06 Feb 2018 17:13 IST

All you wanted to know about grandfathering of gains

This clause allows people who made their decisions under the old law to continue to enjoy a concession

The stock market’s manic behaviour after the budget session has been (rightly or wrongly) blamed on the FM’s proposal to levy a 10 per cent long-term capital gains tax on stocks and equity funds.

But if you’re a long-term investor, you may sleep easier after taking a deep dive into the grandfathering clause that accompanies this proposal.

What is it?

Tax laws keep shifting and changing with every budget. A grandfathering clause in any new tax law allows people who made their decisions under the old law to continue to enjoy a concession, until the original timeframe for it runs out.

In the latest budget, there’s a grandfathering clause attached to the new section 112A on long-term capital gains. It seeks to shield investors who have bought listed shares or equity mutual funds before February 1 2018, from the impact of the 10 per cent tax. Shorn of legalese, the section says that if a taxpayer has acquired listed shares or equity funds before February 1, all the long-term capital gains he has made on them will remain tax-free for all future years. In short, these past gains have been ‘grandfathered’ for the taxpayer. ‘Long-term’ here implies a holding period of one year.

The extent of gains (or losses) will be calculated based on two things: your cost of acquisition and the highest traded price for the stock (or closing Net Asset Value of the fund) as of January 31, 2018.

Why is it important?

Investors deciding where to put their money and businesses deciding on new projects, often base these decisions on existing tax structures. But if the Government changes its mind on tax at a later date, it could negate the basic premise for the decision.

Frequent changes to tax laws, can weaken public faith in the Government’s promises. This is indeed why there was such a furore over the retrospective tax amendments in the Vodafone case. Still, tax laws and rules do need to change with evolving circumstances.

Grandfathering provisions allow the Government to introduce changes to tax rules for the future, without reneging on its past promises.

In the case of the long-term capital gains tax on equity, the grandfathering clause is also a clever ruse to prevent investors from rushing to sell all their holdings before the effective date of April 1. With gains up to January 31 protected, only incremental profits will be taxed. Had there been no grandfathering, the recent correction may have turned out to be a full-blown meltdown.

Why should I care?

You may fret and fume about the taxman getting his hands on one of the last bastions of tax-free income left to you. But you must admit that the grandfathering clause softens the blow.

Suppose you bought a fund at a NAV of ₹150 two years ago, it shot up to ₹200 by January 31 and you finally sell it at ₹250 on April 30 this year. Your taxable gains without the grandfathering would have been ₹100 per unit. But with the grandfathering, you pay tax only on ₹50.

If the same fund sees its NAV tank to ₹90 on April 30, the clause ensures that you can book a capital loss of ₹60 per unit (₹150 minus ₹90) and set it off against future profits.

The only catch is that you will need records of prices and NAVs as of January 31 on all your equity holdings to avail of the tax break.

The bottomline

Who ever said taxes are fair? Be happy there’s an escape clause!

(The article first appeared in The Hindu BusinessLine.)