Income Tax Grandfathering Rules and Scenerios

Income Tax Grandfathering Rules and Scenarios

Grandfathering is a term used to describe the protection of existing rights, privileges, or conditions from new rules or laws that may otherwise have an impact on them. In the context of income tax, grandfathering refers to a provision that allows individuals to continue to enjoy certain tax benefits or exemptions that were available to them before changes were made to the tax laws.

One such instance of grandfathering in the Income Tax Act, 1961, is the provision of grandfathering of gains on listed equity shares and equity-oriented mutual funds. This provision was introduced in the Union Budget 2018 and was aimed at providing relief to investors who would have otherwise faced a tax liability due to changes in the taxation of long-term capital gains on listed equity shares and equity-oriented mutual funds.

Before the Union Budget 2018, long-term capital gains (LTCG) on listed equity shares and equity-oriented mutual funds were exempt from tax. However, in the budget, the government introduced a tax of 10% on LTCG exceeding Rs. 1 lakh from the sale of listed equity shares and equity-oriented mutual funds held for more than one year. This change was made effective from 1st April 2018.

To provide relief to investors who had invested in these assets before 31st January 2018 and were holding them on 31st January 2018, the government introduced the grandfathering provision. Under this provision, the cost of acquisition of the asset for the purpose of calculating LTCG would be higher of the actual cost of acquisition or the fair market value (FMV) of the asset as on 31st January 2018.

For example, 

if an investor purchased shares of XYZ Ltd. for Rs. 500 per share in 2016 and sold them for Rs. 800 per share in 2021, the LTCG would be Rs. 300 per share. However, as per the grandfathering provision, the cost of acquisition for the purpose of calculating LTCG would be higher of the actual cost of acquisition (Rs. 500 per share) or the FMV of the share as on 31st January 2018 (let's assume Rs. 700 per share). In this case, the cost of acquisition would be Rs. 700 per share, and the LTCG would be Rs. 100 per share (Rs. 800 - Rs. 700).

The grandfathering provision for LTCG on listed equity shares and equity-oriented mutual funds has provided relief to investors who would have otherwise faced a significant tax liability due to the changes in the taxation of LTCG. However, it's important to note that this provision is only applicable to gains made before 31st January 2018, and any gains made after that will be subject to the new tax regime.

In conclusion, grandfathering is a provision in income tax laws that allows individuals to continue to enjoy certain tax benefits or exemptions that were available to them before changes were made to the tax laws. The provision of grandfathering of gains on listed equity shares and equity-oriented mutual funds has provided relief to investors and has been a significant development in the taxation of LTCG in India. However, investors should seek professional advice and guidance to understand the tax implications of their investment decisions and optimize their tax planning strategies.

Apart from the grandfathering provision for LTCG on listed equity shares and equity-oriented mutual funds, there are other instances where grandfathering has been provided in the Income Tax Act, 1961. Some of these instances are:

Dividend distribution tax (DDT) abolition: In the Union Budget 2020, the government abolished DDT and introduced a new tax regime where dividend income would be taxed in the hands of the recipient. To provide relief to investors who had invested in companies that were paying DDT before 1st April 2020, the government introduced the grandfathering provision. Under this provision, the tax paid by the company on dividends declared before 1st April 2020 would be allowed as a deduction while calculating the dividend income of the investor.

Reduction in corporate tax rate: In the Union Budget 2019, the government reduced the corporate tax rate to 22% (from 30%) for domestic companies that do not avail of any exemptions or incentives. To provide relief to companies that were already availing exemptions or incentives before 1st October 2019, the government introduced the grandfathering provision. Under this provision, such companies could continue to avail of the existing exemptions or incentives for the remaining period of their validity, and after that, they would be taxed at the new reduced rate.

Grandfathering provisions in income tax laws are important as they provide relief to individuals and companies who may otherwise face a significant tax liability due to changes in the tax laws. However, it's important to note that the provisions are time-bound and applicable only for a specified period. Therefore, investors and companies should stay updated with the latest tax laws and regulations and seek professional advice to optimize their tax planning strategies.