Capital gains on transfer of capital assets including immovable property may decline after the announcement of change in base year of Indexation from 1981 to 2001 for calculating the cost of indexation benefit. The cost indexation benefits to increase the cost of acquisition of a capital asset by taking inflation into the account.
How Will Change in Base Year of Indexation affect your Capital Gains Tax Liability
Previously, the cost of acquisition (COA) of the capital asset was assumed to be the fair market value (FMV) of the year 1981 for older properties. To compute the long-term capital gain at the time of selling any capital asset acquired before 1981, its acquired cost calculated on the basis of its fair market value (FMV) of the year 1981. With this new proposal, the basis of fair market value calculation will be done with the base year 2001 instead of the year 1981, and this may increase the cost of acquisition (COA) and lower the capital gain.
If the capital asset including immovable property is held for more than 3 years, then the capital gain tax (Long term Capital Gain) applicable is 20 per cent with indexation benefit. However, to calculate the cost of indexation, the cost of acquisition is to be considered and this was assumed to be the Fair Market Value of the year 1981 for older properties.
Now after the proposal, the base year would be 2001 instead of 1981, the cost of acquisition (COA) will be higher in comparison to earlier (when the base year was assumed to be 1981), as property prices inflated between 1981 to 2001.
Change in base year of Indexation Can have Both Positive and Negative Impact on on Your Capital Gains Tax Liability
The Long Term Capital Gains will decline because the cost of acquisition of property will increase and hence, the long-term capital gain tax burden will be lower while transferring property.
One of the concern for changing the base year (1981) is possible to align the inflation in property prices between the period 1982 and 2001. The change in the base year (from the year 1981 to the year 2001) will affect all classes of capital assets, including silver and gold ornaments, where the assessee can derive the indexation advantage.
However, In the case of gold and silver jewelry, it is quite possible to determine the price in the year it was purchased or acquired and hence the fair market value (FMV) could be practically estimated.
In a case of the capital asset being immovable property it would be difficult to determine and hence the change in the base year will impact property transactions more.
Now the Negative Impact of change in base year of Indexation
The change in base year of Indexation can have negative impact too i.e. it may increase your Capital Gains Tax Liability as well, though the exact impact cannot be quantified at the moment. The value of earlier base year, 1981 was taken at 100 and till Fy 2001, the value had increased to 406 thus recording on an average 7% rate of inflation in capital cost. Now what will be the base value? and how it increase over period of time would impact the capital gains tax liability.
Another factor that would impact the capital gains tax liability would be the increase in official value, or reference value in the property over the period 1981 to 2001. The capital gains index has increased by about 4 times while the official price of the property to be taken as reference has increased by varying figures in different regions. Taking Chandigarh as an example, the “official price” or FMV of the property to be taken as reference has increased from 6500 per square yard to 14000 per square yards, thus giving the indexation benefit of about 2.05 times while the earlier index had given benefit of 4 times.
This in places, well most of the places in the country, excepting probably Metro Cities, the assessees would be at loss as they will have lower Indexed Values
This is why I feel, the budget is not tax payer friendly and may encourage tax evasion at various levels
Related Read- How to Minimize Capital Gains Tax Liability