Concerns with Removing Indexation

Source: The post concerns with removing indexation has been created, based on the article “On discarding indexation for LTCG” published in “The Hindu” on 1st August 2024

UPSC Syllabus Topic: GS Paper3- Economy-mobilisation of resources

Context: The article discusses Finance Minister Nirmala Sitharaman’s proposal to eliminate indexation for calculating long-term capital gains (LTCG) tax, replacing it with a 12.5% tax rate on gains. It explains how indexation works and its implications for different assets and taxpayers.

For detailed information on Changes in India’s tax regime for capital gains read this article here

What is the New Proposal regarding LTCG Tax?

Finance Minister Nirmala Sitharaman has proposed removing indexation in the calculation of long-term capital gains tax. Instead, all gains will be taxed at a flat rate of 12.5%. This change is intended to simplify tax calculations for both taxpayers and the tax administration.

For detailed information on Indexation read this article here

How Does Indexation Work?

1. Indexation adjusts the purchase price of an asset to account for inflation, ensuring taxpayers are taxed on real gains.
2. For example:

A house bought for ₹10 lakh in 2001.

Sold for ₹75 lakh in 2021.

Calculation:

Cost Inflation Index (CII) for 2021: 317.

CII for 2001: 100.

Indexed purchase price: ₹10 lakh * (317/100) = ₹31.7 lakh.

Taxable gain: ₹75 lakh – ₹31.7 lakh = ₹43.3 lakh.

Tax Comparison:

With indexation at 20% tax rate: Tax = ₹8.7 lakh.

Without indexation at 12.5% tax rate: Tax = ₹8.13 lakh.

What Are the Concerns with Removing Indexation?

1. Higher Tax Liability: Without indexation, tax liabilities can increase significantly. For example, selling a house for ₹40 lakh in 2021 without indexation results in a tax of ₹3.75 lakh, compared to ₹1.66 lakh with indexation.
2. Flat or Slumping Markets: Assets that do not grow exponentially benefit more from indexation, as seen with a BankBazaar study showing LTCG tax tripled for properties bought after 2010 without indexation.
3. Short-Term Sales: Individuals benefit more by selling assets quickly (3-4 years) rather than holding them long-term (10 years or more).
4. Investment Trusts and Bonds: REITs and infrastructure funds, which have lower returns, may suffer. Bonds might become less popular.
5. Property Undervaluation: Properties may be sold at circle rates to reduce tax, increasing black money transactions, as warned by AAP MP Raghav Chadha.

Question for practice:

Discuss the potential implications of removing indexation for calculating long-term capital gains tax and replacing it with a flat 12.5% tax rate, as proposed by Finance Minister Nirmala Sitharaman.