies.
  5. Foreign Institutional Investors (FII) are also not included because the securities held by them are indeed capital Assets and there is no requirement of proving the same. 
  6. If the assesses prove that the securities held by him are capital assets and not Stock in Trade. 

Acquisition Cost (Capital Gains on or before 31 Jan 2018)

Acquisition costs subject to tax should be determined using a value that is greater than the lower of the asset’s financial market worth and the sales consideration. Gains in excess of INR 1,00,000 are subject to a 10% tax rate, whereas gains under that threshold incur no tax.

If the financial market worth of an asset is INR 5,50,000, sales consideration is INR 6,00,000, and the real cost of purchase is INR 5,00,000.

The taxable capital gain is determined as follows: 

  • Step 1: Take the lesser of the fair market value and the sales consideration, or INR 5,50,000. 
  • Step 2: Compare the value taken to the actual cost of purchase and use the larger number, or INR 5,50,000.
  • Step 3: INR 50,000 is the result when INR 6,00,000 is subtracted from INR 5,50,000; this is the amount of capital gain that must be reported and taxed.
  • Step 4: Determine Your Tax Bill: If you make an INR 50,000 profit, then your capital gains tax is INR 5,000 (10% of 50,000).

Note: Please be aware that any losses under this section can be carried forward and set off, after which the balance would be subject to taxation as per Section 70 through Section 80.

Adjustment for Rs 1,00,000 exemption

Gains in excess of Rs. 1 lac would be subject to 10% LTCG taxation under Section 112A.

In its frequently asked questions section, CBDT assured taxpayers that the tax calculator software would automatically remove Rs 1 lac from the overall capital gains amount.

To qualify for the lower rate provided for in Section 112A of the Income Tax Act, the following requirements must be met:

  1. Securities transaction tax (STT) was reported upon the purchase and sale of the company’s equity interest.
  2. These long-term capital gains would not be eligible for the deduction under chapter VI A if:
  1. The asset was not a security, 
  2. The STT was not provided at the time of disposal, and 
  3. The asset was not an equity-oriented fund or a business trust unit.
  4. The long-term capital gains tax owed under Section 112A could not be deducted from the Section 87A refund.

Conditions to Tax Capital Gains Under Section 112A

The following stipulations clarify the application of Section 112A: 

  1. The sale must be of listed equity shares, units of a mutual fund, or units of a business trust.
  2. Investments in securities should be used for long-term capital projects.
  3. Equity share purchases and sales are taxable events under the STT (Securities Transaction Tax). 
  4. In the event of equity-oriented mutual fund units or business trust shares, the selling transaction is subject to STT.

Fair market value 

The fair market value (FMV) of a product is the price at which it would sell on an open market if it were assumed that both the buyer and the seller have a reasonable level of knowledge about the asset, are acting in their own best interests, are not under any undue pressure, and are given a reasonable amount of time to complete the transaction. It is important to note that the concept of “fair market value” is not interchangeable with concepts such as “market value” or “evaluated value” since it takes into account the economic principles that underlie the operation of free and open markets. On the other hand, when people talk about an asset’s market value, they mean the price that it fetches on the market. Therefore, while the market value of a home may be easily accessed on a listing, the fair market value of a home is far more challenging to assess.

In a similar manner, the phrase “appraised value” refers to the worth of an item according to the judgment of a single assessor. This does not automatically qualify the assessment as being equal to the fair market value.

An appraisal is typically all that is required to determine a property’s fair market value in situations where such a valuation is required.

The phrase “fair market value” is frequently used in legal contexts since it takes a number of different factors into consideration. For instance, fair market value of real estate is frequently used in the process of reaching agreements on divorce and in calculating compensation for eminent domain taken by the government.

Additionally, fair market values are frequently applied in the process of taxes, such as in the process of assessing the fair market value of a property in order to claim a tax deduction following a loss caused by a casualty.

The highest price at which a listed asset was ever traded on a recognised stock exchange is considered to be the FMV of that security.

If there was no trading in the security on the 31st of January 2018, the FMV is determined by the highest price that was offered for the security on a date immediately prior to the 31st of January 2018, at a time when the security had traded on a recognised stock exchange.

In the event that an equity share was acquired as a result of a merger or other transfer under Section 47, or if the share was listed after January 31, 2018, the FMV will be as follows: 

Cost of the purchase x (The cost inflation index for the fiscal year 2017-18/the cost inflation index for the fiscal year 2001-2002)

How can one report a case under Section 112A 

It is possible to record long-term capital gains on a scrip-by-scrip basis using Section 112A which is included in the income tax returns for the AY 2020-21. The information that must be included on Schedule 112A includes the ISIN code, the name of the scrip, the number of units or shares sold, the selling price, the acquisition cost, and the FMV as of January 31, 2018. The specifics are required so that one may calculate the appropriate amount of long-term capital gains in situations in which the grandfathering laws are relevant.

The grandfathering rules were implemented by the Finance Act of 2018, which exempted long-term capital gains generated up until January 31, 2018, from taxation. When determining the cost of acquisition for specified securities that were purchased prior to February 1, 2018, we begin by taking whichever of the following two values is lower: the fair market value as of January 31, 2018, or the sale consideration. Then, we look at the difference between the outcome and the sale price, and we go with the higher of the two. A grandfather clause, grandfather policy, or grandfathering is a provision in which an old rule continues to apply to some current instances, but a new rule will apply to all future cases. Those individuals who are exempt from the new regulation are referred to as having grandfather rights, acquired rights, or as having been grandfathered in.

In a recent press release, the Central Board of Direct Taxes (CBDT) provided clarification that scrip-wise information is not required for the reporting of long-term capital gains from investments made after January 31, 2018. 

Case laws 

P.M. Kunhabdulla Haji vs Income-Tax Officer 1986 162 ITR 304 Ker

The court in this case referred to the case of Gita Devi Dhurka vs. Income Tax Officer & others [1977] Tax LR 722, and held that, Income Tax Act Sections 132(5) and 132(11) provide that if the property is taken during a search and afterward claimed by a third party, the Income Tax Officer must be satisfied as to the identity of the person against whom he intends to proceed u/s 132 before issuing a notice under Section 112-A. Therefore, if the Income Tax Officer has reason to believe, at the time notice is given under Rule 112-A, that the commodities seized do not belong to the person from whom they were taken, then he may initiate proceedings under Section 132(5) against the third party making the claim.

Rajesh Kumar Gupta, Kanpur vs Department Of Income Tax I.T.A.No.605(LKW.)/2010

In this case, with an individual tax status, the assessee benefits from dalali and commission income. The Station Officer of the Ganga Ghat Police Station in Shukla Ganj, Unnao informed the AO that on 6th December, 1994 they had collected ten lakh rupees from the assessee, Shri Rajesh Gutpa. In the end, Rs. 10 lacs in hard cash was seized in accordance with Section 132A of the Income Tax Act. During Section 112A proceedings, the assessee was asked to detail how he came into possession of the Rs.10 lacs in cash and from where he got the money.

The court held that the income reported by the assessee was all that was subject to taxation, and no further amount was due. This case did not meet the requirements for a penalty under Section 271(1)(c) of the Income Tax Act since the assessee had already revealed his ‘Income from other sources,’ which included the Rs. 10 lacs that were discovered in his hands on 7th June, 1994. There was no attempt to hide income or provide false information in the assessee’s income tax return for the 1995-1996 tax year because the return was filed on time. It follows that the AO’s sentence was unjustified, and the learned counsel, Commissioner of Income Tax (Appeals) [ld. CIT(A)] made the correct decision in cancelling it.

Conclusion 

Section 112A was added to the Finance Act of 2018, and it imposes taxes on long-term capital gains derived from the sale of listed equity shares, units of equity-oriented mutual funds, and units of business trusts. Gains that were previously exempt from taxation are now able to be declared on form 112A, as of the 2017–2018 fiscal year (AY 2018-19). Previously, under Section 10, sales of listed equity shares, units of mutual funds, and business trusts were exempt from the capital gains tax under Section 10 (38). Previously, long-term capital gains on the sale of Specified Assets were exempted from the application of the Securities Transaction Tax (STT), as stipulated in clause 38 of Section 10. The requirements of Section 10(38) have been superseded by Section 112A, and as a result, long-term capital gains derived from the sale of Specified Assets are now subject to taxation in line with the provisions of Section 112A.

Frequently Asked Questions (FAQs) 

Will the taxpayer be subject to taxation on any capital gains that they make as a non-resident?

Yes, the TDS deduction will be applied at a rate of 10% for any non-resident Indian’s long-term capital gains earned, and this rate will apply to all non-resident Indians. The calculation of capital gains, on the other hand, needs to be carried out in accordance with the terms of the Finance Bill of 2018.

When figuring out long-term capital gains, will one be able to take advantage of indexation?

When calculating long-term capital gains on equity shares or other equity-oriented funds, one will not enjoy the advantage of indexation of the cost of acquisition because the cost of acquisition is not taken into account. In this regard, the Department of Income Tax has just recently published a clarification.

How can one determine the cost of acquisition for any investment that was purchased on or before the 31st of January 2018?

If the Fair Market Value (FMV) of the item on January 31, 2018, is higher than the actual cost of the item, then the Cost of Acquisition (COA) will be the FMV. If, on the other hand, the complete value of consideration at the time of transfer is less than the FMV, then the cost of acquisition of this investment is determined by either the full value of consideration or the actual cost, whichever is higher.

When submitting ITR, which pieces of information are required for compliance with Section 112A?

When you file your income tax returns for the assessment year 2020-21, you will need to fill out Schedule 112A as part of the process. This schedule will be of use in reporting your long-term capital gains in a scrip-wise manner. You will need to submit the following information in this section: the ISIN code, the name of the script, the total number of units sold, the purchase cost, the sale price, and the FMV as of January 31, 2018.

Can I set off a long-term capital loss from my income?

The answer is yes. However, you can only deduct a long-term capital loss from long-term capital gains. You cannot deduct the loss from short-term gains. In the event that you incur losses from some securities but realise profits from others, you are permitted to deduct those losses from the total amount of gains you have accumulated. However, you won’t be able to deduct this loss until the assessment year which comes eight years after the year in which the loss occurred.

Is compliance with Section 112A mandatory?

It is required that you complete Schedule 112A for the assessment year 2020-21 in order to provide information of each transaction involving the purchase, sale, or redemption of listed equity shares and equity-oriented mutual funds.

References 


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