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Budget 2014: Amendment to Sec 2(42A) Of The IT Act 1961

Published on Tue, Jul 22,2014 | 19:16, Updated at Tue, Jul 22 at 19:16Source : 

By: Hiten Kotak, Co-Head Of Tax, KPMG India

Newly elected government, which had set one of its agendas as reform, presented its first union budget in the backdrop of towering expectations. Considering the challenges highlighted in the economic survey and the fact that new government had less than 2 months to present the budget, the Finance Minister has tried to maintain a fine balance between managing the fiscal deficit and the necessary impetus needed to rev-up the ailing economy. Union Budget 2014 mainly focuses on higher growth and job creation through various programs, with a significantly higher focus on infrastructure, higher investment through FDI, encouragement of domestic saving and some relief for individual tax payers.  

This government had in the run up to the elections and subsequently as well stressed on a stable and progressive tax environment, however inadvertently the government has created a negative impact on retail & institutional investors. The Proposal to amend the definition of “Short Term Capital Assets” in Finance (No. 2) Bill, 2014, has in a significant way impacted the debt mutual fund investors, domestic venture capital & private equity funds, and several private investors in various sectors ranging from real estate, infrastructure to media.  

Currently, unlisted securities and units of non-equity oriented mutual funds are classified as short-term capital assets, if held for less than 12 months and long-term capital assets, if held for more than 12 months. The proposed amendment means that an investor who exits an investment in unlisted securities and non-equity oriented mutual funds before 36 months will have twofold negative impact (a) investor has to shell out a higher tax (as usually the tax rate of 30% applicable to short-term capital gains is higher than 10% or 20% tax rate of long term capital gains) and (b) investor will not be entitled to claim the indexation benefit (which is available only to long term capital assets).  

More importantly the above proposed amendment will be retrospectively applicable to the purchase transaction made prior to the Budget Day and even to the sale transactions which are done during the period April 01, 2014 to July 10, 2014. When these transactions were initiated, the classification between short term and long term capital assets was amply clear and the investment decisions were made based on the income tax laws which were applicable before March 31, 2014.

The proposed retrospective amendment is contrary to the budget speech of Honorable Finance Minister which promised categorically that the new government would never create a past liability by means of retrospective change in tax laws and yet in the same Budget, the above proposed amendment of retrospective nature has been inserted.

On account of such proposed retrospective amendment, the retail & institutional investors, who have made/sold the investments prior to the date of Union Budget 2014 (keeping in mind the existing income tax laws); will not even get the necessary time to re-align their exit plans and will have to pay taxes retrospectively for the units redeemed or unlisted securities sold before this year’s budget was presented.  

Further this also creates a distinction between listed and unlisted shares. Small entrepreneurs or start-ups are not in a position to list their shares initially. All equity investments in such ventures are through unlisted shares, now by creating this distinction it shall make it more difficult for such entrepreneurs and start-ups to raise funds, which again goes against the stated objective of the government to encourage start-ups and small business.

Proposed retrospective amendment to the definition of short term capital assets is not in the nature of a clarification and instead would tend to widen the tax base. Proposed retrospective amendment was not done after exhaustive and transparent consultation with all the stakeholders, who would be affected in the rarest of rare case.  

To better reflect the principles of equity & morality in the formulation & implementation of commonly recognized taxation principles, the government should consider prospectively applying the proposed amendment in Section 2(42A) with effect from assessment year 2016-17.


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