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FM Arun Jaitley's new income tax rule has the potential to kill black money market
July, 18th 2014

It's a small step buried inside the Finance Bill 2014. Yet, it has the potential to partly kill the black money market. Finance minister Arun Jaitley has tweaked an income tax rule with the aim of blocking a way of converting black money into white, tax consultants and chartered accountants said.

The government proposes to tax any amount received as advance or earnest money for the sale of a capital asset, even if it is forfeited when negotiations fall through. Previously, sellers did not have to pay tax on the forfeited amount and people allegedly used this loophole to regularise unaccounted income.

"The Finance Bill 2014 has now made this forfeited amount chargeable to tax under Section 56, thus making it an income and plugging this loophole," said Amit Maheshwari, partner at Ashok Maheshwary & Associates, a Gurgaon-based chartered accountancy firm. "Now, it's not to be reduced from the cost of acquisition." The advance money will be taxed at 30 per cent, tax experts said. Earlier, a person wanting to bring into books unaccounted money would enter into an agreement to sell his property, usually held for the long term, with an accommodating party on the understanding that whatever earnest money is paid by cheque or demand draft will be forfeited as per the terms of the agreement.

In return, the accommodating party used to get a commission of 2-3 per cent of the transaction value. The agreements were entered into without any intention of honouring them. The Finance Act of 2012 had curtailed the practice of receiving a very high premium against the issue of shares.

"The amendment under Section 56 is expected to cap sham transactions being entered into to convert black money into white. Till now, forfeiture of advance against capital assets was mainly used to avoid payment of tax.

Such a receipt was claimed as tax-free being capital receipts based on some judicial rulings and also taking resort to Section 51 of the Income-Tax Act," said Alok Gupta, director taxation at SS Kothari Mehta & Co. The amount forfeited was treated as a capital receipt not chargeable to tax and was reduced from the cost of acquisition of the property.

Since these properties were held for the long term, any capital gains arising from the sale could be avoided by claiming exemption under Section 54. A new clause (ix) has been inserted in Section 56(2) of the IT Act, which will make the advance money taxable in the year in which the negotiations failed. This will come into effect from April 1, 2015. Transactions already entered from April 1, 2014, to date will also be covered.

"Post-amendment, if the transaction falls through, the amount forfeited will be taxed as income from other sources and taxed at the rate of 30 per cent," said tax expert AK Doshi of Doshi, Chatterjee, Bagri & Co. "The government is expected to gain to the extent of 10 per cent being the difference between tax rate on income from other sources (30 per cent) and on capital gains (20 per cent)."

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