Budget 2024-25 proposals go a long way in simplifying capital gains tax on most financial assets. The proposed 12.5 per cent rate of tax for long term capital gains (LTCG) on most financial assets held for more than one year is reasonable, even without indexation. It will generate a substantial revenue stream without aggrieving the taxpayer.

However some other related provisions are worrying and are likely to cause legal issues in the future. Most important is the treatment of capital gains in the case of buybacks.

Earlier, the tax was paid by the company and the proceeds were tax-free in the hands of the selling shareholder. This was inequitable. The tax burden fell on the continuing shareholder and the selling shareholder got tax-free proceeds. It is against the fundamental principles of economics and taxation, where taxes should be paid by the seller, if there is a gain. These rules existed because a large amount of tax was collected at a single point with minimal administrative issues.

This provision is being replaced by a proposal where the entire proceeds of shares sold in a buyback will be treated as dividends in the hands of the selling shareholders and taxed at their marginal rate. It further states that the cost of the shares will be treated as a capital loss and set off against future capital gains.

Key issues

There are many issues with this proposal:

The sale of a capital asset is being treated as a revenue item and taxed as such, with no cost allowed to be set off against it.

A buyback could be through two methods. One, by the tender offer method where there is full clarity of the buyer of the shares being offered in the buyback, in which case this proposal could apply, with tax being paid by the seller.

However, a buyback could also be done through open market purchases. Here it is not possible to differentiate whether the shares are being absorbed in the buyback or by another market participant. Hence the seller could sell his shares in the market and pay capital gains in the regular method.

The department would never be able to prove that the shares went to the buyback and hence should be taxed as dividend. Result, in due course the buyback by the tender offer method will disappear and only buybacks through open market purchases will survive.

All sellers will claim they have sold in the open market and not in the buyback. Pay capital gains at 12.5 per cent or 20 per cent and not as per the proposed provisions.

Another complication can arise when a company takeover occurs, where an open offer for usually 26 per cent has to be made to the public shareholders. Hopefully this will not be considered buyback, and normal capital gains tax will apply. A clarification is needed in this regard.

The issue of treating the cost of the shares as a capital loss to be set off against future gains, is difficult to digest. This is because the sale of a capital asset is treated as revenue and its underlying capital cost is not set off but carried forward to be set off against future capital gains. If for any reason there is no future capital gain, the assessee is hit hard.

It also needs to be clarified whether these ‘dividends’ will get the ‘dividend pass through benefits’.

Clarification is also needed as to whether the valuation date of January 31, 2018, continues.

Summing up , the basic proposals of the capital gains taxation in the Budget are simple, clear and straightforward. They can be applied to an assessee whichever way the shares are sold — that is, in the open market, buyback or open offer. The tax liability can be easily ascertained and the assessee would pay it without a grudge.

If simplification and equity or fairness of our tax code is the objective, this is the way to go.

The writer is a chartered accountant

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