Here is how to calculate indexation benefits for gifted assets sold later

Capital gains will be calculated from the original owner's purchase date

Calculation of indexation benefit for assets that are gifted and sold later has long been a contentious issue between the income-tax department and taxpayers. Sample this: A person sells a house that his father gifted him in 2010. But the property was purchased in 2001. Now, when calculating indexation benefit, should the son consider the date when he received the property as a gift or the date when his father purchased it?

Mumbai’s Income Tax Appellate Tribunal (ITAT) recently ruled that taxpayers should be allowed to calculate indexation benefit from the date the original owners purchased the asset. “As there is no clarity in the law on the period of holding to calculate indexation, it has remained contentious. But most tribunals have ruled in favour of taxpayers,” said Naveen Wadhwa, a chartered accountant with Taxmann.com.

Indexation is the process that takes into account inflation from the time a person purchases the asset to the time he sells it. The way it works is that it allows the asset owner to inflate the purchase price of the asset to take into account the impact of inflation. The result is that the taxpayer’s tax liability is reduced.

To calculate capital gains tax, four things are needed – sale consideration, cost of acquisition, the period of holding and cost inflation index (CII). The law states that if gifted assets are sold, the cost of acquisition will be the price that the original owner paid. But it does not mention what should be the period of holding, which can significantly impact the total tax outgo.

In the above example, let’s say the cost of the house was Rs 1.5 million in 2001. The son, who received it as a gift in 2010, sold it for Rs 10 million in the current financial year. If the indexation benefit is calculated from 2001, the long-term capital gains (LTCG) tax post indexation benefit comes out to be around Rs 1.16 million. Here, the period of holding is a little over 17 years. If the indexation benefit is calculated from 2010 (holding period of little over eight years), the LTCG tax outgo will be Rs1.5 million, or an increased outgo of Rs 340,000.

In a recent case, a taxpayer sold a property in Mumbai and offered Rs 140 million as LTCG tax calculating the indexation benefit from the date the original owner acquired the property. But the assessing officer disputed the holding period and said that the tax liability should be Rs 159.80 million. The Commissioner of Income Tax (appeals) ruled in favour of the assessee. Not satisfied with the order, the assessing officer appealed before the ITAT, which again gave an order favouring the assessee.

The ruling also protects the taxpayers from short-term capital gains (STCG) tax, in case he sells the assets soon after receiving it as a gift. For immovable assets like property, STCG applies if the asset is sold within two years of acquisition. For movable capital assets such as gold and jewellery, STCG is applicable if sold within three years from the date of purchase.

CASE STUDY

• A taxpayer sells property gifted to her

• When calculating indexation, she considers the date from which the previous owner held the asset

• Assessing officer (AO) disputes the method

• AO calculates it from the date the asset was gifted to her

• Lowering the holding period increases the tax liability

• Income tax tribunal rules in favour of the taxpayer