Abbreviations & Concepts
Concept of Grandfathering
The concept of grandfathering in the case of LTCG on sale of equity investments works as follows:
A method of determining the Cost of Acquisition (COA) of such investments have been specifically laid down as per the COA of such investments shall be deemed to be the higher of: The actual COA of such investments; and The lower of-Fair Market Value (‘FMV’) of such investments; and the Full Value of Consideration received or accruing as a result of the transfer of the capital asset i.e. the Sale Price Further, the Fair Market Value would be the highest price quoted on the recognised stock exchange on 31 January 2018.
In case there is no trading of the said asset in such stock exchange, the highest price on a day immediately preceding 31 January 2018 shall be considered to be the Fair Market Value. In effect, the taxpayer can claim the highest price quoted on the recognised stock exchange on 31 January 2018 as the Cost of Acquisition and claim the deduction for the same.
Grandfathering for shares acquired on or before 31 January 2018
- The Finance Act, 2018 w.e.f. 1 April 2018, introduced 10% tax on long term capital gains arising on transfer of listed equity shares, units of equity oriented mutual fund and units of business trust. Such long-term capital gains up to Rs INR 1 lakh is exempt from tax. The concessional tax rate of 10% is available if STT has been paid in following scenarios:
- Long term capital assets being listed equity shares, STT has been paid on acquisition* and transfer of such capital asset.
- Long term capital assets being a unit of an equity-oriented fund or a unit of business trust, STT has been paid on transfer of such capital asset.
- *The CBDT has notified a circular to specify the transactions where the condition of STT on acquisition would not apply for applying tax rate of 10% on transfer of listed equity shares.
- While computing the capital gains under section 112A (i.e., availing concessional rate of tax of 10%), benefits of foreign currency fluctuation for NRIs and indexation benefits for resident are not available.
- Determination of Cost of Acquisition: (Grandfathering)
- Long term capital gains that arise on shares purchased prior to 1 February 2018 is grandfathered for the notional gains earned on such shares till 31 January 2018. The cost of acquisitions of listed shares acquired before 1 February 2018 and held for more than 12 months, is deemed to be the higher of
- the actual cost of acquisition; and
- the lower of (a) the fair market value of such asset; and (b) the full value of consideration received or accruing on transfer of the capital asset.
- For this purpose, the fair market value will be determined based on highest price of the capital asset quoted on the stock exchange on January 31, 2018, for equity shares and net asset value of equity oriented mutual funds as on January 31, 2018.
- Long term capital gains that arise on shares purchased prior to 1 February 2018 is grandfathered for the notional gains earned on such shares till 31 January 2018. The cost of acquisitions of listed shares acquired before 1 February 2018 and held for more than 12 months, is deemed to be the higher of
- The Finance Act, 2018 also amended that in such case where the equity shares were unlisted on 31 January 2018 and listed at the time of transfer, the fair market value would be after considering indexation benefit on the original cost of acquisition.
Concept of Indexation
Indexation is applicable to long-term investments, which include debt fund and other asset classes. Indexation helps you in adjusting the purchase price of the investments. Capital gains refer to an increase in the value of an investment over a specific timeframe. A capital gain is a difference between the purchase price and the sale price of an investment. In the case of debt funds, which are long-term in nature (held for more than 36 months), capital gains are arrived after indexing the purchase price of the investment. Unlike equity funds, long-term capital gains on debt funds are taxable at the rate of 20% with the benefit of indexation. Indexation is used to adjust the purchase price of an investment to reflect the effect of inflation on it. A higher purchase price means lesser profits, which effectively means a lower tax. With the help of indexation, we will be able to lower your long-term capital gains, which brings down your taxable income. Indexation is the reason why debt funds are considered an excellent fixed-income investment option when compared to conventional fixed deposits (FDs). The rate of inflation to used for indexation can be obtained from the government’s Cost Inflation Index (CII).
Indexation on long term capital assets
Indexation benefit is available in case of capital gains arising from transfer of long-term capital assets. Indexation is a process that allows investors to adjust the
cost of acquisition of an asset to account for inflation between the time that the asset was purchased and sold. While computing the capital gains the ‘cost of acquisition’ is replaced with ‘indexed cost of acquisition’ and ‘cost of improvement’ is replaced with ‘indexed cost of improvement’.
The indexed cost is computed as under:
| Indexed cost of acquisition = | (Cost of Acquisition) × (CII for the year of transfer) |
| (CII of year of acquisition or FY 2001-02, whichever is later) |
| Indexed cost of improvement= | (Cost of Improvement) × (CII for the year of transfer) |
| (CII of year of improvement) |
- capital gains arising from transfer of bonds or debentures except (i) Capital indexed bonds (issued by the Government) and (ii) Sovereign Gold Bond (issued by RBI under the Sovereign Gold Bond Scheme, 2015).
- capital gains arising from transfer of equity share, or a unit of an equity-oriented fund or a unit of a business trust which is eligible for concessional tax rate of 10% under section 112A of the Income-tax Act, 1961.
- non-residents are generally not eligible for indexation benefits from sale of shares and debentures.