TIME TO SIMPLIFY HOLDING PERIODS FOR ASSETS
The manner of computation the exemptions available and the rate of taxation of capital gains depends upon whether the asset transferred is a long-term capital asset or a short-term capital asset. An asset is classified as long-term or short-term depending upon the period for which the capital asset was held by the taxpayer before the asset is transferred by him. Classification as a long-term capital asset could make a huge difference to the capital gains tax liability, resulting in substantially lower tax, which is why such basic determination of classification is so important.
Till 1998, this classification was very simple: if an asset was held for more than 3 years, it was a long-term capital asset; if it was held for 3 years or less, it was a short-term capital asset. In recent years, this classification has become far more complicated, with the holding period for such classification differing depending upon the type of asset. Even within a type of asset, different periods apply for different classes within a particular type.
For shares (equity as well as preference), the period of holding depends upon whether the shares are listed or not. For listed shares, the period is 1 year; for unlisted shares (whether of a private company or of a public company) the period of holding is 2 years.
The period for classification of units of mutual funds depends upon whether they are equity-oriented units or not. In the case of equity-oriented units, the period is 1 year; for other units of mutual funds, the period is 3 years.
For debt securities such as debentures or bonds or government securities, the factor of listing determines the required period of holding. Listed debt securities need to be held for more than 1 year to qualify as long-term assets; other debt securities need to be held for more than 3 years to so qualify. To that, there is again an exception—zero coupon bonds need to be held for only more than 1 year to qualify as long term, even if they are not listed.
For immovable properties which are in the nature of land or building, the required period of holding is 2 years. For other interests in properties, such as tenancy rights or a house or building under construction, the required period of holding to qualify would be 3 years. For all other assets, fortunately, the period is uniform at 3 years.
Determining whether an asset is a long-term capital asset or a short-term capital asset should have really been a simple exercise. With so many permutations and combinations, it is no wonder that taxpayers often need to consult a tax adviser to understand where exactly the asset fits in. Even tax advisers need to open their tax law books to check that the advice they are providing on the classification is correct.
The complications do not end here. Under certain circumstances, such as conversion of debentures into shares or inherited assets, determination of the period of holding involves an additional exercise. One has to ensure that the transaction of acquisition is covered by the provision, which lays down how the period of holding is to be computed under certain specified circumstances. For instance, there is no clarity (with differing decisions of different courts) about how to compute the period of holding of a house property, which was acquired when it was under construction—whether the period starts from the date of the letter of allotment, the date of signing of the agreement, the date of completion of construction or the date of possession.
This basic determination of classification as long term or short term is just one of the many complexities in computing capital gains tax liabilities. There are many more issues in computation of the gains, the computation of the exemptions and even determination of the applicable rate of tax. It is therefore no wonder that there is so much litigation on the subject of capital gains. One wonders whether this basic determination between long term and short term cannot be simplified, to make life easier for taxpayers. This is clearly one of those issues that are crying out for simplification.
In today’s fast paced times, there is perhaps a need to reduce the period in all cases where it is 3 years, to 2 years, as a period of 2 years would be fairly long enough. One can understand the need to have an incentive provision for assets such as listed equity shares and other securities, and equity oriented units of mutual funds, where the objective is to promote savings in equity instruments, and therefore the period of holding required would be less than the norm. There could, therefore, be just two periods prescribed for this purpose—a period of 1 year for such equity-related assets, and 2 years for all other assets.
Such a classification would be much simpler to understand, and would result in reduction of unnecessary litigation. Maybe the government will consider the difficulties faced by a large number of taxpayers who are affected, particularly individuals, and make the necessary changes in the next Budget.
Gautam Nayak is a chartered accountant.