Grandfathering concept in capital gain calculations

New financial year - New assessment year - Time for filing tax returns

Are you ready to file income tax return before July 31st?

When we are filing our tax returns this year, we should understand and incorporate the new proposals while arriving at the capital gains of our equity-based investments. As per the recent budget, the capital gains are taxed differently. Major changes are in place.

Grandfathering in equity capital gains

What is the change?

Old law: All equity capital gains of more than a year are tax free

New law: Capital gains received before 31/01/18 are non-taxable as earlier but the capital gains received after 31/01/18 are taxable with an exemption of capital gain up to the first one lakh. This is applicable to all equity based investments. This concept of capital gain exemption till 31st Jan 18 is called Grandfathering in equity capital gain calculations. The term was coined in budget speech and is being widely used in media.

For seasoned investors, this may be easy to understand. For the remaining, it may be confusing. When we sit with pen and paper or in front of the computer to calculate the taxable capital gain portion, it is a herculean task for sure. Even if it is done by third party providers like charted accountants or online portals, to review capital gain calculations we need to very clearly understand the concept of Grandfathering in equity capital gain and convince ourselves that the calculations are correct, and the tax arrived is in order.

Applicability of Grandfathering in equity capital gain

Let us understand when and where Grandfathering in equity capital gain is applicable:

1.      Long term capital gains and not for short term capital gains - Securities holding period should be more than one year

2.      Equity based investments and not for debt-based investments

3.      Both investments

a.      Trading in stocks

b.      Equity based mutual fund investments

4.      Purchased before 31/01/18

5.      Sold after 31/01/18

Example: Securities bought on first March 2017 and sold on first May 2018. Here the total holding period is more than a year. The period between 01/03/17 and 31/01/18 is less than one year but applicable for grand fathering concept.

Calculation of Grandfathering in equity capital gain

Previously to arrive at capital gains we need the sales price (sp) and the buy price (bp). Only these two values and their corresponding dates. But in the case of grandfathering concept we need three values. The actual sales price (sp), the buy price (bp) and the market price of the same security on 31 Jan 18 (MP310118). These three prices and their corresponding dates are required. Keep in mind that it is not possible to arrive at the grandfathering concept of capital gains with only two values as in the old case.

Please refer the excel table / the provided template. Formulae and steps used to arrive the value

1)      First step is to collect the market price of our securities sold as on 31/01/2018. This is over and above usual buy and sell prices. Price of security on 31/01/2018 is referred as (MP310118.

2)      Out of all our sold transactions, we need to pick the transactions that are eligible for the grandfathering concept - use the following techniques

a.      Sdate (Sold Date) > 31/01/2018

b.      BDate (Bought Date) < 31/01/2018

c.      Sold security is equity-based product (eq or db)

3)      To arrive at the taxable capital gain, let us use the revised purchase (MPRevised) price. As per the formulae used here - compare BP, SP, MP310118

a.      SP > MP310118 > BP then MPRevised = MP310118 (Refer sno 2)

b.      MP310118 < BP and MP310118 < SP then MPRevised = BP (Refer sno 3)

c.      SP < MP310118 < BP then MPRevised = SP (Refer sno 5)

4)      Using the revised purchase price, the revised bought amount is calculated (BAmountR)

5)      Revised profit and loss amount (PnLR) are arrived using the revised purchase value

6)      We need to pay capital gain tax for this revised profit/loss after due indexation

Refer the table to understand this better. You can write to us through contact form to get the working template in excel with all formulae in place https://radhaconsultancy.blogspot.com/2016/10/email-me.html

Conclusion

When using third party service provider’s data, please check thoroughly if their working is correct. Everyone uses different methods to arrive at the value and at the end of the day the arrived value should be same for all - Please ensure this before filing returns.

Tips

Since mutual funds have undergone major scheme classifications in the past financial year, keep in mind that the merger of schemes and the change in units need not be considered for capital gain, unless otherwise you have intentionally made a switch or redemption. Be careful about this point and confirm that the arrived capital gains are correct in this regard also - for example money manager fund in idfc is merged into a new low duration scheme - this change should not reflect in your capital gain. Your money manager units are now zero and all the units are suitably moved into the merged scheme. If any third-party providers have worked in a different way, please get this clarified with them.

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