The Hindu Business Line : Retrospectively unfair

Investments in capital gains bonds are made on the promise of exemption. Withdrawal of such exemption should be prospective and not retrospective as mentioned in the Notes on Clauses.

The scheme for taxation of long-term capital gains (LTCG) is undergoing subtle changes. At present, investments in LTCG bonds — issued by the National Bank for Agriculture and Rural Development, the National Highway Authority of India (on or after April 1, 2000), the Rural Electrification Corporation Ltd (on or after April 1, 2001), the National Housing Bank and the Small Industries Development Bank of India — are exempt from tax when redeemed after three years.

The Finance Act, 2006 has amended Section 54 EC of the Income-Tax Act, 1961, granting exemption only to bonds issued by the NHAI and REC. The amendment, contained in clause 13 of the Finance Bill, specifically mentions that the change will take effect retrospectively from April 1, 2006.

Mischief potential

Does this mean that in assessment year 2006-07 exemption will be granted only in respect of the NHAI and REC bonds? This will be palpably unreasonable. Investments in capital gains bonds are made on the promise of exemption. Withdrawal of such exemption can only be prospective and not retrospective as mentioned in the Notes on Clauses.

The Memorandum makes it clear that the amendment will apply to bonds issued by the NHAI or the REC on or after April 1, 2006. Reference to retrospective amendment should have been omitted. There is potential for mischief in the way the Notes are drafted.

The Finance Bill omits Section 54 ED from the Act. Investment of LTCG arising out of listed securities or units of a mutual fund/UTI in equity shares forming part of an eligible issue of capital will be exempt under Section 54ED. Now that long-term capital gains are completely exempt on payment of the securities transaction tax, Section 54ED has lost all relevance and is to be withdrawn with effect from April 1, 2007.

LTCG and MAT

Long-term capital gains tax will hereafter be includable in the computation of book profits. Analyst have pointed out that such inclusion will have an impact on holding and investment companies formed to promote new ventures. If such companies are MAT companies, any sale of shares they hold will attract book profits tax.

When acquisitions are thought of hereafter, the tax element arising because of MAT, by inclusion of long-term gains in book profits, will be built into the acquisition price. An element of discrimination arises here, as non-MAT companies will not be liable for LTCG tax.

Holding companies will suffer LTCG tax if they sell shares of subsidiaries and happen to be MAT companies. While dividend income will be exempt, there is no exemption for LTCG in respect of MAT companies. There is no indexation benefit for LTCG included in book profits. LTCG, as recorded in the books of accounts, will have to be taxed without the benefit of indexation. Earlier, there was the option to pay LTCG at 20 per cent with indexation or 10 per cent without indexation.

The latest amendment, of including LTCG in book profits, levies tax on LTCG at a rate which is higher than on short-term capital gains (10 per cent). It does look anomalous that merely because the company happens to come under the MAT category, its income from LTCG should be treated more stringently than if its income came by way of short-term capital gains.

Some fine-tuning is required in the entire scheme of LTCG taxation. The very rationale of exempting non-MAT entities from tax is questionable, particularly when the stock market is booming. However, it is argued that it is this exemption that is responsible for corporate leaders to reveal the real value of their equity shares. The Sensex was low in the earlier years because share valuations were weighed down by concerns of long-term capital gains at 20 per cent.

As long as wealth tax was levied on equity shares, the inclination to under-state or under-quote their value was high. Now corporate houses do not seem edgy when equity prices move up.

(The author is a former Chief Commissioner of Income-Tax.)

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