Section 112 & 112A of Income Tax Act for LTCG

Understanding various sections of the Income Tax Act is crucial for effective financial planning. Let’s delve into Sections 112 and 112A of the Income Tax Act, focusing on their implications for Long Term Capital Gains (LTCG). Whether you're an individual investor, a financial advisor, or simply keen on understanding tax laws, this guide aims to simplify these complex sections and explain their relevance in today's financial scenario.

What is LTCG?

LTCG stands for Long Term Capital Gains. In simple terms, LTCG refers to the profit or gain earned from the sale of a capital asset that has been held for a specific period. This period varies depending on the type of asset. For instance, for equity investments, an asset must be held for more than a year to qualify as a long-term capital asset.

What is Section 112A?

Section 112A of the Income Tax Act is a pivotal provision that specifically addresses the taxation of Long Term Capital Gains (LTCG) arising from the transfer of equity shares, units of equity-oriented funds, and units of a business trust. This section was introduced to bring about a significant change in how LTCG from these specific assets is taxed, marking a shift in the investment and tax planning.

Prior to the introduction of Section 112A, long-term capital gains from the sale of equity shares and equity-oriented mutual funds were exempt from tax, provided the Securities Transaction Tax (STT) was paid. However, with the enforcement of Section 112A, this exemption was altered. Now, LTCG exceeding ₹1 lakh from the transfer of these assets is taxable at a rate of 10%, without the benefit of indexation.

This change, effective from April 1, 2018, aims to bring a more equitable tax system and broaden the tax base. It's crucial for investors to understand that the ₹1 lakh exemption is not per transaction but a cumulative limit for the financial year across all equity investments.

For instance, if an investor earns LTCG of ₹1.5 lakh in a financial year from equity investments, only ₹50,000 would be taxable under Section 112A. It's also important to note that this tax is applicable only when the assets are sold after holding them for more than one year, thereby falling under the category of long-term capital gains.

What is Section 112?

Section 112 of the Income Tax Act plays a crucial role in the taxation of Long Term Capital Gains (LTCG), particularly for assets other than those covered under Section 112A. This section primarily deals with the taxation of LTCG arising from the transfer of assets like debt-oriented mutual funds, real estate, gold, and other non-equity investments.

Under Section 112, LTCG from these types of assets is taxed at a rate of 20%. However, what sets this section apart is the benefit of indexation. Indexation is a method used to adjust the purchase price of an investment to reflect inflation. By increasing the purchase price, indexation effectively reduces the capital gain, thus lowering the tax liability. This makes Section 112 particularly relevant for assets held over long periods, where inflation can significantly impact the cost basis.

For instance, if you purchase a property and sell it after several years, the cost of acquisition will be adjusted for inflation, reducing the taxable gain. This adjustment is done using the Cost Inflation Index (CII), which is published by the government every year.

It's important to note that Section 112 applies to assets held for more than a stipulated period, qualifying them as long-term. This period varies for different assets. For example, for real estate, the asset must be held for more than two years, while for debt-oriented mutual funds, the period is three years.

Understanding Section 112 is essential for investors in non-equity assets, as it directly impacts investment returns and tax planning. By being aware of these provisions, investors can make more informed decisions about when to sell assets and how to optimise their tax liabilities.

What is the Difference Between Section 112A and Section 112?

Understanding the differences between Section 112A and Section 112 is crucial for effective tax planning and investment strategy. Let's compare these two sections in a tabular format for a clearer understanding:

This table summarises the key aspects of Sections 112A and 112. While both deal with the taxation of LTCG, they cater to different types of assets and have distinct tax implications. Investors need to be mindful of these differences when making investment decisions and planning for taxes.

Exceptions to Section 112A of the Income Tax Act

While Section 112A of the Income Tax Act outlines the tax implications for LTCG on certain equity investments, there are notable exceptions where this section does not apply. Understanding these exceptions is important for investors to know their tax liabilities effectively. Let’s explore these exceptions:

• Non-Resident Indians (NRIs): Section 112A's provisions do not apply to Non-Resident Indians (NRIs) on the sale of shares or units purchased in foreign currency. For such transactions, the taxation rules are governed by Section 115AD of the Income Tax Act.

• Gains from Securities Not Subject to STT: The 10% tax rate under Section 112A is applicable only if the Securities Transaction Tax (STT) has been paid at both the time of purchase and sale of equity shares. However, there are exceptions where STT may not be applicable, such as off-market transactions or certain acquisitions specified by the government.

• Equity Shares Acquired Before 2004: For equity shares that were acquired before 1st April 2004 (the date when STT was introduced), Section 112A does not apply even if the sale of these shares is subject to STT.

• Other Asset Classes: Section 112A specifically targets LTCG from equity shares, equity-oriented funds, and business trusts. Gains from other asset classes like debt funds, real estate, gold, etc., are not covered under this section and are instead governed by Section 112.

• Special Cases of Mergers, Acquisitions, and Buybacks: There are special provisions under the Income Tax Act for scenarios like mergers, demergers, and buybacks, where Section 112A might not apply, and different tax rules are considered.

It's crucial for investors to be aware of these exceptions to plan their investments and taxes accordingly. The application of Section 112A depends on various factors, including the type of asset, the nature of the transaction, and the investor's residency status.

Strategies for Tax Planning Under Section 112 and Section 112A

Tax planning is an essential aspect of financial management, especially when it comes to capital gains. With the right strategies, investors can optimise their tax liabilities under Sections 112 and 112A of the Income Tax Act. Let's explore some effective strategies:

Strategies under Section 112A

• Utilise the ₹1 Lakh Exemption Wisely: Since LTCG up to ₹1 lakh is exempt from tax each financial year under Section 112A, plan your equity sales to maximise this benefit. You can consider staggering the sale of equity investments over multiple years to avail the exemption limit each year.

• Hold Investments for the Long Term: To qualify for the lower tax rate under Section 112A, ensure that equity shares and mutual fund units are held for more than 12 months.

• Balance Portfolio with Non-Equity Investments: Diversifying your portfolio with non-equity assets like debt funds or real estate can help manage risk and optimise taxes, as these are taxed under different provisions.

Strategies under Section 112

• Leverage Indexation Benefit: For assets taxed under Section 112, use the indexation benefit to adjust the cost of acquisition, thus reducing the taxable gain. This is particularly beneficial for assets held over long periods.

• Strategic Timing of Asset Sales: Plan the sale of assets like real estate or debt funds by considering the holding period to qualify for long-term capital gains tax and utilise indexation.

• Consideration of Asset Types: Different asset types have different holding periods to qualify for LTCG under Section 112. Understanding these nuances can help in strategic planning of asset sales.

General Strategies

• Investment in Tax-Saving Instruments: Investing in tax-saving instruments like ELSS (Equity Linked Savings Scheme) can help reduce overall tax liability.

• Regular Portfolio Review: Regularly review your investment portfolio to align with your financial goals and tax-saving strategies.

• Consult your Relationship Manager: Tax laws can be complex and subject to change. Consulting InsuranceDekho’s relationship manager can help you benefit from personalised advice based on your specific financial situation.

By employing these strategies, investors can not only save on taxes but also align their investment decisions with their long-term financial objectives.

What is “Grandfathering Provisions” Under Section 112A

The introduction of Section 112A in the Income Tax Act came with a crucial aspect known as the 'Grandfathering Provision'. This provision was designed to protect the interests of investors who had invested in equity shares and equity-oriented mutual funds before the law changed on April 1, 2018. Understanding this provision is vital for investors to accurately calculate their tax liabilities. Let’s break down what this means:

What is the Grandfathering Provision?

The Grandfathering Provision under Section 112A refers to the special rule that exempts capital gains on equity investments realised until January 31, 2018. In essence, this means that the gains made on these investments until this cutoff date are not subject to the 10% LTCG tax introduced by Section 112A.

How Does it Work?

• Fair Market Value (FMV) Consideration: For the purpose of tax calculation under Section 112A, the cost of acquisition of an equity share or unit is deemed to be the higher of the actual purchase price or the asset's FMV as of January 31, 2018.

• Calculation of Capital Gain: When you sell these investments after April 1, 2018, the gains made over and above the FMV as of January 31, 2018, are considered for taxation.

• Exemption for Gains up to January 31, 2018: Any gains accrued up to January 31, 2018, are effectively exempt from tax, aligning with the old tax regime where LTCG on equity was exempt.

Example for Better Understanding

Suppose you bought an equity share for ₹100 in 2017. The FMV of this share on January 31, 2018, is ₹150, and you sell it for ₹200 in 2019. The taxable gain under Section 112A would be ₹50 (Sale Price - FMV on January 31, 2018), not ₹100 (Sale Price - Purchase Price), thanks to the grandfathering provision.

Strategic Implications

Investors need to be aware of the FMV of their equity investments as of January 31, 2018, to correctly calculate their tax liability under Section 112A. This provision offers a significant tax-saving advantage for investments made before the introduction of the 10% LTCG tax.

Reporting ITR Under Section 112A

Reporting Long Term Capital Gains (LTCG) under Section 112A in your Income Tax Return (ITR) is an important aspect of compliance for investors in equity and equity-oriented investments. This process ensures accurate tax calculation and adherence to tax laws. Here's a guide to help you understand this aspect of tax filing:

Understanding the Reporting Requirement

• Disclosure of LTCG: Taxpayers need to disclose their LTCG from equity shares, equity-oriented mutual funds, and units of business trusts in their ITR. This is crucial since LTCG exceeding ₹1 lakh is taxable at a 10% rate under Section 112A.

• Separate Disclosure for Grandfathered Gains: It's important to separately report gains that are grandfathered under the provision as of January 31, 2018. This ensures that only gains accruing after this date are considered for taxation.

Steps for Reporting in ITR

• Choose the Correct ITR Form: Ensure that you select the appropriate ITR form that allows reporting of capital gains. For most individuals, this would be ITR-2 or ITR-3.

• Fill in the Schedule CG (Capital Gains): Schedule CG in the ITR form is where you need to provide details of your capital gains. Ensure accurate entry of details like the date of acquisition and sale, full value of consideration, and cost of acquisition.

• Calculate Taxable Gain: Use the FMV as of January 31, 2018, for the cost of acquisition if it's higher than the actual purchase price, and calculate the taxable gain accordingly.

• Include Grandfathering Clause: Ensure that the gains accrued till January 31, 2018, are reported as exempt under the grandfathering provision.

• Report Exempt Income: If your LTCG is under ₹1 lakh, report it as exempt income under the relevant section of the ITR form.

• Pay Advance Tax if Applicable: If your taxable LTCG exceeds ₹1 lakh, ensure that you have paid the applicable advance tax to avoid interest charges.

Points to Remember

• Accuracy is Key: Inaccuracies in reporting can lead to notices from the tax department and potential penalties.
• Documentation: Keep all relevant documents like sale and purchase statements, FMV details, etc., for future reference.
• Seek Professional Help: If you find the process complicated, consider consulting your relationship manager from InsuranceDekho for accurate filing.

Reporting LTCG under Section 112A in your ITR is a detailed but essential process. Proper compliance not only ensures adherence to tax laws but also helps in efficient tax planning and management.

Set Off Long-Term Capital Loss Against Long-Term Capital Gain

One of the key aspects of tax planning in the context of capital gains is understanding how to set off long-term capital losses against long-term capital gains. This can significantly impact your tax liability and investment strategy. Here’s an insight into how this process works:

Understanding Capital Loss Set-Off

• Nature of Loss and Gain: Only long-term capital losses (LTCL) can be set off against long-term capital gains (LTCG). This means that if you incur a loss on the sale of an asset held for the long term, this loss can be used to reduce your taxable income from other long-term gains.

• Asset Class Consideration: It’s important to note that LTCL from the sale of equity shares or equity-oriented mutual funds (covered under Section 112A) can only be set off against LTCG from the same type of assets. However, LTCL from other assets can be set off against LTCG from any asset class.

Steps for Set-Off in ITR

• Calculate the LTCL: Determine the amount of loss incurred from the sale of long-term assets. This involves subtracting the sale value from the adjusted cost of acquisition (factoring in indexation where applicable).

• Report in ITR: While filing your Income Tax Return, report the LTCL under the capital gains section. Make sure to provide all relevant details of the transaction that led to the loss.

• Adjust Against LTCG: Offset the calculated LTCL against any LTCG earned during the financial year. This reduces the overall taxable capital gains.

Carry Forward of Unadjusted Loss

• If the LTCL is not fully set off against LTCG in the same year, it can be carried forward for up to eight subsequent years.
• In the following years, this carried-forward loss can be set off against LTCG of those years, provided the loss is disclosed in the tax returns of the year it was incurred.

Key Points to Remember

• Document and Record: Keep all necessary documentation for both the loss and gain transactions, as these might be required for tax assessment.
• Timely Filing of ITR: Ensure to file the ITR on time, as late filing can disallow the carry forward of losses.

Setting off LTCL against LTCG is a valuable tool in tax planning. It not only helps in reducing the tax burden but also encourages prudent investment decisions.

Conclusion

Grasping the basics of Sections 112 and 112A of the Income Tax Act is essential for effective tax planning and investment strategy. Understanding the differences between these sections, along with the grandfathering provisions, reporting requirements, and the ability to set off long-term capital losses against gains, can significantly impact your financial decisions. As an investor, staying informed and compliant with these tax laws not only helps in optimising your tax liabilities but also paves the way for more informed and strategic investment choices.

FAQs

• What is LTCG?

Long Term Capital Gains (LTCG) refer to the profit earned from the sale of a capital asset held for a specified period, typically more than a year.

• How does Section 112A impact equity investments?

Section 112A taxes LTCG from equity shares, equity-oriented funds, and business trusts at 10% if the gains exceed ₹1 lakh in a financial year.

• What are the key differences between Section 112 and 112A?

Section 112A applies to LTCG from equity investments and taxes gains above ₹1 lakh at 10% without indexation. Section 112 deals with LTCG from non-equity assets, taxed at 20% with indexation benefits.

• Can LTCG under ₹1 lakh be taxed under Section 112A?

No, LTCG up to ₹1 lakh in a financial year is exempt from tax under Section 112A.

• What is the Grandfathering Provision in Section 112A?

It's a rule exempting capital gains on equity investments realised until January 31, 2018, from the 10% LTCG tax.

• How is the cost of acquisition calculated under the Grandfathering Provision?

It’s calculated as the higher of the actual purchase price or the asset's FMV as of January 31, 2018.

• Can long-term capital losses be set off against other income?

No, long-term capital losses can only be set off against long-term capital gains.

• Is it mandatory to report LTCG in ITR if it's below the exemption limit?

Yes, it's mandatory to report all capital gains in ITR, even if they are below the exemption limit.

• Can I carry forward unadjusted long-term capital loss?

Yes, unadjusted LTCL can be carried forward for up to eight years to set off against future LTCG.

• Does Section 112A apply to Non-Resident Indians (NRIs)?

No, Section 112A does not apply to NRIs for shares or units purchased in foreign currency. They are governed by Section 115AD.