How New LTCG Rules in Unlisted Shares from 20% with Indexation to 12.5% without Indexation Is Bad for NRIs vs. Residents in Budget 2024

The recent amendment in long-term capital gains (LTCG) tax rules, effective from July 23, 2024, has introduced a flat tax rate of 12.5% on unlisted shares for both NRIs and resident Indians. This change eliminates the previous LTCG of a 20% tax rate with indexation for Resident and 10% without indexation for NRIs. While this adjustment simplifies the tax structure, it disproportionately impacts NRIs compared to residents due to the removal of indexation and the foreign currency adjustment that was initially proposed but never implemented. Key Factors Impacting NRI and Resident Returns Currency Fluctuations: NRIs are exposed to currency risk, as their returns depend on the exchange rate between their home currency (e.g., USD) and INR at the time of purchase and sale. Currency depreciation can reduce their gains significantly when converting proceeds back to their home currency. Impact of Indexation: Residents: Previously benefited from indexation, which adjusted the purchase price for inflation, reducing taxable gains. With the new 12.5% rate, this benefit is lost, but the lower tax rate can still result in higher post-tax returns. NRIs: Never had indexation benefits but now face a higher tax rate without the proposed foreign currency adjustment, leading to potentially lower net returns. Example: Comparing NRI and Resident Returns Scenario Details: NRI Investor: Purchased 1,000 shares of CSK at INR 50 each in 2020. Selling Price: INR 150 per share in 2024. Exchange Rate in 2020: 1 USD = INR 70. Exchange Rate in 2024: 1 USD = INR 80. Table 1: NRI Capital Gains Comparison (Before and After July 23, 2024) Particulars Before July 23, 2024 After July 23, 2024 Purchase Price (INR) 50,000 50,000 Selling Price (INR) 150,000 150,000 Capital Gains (INR) 100,000 100,000 Foreign Currency Adjustment No No Capital Gains in USD 1,428.57 (100,000/70) 1,250 (100,000/80) Taxable Gains in INR 100,000 100,000 LTCG Tax Rate 10% 12.5% Tax Payable (INR) 10,000 12,500 Net Gains After Tax (INR) 90,000 87,500 Net Gains After Tax (USD) 1,285.71 (90,000/70) 1,093.75 (87,500/80) Table 2: Resident Indian Capital Gains Comparison (Before and After July 23, 2024) Particulars Before July 23, 2024 After July 23, 2024 Purchase Price (INR) 50,000 50,000 Selling Price (INR) 150,000 150,000 Capital Gains (INR) 100,000 100,000 Indexation Benefit Yes No Indexed Cost (Assumed Indexing) 60,000 NA Taxable Gains (INR) 90,000 100,000 LTCG Tax Rate 20% 12.5% Tax Payable (INR) 18,000 12,500 Net Gains After Tax (INR) 82,000 87,500 Analysis NRIs: The transition to a 12.5% tax rate without any foreign currency adjustment means that NRIs may face reduced returns, particularly in scenarios where the INR has depreciated against the USD. The lack of a currency adjustment mechanism further exacerbates this issue. Resident Indians: While they lose the benefit of indexation, the reduced tax rate of 12.5% can, in some cases, lead to higher post-tax returns, making the change more favorable compared to NRIs who are still dealing with currency risk without any mitigating benefits. In conclusion, the new LTCG rules are less advantageous for NRIs due to the combined effect of higher tax rates and currency risk, whereas resident Indians might benefit from the simpler, lower tax structure.