The government gives away more than it wants to in the capital gains scheme
No doubt the Capital Gains Account Scheme (CGAS), 1988 is a well-conceived idea. But its implementation reveals loopholes that will be evident to anyone reading the fine print. A little finetuning could, however, plug these holes and make the scheme much more meaningful.
To understand these loopholes, let us first look at the details of the scheme. According to the Income Tax Act, assessees can claim relief on tax on long-term capital gains under Sections 54, 54B, 54D, 54F or 54G for different assets. The only condition is that the assessee should purchase another specified asset within a given time frame.
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Let us consider an assessee who has earned long-term capital gains of Rs 50 lakh by selling some bonus shares, which would have cost him nothing. The tax on this amount, at the rate of 20 per cent, works out to Rs 10 lakh. Under Section 54F, he need not pay this tax if he purchases within 2 years, or constructs within 3 years, a residence costing Rs 50 lakh. It is stipulated that he should not be the owner of another residential property if he is to make this investment. And reinvestment of a smaller amount would earn him proportionate exemption.
Prior to the introduction of this scheme in 1988, the assessee was required to pay tax in the financial year during which he made capital gains, even if he intended to buy or construct a house. In the event of his purchasing or constructing a house within the stipulated time frame, he could seek a refund, though there was no knowing when the refund would be paid. Having already paid a tax of Rs 10 lakh, he could not naturally purchase or construct a house for the amount of Rs 50 lakh. It proved cumbersome for the Income Tax Office (ITO) too, which had to dig up past records to check the validity of the claim.
CGAS was introduced with the explicit aim of avoiding such problems. The scheme is a special account that rests with banks or specified institutions.
Salient features
The amounts deposited in these accounts before the due or actual date for furnishing returns, for the financial year during which the capital gains have accrued, along with the amounts utilised for purchasing the new asset, will be deemed to be utilised for the purchase of the asset.
If the amount is not utilised within the specified period, the unutilised amount will be treated as capital gains for the year during which the period expires.
There are two types of accounts: Type-A which is a savings deposit and Type-B which is a term deposit. Type-B can be either cumulative or non-cumulative. They will invite the same interest rates as normal savings and term bank deposits.
The date for claiming exemption will be the date on which the bank receives the application. But interest will be payable from the date on which cash is paid or the cheque or draft is realised.
Amounts are freely transferable between Type-A and Type-B. For premature transfers from Type-B to Type-A, the normal penalties will be applicable. Withdrawals can be made only from Type-A. This requires filling up of Form-C, which contains a declaration that the withdrawn amount will be utilised for the intended purpose. Where the amount to be withdrawn exceeds Rs 25,000, the bank will make the payment through a crossed demand draft drawn in favour of the person to whom the depositor intends to make the payment. The amount withdrawn must be utilised within 60 days. The unutilised portion should be redeposited in CGAS.
While applying for any withdrawal other than the first, the assessee must furnish (Form-D) details regarding the utilisation of the amount. The account can be closed (Form-G) only with the approval of the ITO.
The lacunae
To understand the extent to which the authors were removed from reality, let us return to the assessee who has made capital gains to the tune of Rs 50 lakh.
(i) CGAS does not allow withdrawals, even of the interest accruing on the amount (Rs 5.5 lakh every year) except for the specified purposes. The assessee cannot use any part of the money for day-to-day expenses. Moreover, he has to pay tax on the interest on accrual basis! Surely it cannot be the intention of the legislation to lock-in the interest also.
(ii) If the sale is effected in April 1997, the assessee may deposit the amount in CGAS as late as June 30, 1998 (the last date for filing IT returns for the financial year 1997-98). So, the assessee has 15 months to use the money as he likes, including the amount that he would have had to pay as advance tax. In June 98, under CGAS, he buys what is really a 2-year fixed deposit. He can then sit tight on the money, neither constructing nor purchasing a house. Since he is not utilising the money as stipulated, it would be charged as income for the year before the three-year period expires. So he will be required to pay capital gains tax in the financial year 2000-01. The first date for payment of advance tax is September 30, 2000, by which time his fixed deposit would have matured.
Prior to the large-scale amendments brought about by FA92, the assessee was required to pay the tax and a penalty in the event of his defaulting. He lost the benefit of the initial deduction of Rs 15,000 under Section 48(2) and also the exemption of Rs 2 lakh under Section 53. But FA92 has deleted these provisions. This effectively means that the penalty on unused deposits also stands neutralised!
Moreover, since the unutilised amount is to be treated as the income of FY 2000-01, he can use the cost inflation index of that year instead of that for 1997-98. Could a person making capital gains ask for a better deal? There are experts who would disagree. Nevertheless, I stand by this assessment of the scheme.
(iii) FA96 introduced Sections 54EA and 54EB, which provide for exemption from tax on long-term capital gains if the entire sales proceeds are reinvested in specified avenues with a lock-in of 3 years under Section 54EA, or if the capital gains are reinvested with a lock-in of 7 years under Section 54EB. This investment must be made within 6 months from the date of transfer.
Now, suppose our assessee has earned long-term capital gains in March, 1997. He is supposed to file his returns by June the same year, by which time the period of 6 months is not over. Does this mean that the assessee can claim exemption merely by declaring an intention to make the stipulated investments within the given period?
(iv) There is yet another provision that needs some rethinking. Circular Number 743 dated May 6, 1996 states that in case an individual dies before the expiry of the stipulated period, the unutilised deposit amount cannot be taxed even in the hands of the legal heirs as the utilised portion of the deposit does not constitute their income as it is deemed only a part of the estate devolving upon them.
The new sections 54EA and EB do not have a parallel provision. A little more home work could have made all the difference to an otherwise perfectly commendable piece of legislation.