Substantial tax savings on gains from Immovable property?

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The much anticipated budget 2017 has been announced. While the budget has triggered mixed reactions from various factions of society, the Finance Minister clearly seems to be favouring sellers of immovable property. In order that the investments in real estate sector are more attractive and to ease the difficulties of sellers the Finance Minister has proposed significant changes to the taxation of gains resulting from sale of land and buildings.

Capital gains from immovable property - current provisions
The gains arising from the sale of immovable property are classified as short term and long term. The long term gains are taxed at a special rate of 20% while the short term gains are taxed on par with regular income at applicable tax rates. In case of real property, in order to qualify as a long term gains, a taxpayer is required to hold such property for more than 36 months. The gain arising from the sale of such long term capital asset is computed after providing for indexation benefit. Indexation is done to adjust the cost of acquisition for inflation and is based on the Cost Inflation Index published by the government every year. Further, the base year for indexation is 1981. For a property purchased before 01 April 1981, for the purpose of determining the purchase price, the taxpayer has an option to consider the actual cost of the property or the fair market value as on 01 April 1981.

Proposed Changes
With a view to encourage investment in real estate sector, the Finance Minister proposes to reduce the holding period to qualify as long term asset from 36 months to 24 months in case of land and buildings . To illustrate, where an individual has purchased the property on 01 April 2015 and proposes to sell the property any time after 01 April 2017, the gain arising from such sale would qualify as long term gain. This would entitle such sale for indexation benefit and the gains would be subject to tax at the special rate of 20%.

Another important change proposed is in respect of indexation benefit. As indicated above, in case the property is purchased before 01 April 1981, the taxpayer had an option to choose the fair market value as on 01 April 1981 or the actual cost of the property as purchase price. Taxpayers were facing a lot of practical difficulties in determining the value of the property as on 01 April 1981 since the information may not be easily available. This is more so in case of inherited properties and assets acquired through gift. Considering the challenges faced by the taxpayers, the Finance Minister proposes to shift the base year of indexation from 01 April 1981 to 01 April 2001. The Finance Minister in his budget speech has indicated that this change will significantly reduce the capital gain tax liability. Let us examine this in greater detail with the help of an example.

An individual proposes to sell his property at about Rs.50 lakhs which he had purchased in 1980 for Rs.1 lakh. Based on the current provisions he has an option to take the cost of the property as 1 lakh or the fair market value as on 01 April 1981.  Assuming there will not be much difference in these two, the indexed cost of the property would be Rs.11.25 lakhs (Cost inflation index of 1125 for 2016-17 has been applied, base year index being 100). Hence, the taxable gain from the property would be Rs.38.75 lakhs.

Now, let us examine the impact of the proposed budget amendment. There has been a significant rise in the property prices in late 1990s. Assuming the market value of the property as on 01 April 2001 was 15 lakhs, the indexed cost of the property would be Rs.39.6 lakhs (Cost inflation index of 2016-17 has been applied, base year index being 426) resulting in a taxable gain of Rs.10.4 lakhs. As you may observe, the taxable gain has reduced by Rs.28.35 lakhs as per the proposed changes resulting in a tax saving of Rs.5.6 lakhs which is significant.

It may be noted that currently there are avenues to save these taxes by investing the funds in a new property or in specified bonds.  Bonds issued by National Highways Authority of India or Rural Electrification Corporation Limited have been specified for this purpose. The Finance Minister now proposes to expand this basket by notifying additional bonds issued by the Central Government, which are redeemable after three years in this connection.

The above changes with respect to capital gains on immovable property is proposed to be effective from 01 April 2018 and is indeed a welcome move by the Finance Minister. It reduces the tax liability for the seller on one hand and also eases the difficulties in obtaining the Fair market value in case of properties acquired prior to 01 April 1981 on the other hand.

- By Aarti Raote, Director and Amaranath Ambati is a Manager with Deloitte Haskins & Sells LLP. Views expressed are personal