The recent Union Budget has led to a widespread but incorrect theory suggesting that taxpayers who transferred long-term capital assets before July 23, 2024, could reduce their tax liability from 20% to 12.5% by depositing the proceeds into a capital gains scheme account and failing to reinvest them within the limitation period. This theory lacks a legal basis and could lead to significant tax compliance issues.
Legal Framework and Interpretation
To dispel this misconception, let’s examine the relevant sections of the Income Tax Act and their implications:
1. Indexation Benefit under Section 48
Section 48 of the Income Tax Act details the calculation for long-term capital gains:
"The income chargeable under the head ‘Capital Gains’ shall be computed as follows:
(A) Full value of consideration received or accrued as a result of the transfer of the capital asset
(B) Less: Indexed cost of acquisition of the asset and indexed cost of improvement, if any."
Indexation adjusts the cost of acquisition for inflation, which reduces the taxable capital gains. These gains are taxed at a rate of 20% as per Section 112:
"The income chargeable under the head ‘Capital Gains’ in the case of a long-term capital asset shall be taxed at the rate of 20%."
2. Amendments Effective from July 23, 2024
From July 23, 2024, significant changes have been made:
- No Indexation Benefit: Indexation will no longer apply to assets transferred on or after this date.
- Reduced Tax Rate: The tax rate on long-term capital gains will be reduced to 12.5%.
These changes are outlined in the Finance Act, 2024, which revises the tax treatment for transactions occurring after the specified date.
3. Capital Gains Scheme Account
Sections 54 and 54F provide deductions for investments made in new assets:
- Section 54: Offers deductions for investments in a new residential property.
- Section 54F: Provides deductions for investments in various assets, including residential property, under specific conditions.
If taxpayers cannot invest the proceeds by the due date, they may deposit the funds into a capital gains scheme account. According to the provisions:
"The amount deposited in the capital gains scheme account shall be deemed to be the long-term capital gain of the year in which the time limit for utilization expires if not used for the specified purpose."
This means that if the funds are not utilized within the prescribed period, they are treated as long-term capital gains in the year when the limitation period ends.
Debunking the Misconception
The misconception suggests that deemed capital gains (from unutilized deposits) would be taxed at 12.5% if the original asset was transferred before July 23, 2024. Here’s why this is incorrect:
- Taxation Due to Deeming Fiction
The tax on unutilized amounts results from a deeming fiction under the capital gains provisions. Since the original transfer occurred before July 23, 2024, the applicable tax rate at the time of transfer remains valid. The deemed gains due to non-utilization of funds are not a new transfer but a reclassification of deferred income.
- Applicability of New Tax Rates
The revised tax rate of 12.5% applies only to long-term capital gains from assets transferred on or after July 23, 2024. Since the asset in question was transferred before this date, the original tax rate of 20% remains applicable to any gains arising from the non-utilization of the capital gains account.
Clarifying with an Example
Consider the following scenario to illustrate the correct tax liability:
Scenario:
- Mr. D purchased a property for Rs. 30 lakhs in January 2015 and sold it on August 15, 2022, for Rs. 1.2 crore.
- He deposited Rs. 80 lakhs into a capital gains scheme account in August 2023.
- Mr. D did not invest in a new property by the deadline of August 15, 2025.
Here’s the computation of his tax liability:
| Particulars | Amount |
|---|---|
| Full value of consideration (A) | Rs. 1,20,00,000 |
| Less: Indexed cost of acquisition (B) | Rs. 30,00,000 (adjusted for inflation) |
| Long-term capital gains (C = A – B) | Rs. 90,00,000 |
| Amount deposited in special account (D) | Rs. 80,00,000 |
| Deduction under Section 54 (E = C or D) | Rs. 80,00,000 |
| Taxable long-term capital gains (F = C – E) | Rs. 10,00,000 |
| Tax saved due to deduction under Section 54 (G = E * 20%) | Rs. 16,00,000 |
| Amount remained unutilized until August 15, 2025 (H) | Rs. 80,00,000 |
| Long-term capital gains taxable in 2025-26 (I) | Rs. 80,00,000 |
| Tax on long-term capital gains (20%) (J) | Rs. 16,00,000 |
| Net Tax Saving (K = G – J) | Nil |
Even though the limitation period ended after July 23, 2024, the gains will be taxed at 20% because the original transfer occurred before the cut-off date.
Conclusion
The theory that deemed capital gains from assets transferred before July 23, 2024, will be taxed at 12.5% is a misconception. The correct rate of 20% applies to such gains, as the new provisions only affect transactions occurring on or after the specified date. Taxpayers should adhere to the established tax rates and consult with professionals to ensure accurate compliance and avoid potential penalties for misreporting.
