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As Budget 2017 changes indexation rule, Good gets Better

Author: S Vijaykrishnan/Thursday, April 6, 2017/Categories: Profit

As Budget 2017 changes indexation rule, Good gets Better

Every capital gain computation involves the following — the price at which the asset was bought, the price at which it was sold, and indexation, which inflates the purchase price so that tax is levied only on the ‘real’ gain.

This is done using the cost inflation index (CII). It is here that Finance Minister Arun Jaitley’s move to ‘rebase’ the CII to 2001 is significant. Experts the Finapolis spoke to say investors in real estate will gain the most from the FM’s move. This is because the CII does not adequately reflect s the rise in property prices over the 1980s and the 1990s. What rebasing will do, is allow investors to substitute the fair market value as of 2001 for the purchase price of their property.

The Income-Tax Act allows investors to choose the higher value between fair market value (FMV) and purchase price at the time of indexation. Experts say since the FMV is a better indicator of the rise in property prices, the rebased index will inflate the purchase cost of properties acquired between 1981 and 2001.

Says Saurabh Gupta, CA, Gupta Saurabh & Co, “An investor who had purchased property in 1981 and sold it in 2001, will be able to inflate his purchase price by only 4.26 times under the current index, while actual property rates would have moved up by at least 6-7 times during this period. Choosing 2001 as the base year now will allow investors to use the FMV as of that year, which will be a better indicator than the CII.” Gupta adds that until now people who had purchased property before 2001 had to rely on CII rather than FMV for indexation, as the FMV for 35 years ago is hard to ascertain.

As for the 2001 FMVs, Gupta says investors would need to refer to circle rates or ready reckoners published by state governments/ municipalities.

Before and After

Let us consider an example to understand how the rebasing will affect capital gains. Suppose Mr X had purchased a property for Rs 12 lakh in 1996-97 (CII value: 305) and sells it for Rs 90 lakh in 2016-17 (CII value: 1125). Indexation will inflate his purchase price to Rs 44.26 lakh [12*(1125/305)]. The capital gain would therefore be Rs 45.73 lakh (90-44.26) and he would pay Rs 9.14 lakh as tax (@20%). Note that here, the CII offers only an increase of 3.7 times (1125/305) over 20 years!

However, Mr X can now choose the 2001 FMV instead of his original purchase price. This will allow him to claim a higher acquisition cost and thereby lower his tax dues. Let us assume that the FMV for 2001 is Rs 22 lakh. (note that this is higher than the original purchase price Rs 12 lakh). Using the FMV, the indexed cost comes to Rs 58.09 lakh [22*(1125/426)], which lowers Mr X’s capital gains to Rs 31.90 lakh (90-58.09) and his capital gains tax to Rs 6.38 lakh.

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S Vijaykrishnan
S Vijaykrishnan

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