What Is 'Grandfather' Clause? How It Helps Lower Tax Burden On Mutual Fund Gains

As the new financial year has kicked off, the income tax (I-T) department's new rules, announced by Union Finance Minister Arun Jaitley on February 1 at the time of announcement of Budget, have come into force. One of the major put-offs for regular stock market investors turned out to be the re-introduction of long term capital gains (LTCG) on the equity investments and equity mutual funds after a gap of 14 years. Though the rate at which the capital gain will be taxed is 10% on equity and mutual funds, and no indexation benefit is allowed, but the only solace offered to the tax payers is that the capital gains accrued prior to January 31 on mutual funds/ equity will be grandfathered. Going by the literal meaning of the 'grandfather' clause, it is the continuation of existing rules in some situations and exemption that allows persons to continue with activities that were approved before the implementation of new rules, or laws.

For the tax on LTCG to get liable, there must be a difference of at least Rs 1,00,000 between the cost of acquisition and the amount of sale.

Also Read: Seven Income Tax Rules That Will Come Into Effect From Today

'Grandfather' Clause: Five Things To Know

1. The grandfathered concept implies that all the gains on mutual funds/ equity until January 31 will be exempt from taxation. This only means that the income tax will not be implied with retrospective effect, but with prospective effect.

2. The income, accruing on the long term capital gains (LTCG) on listed equities/mutual funds has been grandfathered for the residents, and for the non-resident assesses. The grandfathering clause exemption will also cover foreign institutional investors (FIIs), as clarified by the income tax (I-T) department a day after the announcement of Budget 2018-19 by the Union Minister Arun Jaitley.

3. Any gains prior to January 31 are grandfathered. This means the capital gains will be zero if the sale price of equity/ mutual funds is more than the cost of acquisition but less than the value on January 31.

4. The tax payer will stand to gain when the shares market price on January 31 was lower against the acquisition cost. Since the higher of two values is chosen (between the cost of acquisition and the price on January 31), the investor stands to gain.

Also Read: LTCG Grandfathered For Residents As Well As Non Residents. 5 Things To Know

5. When the sale price of equity or mutual funds is lower than the acquisition cost as well as from its price on January 31, then instead of the higher, one must take into consideration the lower of the two values for calculating the LTCG. For example: An equity share is bought on January 1, 2017 for Rs 100, its fair market value is Rs 200 on January 31, 2018 and sold on April 1, 2018 for Rs. 50. In this case, the actual cost of acquisition is less than the fair market value as on 31st January, 2018. The sale value is less than the fair market value as on 31st of January, 2018 and also the actual cost of acquisition. Therefore, the actual cost of Rs. 100 will be taken as the cost of acquisition in this case. Hence, the long-term capital loss will be calculated at Rs 50 (Rs. 50 - Rs. 100).