Why Indexation is Essential for Long-Term Capital Gains Tax
LTCG tax, long-term investment, capital gains, indexation benefit, investment in property, real estate, long term capital
Ltcg TaxLongterm InvestmentCapital GainsIndexation BenefitInvestment In PropertyReal EstateReal Estate NewsAug 20, 2024
However, it needs to be highlighted that indexation of long term capital gains is a must in all cases - past as well as future. Not only do proper valuation principles require indexation but it is also critically needed to promote social security and economic growth of the country.
LTCG should be taxed at a significantly lower rate than regular income. However, this is not sufficient. Indexation is also needed while calculating the gains on long-term capital investments.
Encourage investment: Taxing LTCG at a lower rate encourages individuals to invest in real estate, stocks, and bonds for the longer term. Long term investments are essential for economic development, growth, job creation, and supporting innovation.
Inflation Adjustment: Capital gain also includes an increase in the value of an asset due to changes in price levels. Infact, most of the gain may be in the form of preservation of purchasing power. Nominal gains on such investments must be inflation-adjusted to know the real gains.
Economic Stability: Lower tax on gains from long-term holdings would encourage one to stay invested over the years rather than doing frequent short-term trading. This incentivizes investors against speculation, resulting in more stable financial markets.
Long term Capital Gain Income Long-term investments have two essential features. First, blocking of capital for the long term. Therefore, long term financing using borrowed funds and opportunity cost of owned of capital become relevant.
Attracting Foreign Capital: A developing economy like India requires a humongous amount of capital for economic and social development and infrastructure, which can only be met by encouraging long-term foreign capital. Lower capital gain tax can attract more capital and increase international competitiveness.
Social security and retirement: Home ownership is a matter of social security and financial safety during retirement in countries like India. Individuals also need to save for their retirement.
Valuation Perspective Cost of Capital: India has higher cost of capital due to higher interest rates and higher inflation. As an emerging economy, risks are also higher. Investors expect higher return on equity, debt and thus over all a higher rate of return is expected.
Time Value of Money: The time value of money is an essential financial concept that holds that money in the present is worth more than the same sum of money to be received over a period in the future.
Conclusion: The amendment tabled in the finance bill is a welcome move as it will provide an option to choose between LTCG tax of 20% with indexation or 12.5% without indexation for property. However, removal of indexation benefit for properties bought after July 23, 2024 and other Long Term Assets classes must be revisited in the light of the factors discussed.
Frequently Asked Questions
What is the current tax rate on long-term capital gains?
The current tax rate on long-term capital gains is 12.5%.
What is indexation and why is it important for LTCG tax?
Indexation is the process of adjusting the cost of an asset for inflation to determine the real gain. It is important for LTCG tax as it helps to determine the real gain and not just the nominal gain.
Why is LTCG tax important for economic development?
LTCG tax is important for economic development as it encourages individuals to invest in long-term assets such as real estate, stocks, and bonds, which are essential for economic growth and job creation.
How does inflation affect LTCG tax?
Inflation affects LTCG tax as it increases the nominal gain of an asset, but not the real gain. Indexation helps to adjust the cost of the asset for inflation to determine the real gain.
What is the impact of removing indexation benefit for properties bought after July 23, 2024?
Removing indexation benefit for properties bought after July 23, 2024 will discourage individuals from investing in long-term assets and may lead to speculation and instability in the financial markets.
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