It was a controversial proposal in this year's Budget. The proposal said: "Long-term capital gains arising from transfer of any listed shares acquired on or after March 1, 2003 but before March 1, 2004 is exempt from tax."
After reading the above proposal, I made the following observation: "Under Section 49(1), where the capital asset became the property of the assessee, through gift or inheritance, the cost of acquisition of the asset shall be deemed to be the cost to the previous owner.
"Now suppose I give a gift of the shares purchased by me years ago to my wife on March 1, 2003 and she sells them in the market. Surely, she will be able to compute the long-term capital gains by using my cost of acquisition.
"These capital gains will be tax-free since the date of her acquisition falls within the above prescribed period. Note that she does not even have to hold the shares for one year since the asset is already a long-term one. Yes, these capital gains will be taxed in my hands because of the clubbing provisions but being tax-free, I am happy and so is she."
I had pointed out the lacuna with a hope that the authorities would plug the loophole to prevent litigation. The authorities have taken excellent, corrective action.
Lacuna corrected
This lacuna has been corrected during the passage of the Budget through Parliament. Now, the shares are required to be purchased from a recognised stock exchange. The word acquired which figured in the original provision of the Budget-03 has been substituted with purchased to plug the possible misuse through the 'gift' route.
Moreover, this exemption will be restricted to only those shares figuring in the BSE-500 index as on March 1, 2003. If, during the course of the year, any of these shares is replaced with another stock in the index, investors who had purchased the share prior to its replacement will continue to enjoy the benefit.
The benefit is also extended to shares of companies making initial public offers during the year.
This new provision has been inserted to boost the share market by attracting fresh capital. If the benefit was extended to the shares, which are already in the custody of the investors, albeit indirectly through the path of the gift, the very intention and purpose of the legislation would stand defeated.
The simple action of replacing the word "acquired" with "purchased" has effectively nullified the gift route.
One fallout of the amendment is that bonus shares, even if issued by BSE-500 companies and even if issued during the specified period between March 1, 2003 and March 1, 2004, will not qualify for the exemption of long-term capital gains. Such shares are distributed by the companies free of cost and therefore, the investor cannot claim to have 'purchased' them.
Many experts feel that this is an unintentional fallout. I beg to disagree strongly. Denial the benefit to bonus shares is very much in line with the intentions. No fresh capital would be instilled in the market through the issue of bonus shares. Therefore, it would be wrong to extend the benefit to the bonus shares.
There was every possibility that unscrupulous companies might take undue advantage from this amendment. Restricting the benefit only to companies under the umbrella of BSE-500 is a stroke of a genius.
All said and done, some of the knotty issues that I pointed out earlier, have still remained unsolved:
- Some unscrupulous elements can take the path of IPOs, advertise aggressively, collect money and vanish. This is what happened during the Harshad Mehta era and much later during the Ketan Parekh era.
- Since the long-term gain is tax-free, the long-term loss arising out of such shares cannot be set off against any gains. This is scary. Is this the intention of the legislation?
- If gains on equity are tax-free, why not those on equity MFs? The MFs are after all pass through vehicles and for all practical purposes represent the collective investments of the investors. If any MF comes out with a scheme of investing only in BSE-500 shares will the benefits be extended to the investors in the scheme?
- The demat account and income tax follow the first-in-first-out method. Therefore, in case the investor has existing old shares (of the same scrip), it will not be possible for him to earn tax-free long-term gains. Whenever he sells the newly acquired shares, fastened to the old holdings as per the FIFO method. This defeats the very raison d'etre of the new law -- to boost investments in the stock market.
For investors, there are two ways of solving this difficulty. One is to open a special DP account for the new shares. The other is to exercise his own choice based on the contract notes of the brokers, as he used to do in the past before the advent of demat.
Thee is a considerable wastage involved in both the methods. In any case, the depositories maintain different records for different dates of purchases. It is easy to give the right to the account holder to give instructions to his DP to choose the serial number of the record representing the shares he desires to sell.
Granted, the bonus shares issued by BSE-500 companies are not eligible for the exemption of tax on long-term capital gains.
What about rights?
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