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Changes in capital gains taxation
June, 11th 2011

There are a number of changes proposed in the Direct Taxes Code Bill, 2010 (the DTC) on capital gains taxation. Foreign Institutional Investors (FIIs) will not be subjected to sporadic questioning as to the true nature of their activities investment or business. That they are in business of buying and selling shares has been the contention of the tax administration.

The DTC seeks to declare that their activities in India are investments, and not business. In the event, what they make by way of profits would be capital gains, and not business income. In the light of this clarification, FIIs can continue to route their investments into India via Mauritius assuming the government does not go through with its threat to review the invidious treaty with that country that bails out capital gains earned in India by a resident of Mauritius from the clutches of Indian tax authorities.

Ironically and curiously the same amendment is not proposed with reference to other institutional investors, particularly those rooted in India.

Grey areas on shares
The extant law confers a straight exemption vide section 10(38) to long term capital gains from shares or units of equity-oriented funds from bourses subject to payment of Securities Transactions Tax (STT). The DTC proposes to continue with the same tax treatment, not vide an exemption but through a deduction. It declares that 100 per cent of such long-term gains would be deductible from such gains, thus effectively conferring a 100 per cent exemption as hitherto. So far so good. But what happens when such computations give rise to a loss. It is a settled legal position that when an income is exempted, any negative income of that variety cannot stick out demanding its set-off. In other words, in such an event, any loss would be treated as non est.

What would happen if there is a loss under the new regime? The DTC has the following to say on this:

if the income computed after giving effect to sub-section (1) is a negative income, hundred per cent of the income so arrived at shall be reduced from such income

If this means the negative income from the transaction would be squared out so as to prevent the loss from standing out demanding set-off, it is all right. The subsequent discussion on short-term capital gains from bourses reinforces this correct and commonsensical interpretation but not quite so as to eschew every vestige of doubt.

In case of short-term gains, 50 per cent would be deducted, leaving the remaining 50 per cent to be taxed. But doubts are once again raised by the language of the provision dealing with short-term losses which are reproduced below: If the income computed after giving effect to sub-section (1) is a negative income, fifty per cent of the income so arrived at shall be reduced from such income.

There is need for a greater clarity on the issue.

Capital losses
As it is, long term capital losses can be set off only against long term capital gains of the same year or of the next eight years whereas short-term capital losses can be set off against both short-term and long-term gains during the same period. But in either case capital loss, short or long, is not allowed to abate against income from other heads of income now or in future.

These taboos are going to vanish in the new regime. First, the distinction between short-term and long term losses would go. Secondly, capital losses can be set off against any income from ordinary sources namely salary, business, house property and other sources now or in future without any time restriction.

While the DTC is liberal to treatment of losses of all hues by removing the time bar of eight years when it came to the maximum period one could carry forward the losses, those nursing capital losses have a special reason to celebrate and would breathe a lot easier.

(The author is a Delhi-based chartered accountant.)

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