Indexation benefit restored what it means for your investments after budget revisions

On 23^rd July, 2024, government of India proposed new Budget for the relevant financial year. Major amendments were made in relation to capital gains and indexation. Indexation for capital gains refers to the adjustment of the purchase price i.e. cost of acquisition of an asset for inflation while calculating capital gains for tax purposes. The purpose of indexation is to account for the erosion of value due to inflation, ensuring that the gain calculated reflects only the real increase in value, rather than nominal gains caused by inflation. Indexation reduces the taxable capital gains by increasing the cost of acquisition to reflect inflation, generally to lower the tax liability.

Budget update 2024:
Indexation benefit on sale of long term assets was removed in the Budget announced on 23^rd July, 2024. This means any sale of long term asset made from 23rd July, 2024 will attract 12.5% tax rate without indexation benefit. However, FMV benefit provision of asset as on 01.04.2001 as cost while selling the asset will be continued without any change. On 23rd July, 2024 Government had abolished the indexation benefit on long-term capital gains. In simple words, the purchase price of the asset will not be adjusted to current price after considering the inflation.

However, due to concerns raised by various taxpayers regarding possibility of arising higher capital gains, government has taken back the decision of abolishment of indexation. Now the government offers indexation benefit at a different tax rate than the rate applied for calculating gains without indexation benefit.

Impact of Indexation:
After an original announcement in the Union Budget was made regarding the reduction of tax on long-term capital gains from 20% with indexation benefits to 12.5% without indexation benefits, an amendment was introduced to The Finance Bill, 2024. This amendment allows taxpayers to select the tax rate that is more advantageous for them when dealing with the transfer of immovable assets such as land and buildings acquired before 23^rd July 2024. 

Long term investments are essential for economic development, growth and for many such economical aspects. LTCG on transfer of such capital assets will attract taxes without indexation benefit if the property is bought after 23^rd July, 2024.

Indexation adjusts the inflation hit to the cost of asset at the time of transfer of such asset. In the absence of indexation, the original purchase price will be considered for calculating gains.

Let us understand this with a small example:

With Indexation-

A property purchased in FY 2003-04 for Rs.15,00,000. The same property sold for Rs. 45,00,000 in FY 2023-24.

Capital Gain on the above transaction would be 

Full Value of Consideration	45,00,000
Less: Indexed Cost of Acquisition (15,00,000*348/109)	(47,88,991)
Capital Gain/(Loss)	(2,88,991)

Without Indexation-

A property purchased in FY 2003-04 for Rs.15,00,000. The same property sold for Rs. 45,00,000 in FY 2023-24.

Capital Gain on the above transaction would be 

Full Value of Consideration	45,00,000
Less: Cost of Acquisition	(15,00,000)
Capital Gain	30,00,000

Tax on Capital Gain @12.5% will be 3,75,000.

As seen from the above example, indexation benefit will help taxpayer as there is a capital loss due to indexation benefit and hence the taxpayer will not have to pay any tax. Whereas, in the situation where indexation benefit is not applied, straightaway a tax liability arises.

However, this depends upon various factors such as changes in cost of acquisition, economic growth, changes in laws etc. Therefore, government has provided taxpayer with an option to choose indexation benefit according to their beneficial position for properties bought before 23^rd July, 2024. This indexation benefit is not applicable for properties purchased after 23^rd July, 2024. This move is expected to provide significant relief to taxpayers, aligning with the broader public sentiment and addressing concerns from various stakeholders in the property sector.

Conclusion:
Post Budget amendment on 23^rd July, 2024, it was considered as one of the controversial amendment because many taxpayers had to face tax liabilities even on the transactions where there was no tax liability due to indexation benefits. Government considered public sentiments in regard to this and restored the benefits of indexation for properties purchased before 23^rd July 2024 and transferred thereafter resulting in a capital gain tax liability. This has provided relief to taxpayer giving them an option to choose a tax rate of 12.5% for computation without indexation benefit of capital gains or 20% tax rate for computation with indexation benefit of capital gains.