Taxation of real estate transactions: A post-budget analysis

Simplification of the income-tax law has been at the forefront of the Government’s agenda. The Government has been vocal in its intent of phasing out deductions, exemptions, allowances, etc., in favor of a simpler tax regime. Over the years, the Government has phased out tax benefits and reduced average tax rates for corporates and individuals.

In line with this intent, Finance (No. 2) Act, 2024 (‘Finance Act’) has made a host of changes to the Income-tax Act, 1961 (‘IT Act’) to rationalize the provisions relating to capital gains tax. Amendments have been made to simplify the characterization of long-term assets, computation of gains and application of tax rates. The proposed amendments inter alia, will have a significant impact on taxpayers transferring their capital assets on or after 23 July 2024.

The present article aims to summarize these amendments and highlight key aspects which warrant taxpayers’ attention.

Summary of key amendments

Presently, any profits or gains arising from the transfer of capital assets (being immovable property) is chargeable to income-tax under the head ‘Capital Gains’ and are taxable in the year of transfer[1]. The income chargeable under the head ‘Capital Gain’ can be classified under two heads, namely (1) long-term capital gains, or (2) short-term capital gains, depending on the period of holding[2].

Under the existing provisions, the long-term capital gains from the transfer of immovable property are computed by reducing the indexed cost of acquisition[3], indexed cost of improvement[4], and expenses connected with the transfer from the full value of consideration[5]. The same is taxed at the rate of 20% (excluding surcharge and cess) in the hands of the resident-transferor.[6]

The benefit of ‘indexation’ was purported to offset accrued capital gains against the inflation rate during the holding period by making an upward adjustment to the cost of acquisition of the asset. This effectively resulted in lowering the effective tax incidence on the taxpayers.

The Finance Act has made following changes in respect of the transfer of immovable property effected on or after 23 July 2024:

Firstly, reduced the tax rate on long-term capital gains from 20% to 12.5%;

Secondly, the benefit of indexation from long-term capital gains computation has been withdrawn;

There is just one caveat to the afore stated position. Taxation of long-term gains derived by a resident individual or HUF from transfer of land and building, acquired prior to 23 July 2024, has been capped at amount of income-tax as would have been payable prior to these amendments. This grandfathering benefit will ensure that the taxpayers who had acquired land and/or building prior to 23 July 2024 don’t end up paying higher taxes because of the amendments.

The overall impact of the proposed amendment can be understood with the help of the following illustration:

Let us assume Mr. A (resident individual) acquired a piece of land in FY 2012-13 for INR 5,00,000, which was later sold on 24^th July 2024 for following sale consideration:

Scenario 1: INR 75,00,000

Scenario 2: INR 8,00,000

Key issues under the proposed amendments

While the Government’s stated intent is to rationalize and simplify the capital gains taxation regime, the taxpayers transferring immovable properties on or after 23 July 2024 may face the following challenges:

No carry forward or set-off of de facto capital loss on sale of immovable property considering inflation and time-value of money: As evident from illustration above (Scenario 2), there may be cases wherein a taxpayer is incurring a loss after reducing the indexed cost of acquisition from full value of consideration under the erstwhile provisions.

With the removal of the indexation benefit, taxpayers will no longer be entitled to carry forward or set off such losses. Thus, the grandfathering provision does not necessarily place the taxpayers on the same footing as before in relation to land and/or building acquired before 23 July 2024.

Higher re-investment for claiming capital gains tax exemption: Section 54 of the IT Act grants exemption to long-term capital gain arising from transfer of a residential house, subject to the condition that the capital gain amount is invested in a new residential house within the specified period. With the removal of the indexation benefit, an individual or HUF intending to claim this exemption in respect of residential house acquired on or after 23^rd July 2023 would be required to invest a higher amount in the new asset.

No grandfathering benefit for leasehold rights: It is provided that the taxation on transfer of immovable property (being land or building or both) acquired before 23 July 2024 will be capped at the tax rates as applicable prior to the amendment.

However, the provision is silent on other categories of rights which are directly associated with immovable property, such as leasehold rights. In certain cases, the phrase immovable property being ‘land’ and/or ‘building’ have been interpreted not to cover rights associated with such immovable property, such as leasehold rights[7]. Accordingly, taxpayers transferring such rights (say, leasehold right or development rights) should carefully evaluate their tax liability in light of the amendments.

Conclusion

The amendments to capital gains taxation will diversely impact the taxpayers. The reduction in tax rates for long-term gains may have the impact of significantly reducing the capital gains tax rate in respect of certain assets such as unlisted shares where there has been a significant increase in the valuation with a relatively lower investment. Nevertheless, elimination of indexation benefits would likely result in increased capital gains, necessitating a larger investment in assets like residential properties to mitigate the tax burden. Accordingly, taxpayers undertaking real estate transactions need to closely examine their capital gains tax liability on a case-to-case basis.

[The authors are Partner, Principal Associate and Associate, respectively, in Direct Tax practice at Lakshmikumaran & Sridharan Attorneys]

[1] Section 45 of the IT Act.

[2] Immovable property being land or building or both held for 24 months or more are classified as long-term capital asset under third proviso to Section 2(42A) of the IT Act.

[3] Cost of acquisition x (Cost Inflation Index (‘CII’) of the year of transfer / CII of the year of acquisition of the capital asset).

[4] Cost of improvement x (CII of year of year of transfer/ CII of year in which improvement of capital asset took place)

[5] Section 48 of the IT Act.

[6] Section 112(1) of the IT Act.

[7] Shivdeep Tyagi: [2024] 163 taxmann.com 614 (Delhi - Trib.); and A. R. Sulphonates (P.) Ltd.: [2024] 161 taxmann.com 451 (Kolkata - Trib.).