CBDT Circular about capital gains- suitable amendment is desirable A liberal circular about exemption from capital gains on extension of term of units in any Fixed Maturity Plans (FMPs) of mutual funds – binding on AO but seems to be beyond authority of CBDT- amendment in Income-tax Act or Income-tax Rules is desirable

[CA DEV KUMAR KOTHARI]

REFERENCES AND LINKS:

Relevant provisions: Section 2(42A), 45, 47, 295 of Income-tax Act, 1961.

Circular No. 6 of 2015   F. No. 133/39/2014-TPL  Dated 9^th April, 2015

The circular dated 9^th April, 2015 is reproduced below with highlights added for easy analysis:

Circular - Income Tax

Circular No. 6 of 2015

F. No. 133/39/2014-TPL

Government of India

Ministry of Finance

Department of Revenue

Central Board of Direct Taxes

(TPL Division)

Dated 9^th April, 2015

Subject: Capital gains in respect of units of Mutual Funds under the Fixed Maturity Plans on extension of their term

As per the provisions of the Income-tax Act, 1961 (hereinafter referred to as the Act) prior to the amendment made by the Finance (No.2) Act, 2014, assets in the nature of shares, listed securities, units of mutual funds and zero coupon bonds qualified as long term capital assets if held for a period of more than twelve months as against the holding period of more than thirty-six months in case of other assets. Accordingly, units of a mutual fund under the Fixed Maturity Plans (FMPs) held for a period of more than twelve months qualified as long term capital asset. The amendment in sub-section (42A) of section 2 of the Act by the Finance (No.2) Act, 2014 changed the period of holding in case of unlisted shares and units of a mutual fund (other than an equity oriented fund) for their qualification as long term capital asset to more than thirty-six months. As a result, gains arising out of any investment in the units of FMPs made earlier and sold/redeemed after 10.07.2014 would be taxed as short-term capital gains if the unit was held for a period of thirty-six months or less.

2.  FMPs are closed ended funds having a fixed maturity date wherein the duration of investment is decided upfront. The funds collected by FMPs are invested by the Asset Management Companies (AMCs) in securities having similar maturity period. To enable the FMPs to qualify as a long-term capital asset, some AMCs administering mutual funds have offered extension of the duration of the FMPs to a date beyond thirty-six months from the date of the original investment by providing to the investor an option of roll-over of FMPs in accordance with the provisions of Regulation 33(4) of the SEBI (Mutual Funds) Regulations, 1996. In this regard representations have been received in the Board seeking clarification regarding applicability of tax on capital gains in the hands of the unit holder at the time of roll over of FMPs that are closed ended schemes.

3. In this matter the Securities and Exchange Board of India (SEBI) has informed that Regulation 33(4) of the SEBI (Mutual Funds) Regulations, 1996 allows the rollover of close-ended schemes. Such regulation provides the following:-

"(4) A close ended scheme shall be fully redeemed at the end of the maturity period:  Provided that a close-ended scheme may be allowed to be rolled over if the purpose,  period and other terms of the roll over and all other material details of the scheme  including the likely composition of assets immediately before the roll over, the net assets and net asset value of the scheme, are disclosed to the unitholders and a copy of the same has been filed with the Board:

Provided further that such roll over will be permitted only in the case of those unitholders who express their consent in writing and the unitholders who do not opt for the roll over or have not given Written consent shall be allowed to redeem their holdings in full at net asset value based price."

SEBI has clarified that in case of roll over in accordance with the aforesaid regulation the scheme remains the same and it does not constitute a different scheme.

4.  In the case of mutual funds, the unit of a mutual fund constitutes a capital asset and any sale, exchange or relinquishment of such unit is a 'transfer' under clause (47) of section 2 of the Act. The roll over in accordance with the aforesaid regulation will not amount to transfer as the scheme remains the same. Accordingly, it is hereby clarified that no capital gains will arise at the time of exercise of the option by the investor to continue in the same scheme. The capital gains will, however, arise at the time of redemption of the units or opting out of the scheme, as the case may be.

(Gaurav Kanaujia)

Director to the Government of India

On reading  of the circular the following factual points, as may prevail in any given situation leading to extension or roll over of specified type of units of certain mutual funds are clear:

1. That unit is a capital asset,
2. That unit is liable to be redeemed as per terms and conditions agreed at the time of issue,
3. That on scheduled date of redemption the unit will be a short-term capital asset,
4. That if unit is redeemed on scheduled date, there will be short term capital gains.
5. That if the tenure or term is extended by mutual fund in any manner say by issue of new units under the same scheme or by rollover of the old units into new units though under the same and / or similar scheme
6. That as per meaning of transfer such rollover involves two transactions,- the old units are transferred (by way of exchange/ surrender / relinquishment etc.) and new units are issued.
7. That there will be change in rights of unit holders
8. That written consent of unit holder is a must

Therefore, at the time of roll over of units or extension of tenure, there is not only change in terms and conditions  but in fact a new contract is entered into whereby unit holder, instead of taking payment of units, either accept new units or accept extension of tenure of units. Therefore, there is a  transaction involving transfer of old units and acquisition of new units.

The circular is beneficial:

The circular is beneficial to interest of unitholder /  taxpayer therefore it is binding on tax authorities.

Whether circular is within powers to issue such circular:

We find that in similar circumstances, there are provisions in income-tax Act, whereby certain transfer are not deemed to be transfer for the purpose of capital gains (vide section 47).

We also find that as per provisions contained  in  Section 2(42A) certain period of holding of old capital  asset (from which new asset is derived or linked) asset are included, in holding period of new asset. For other capital assets, the period of holding will be determined subject to Rules framed by the Board in this regard. As per reading by author, we also find that there is no Rule framed so far by the Board in terms of S. 2(42A) (ii).

On reading of Section 295 also we do not find any specific power granted to the Board to allow exemption from capital gains as has been allowed vide the  circular discussed in this article.

It is advisable to amend Income-tax Act or at least frame Rules:

As there is no specific power to exempt a transaction involving transfer of capital gains, from taxation under head capital gains, the best course will be to amend section 47 to include specific clause exempting transfer in case of roll over or extension of unit. Alternatively, as required u/s 2(42A) (ii) suitable Rule may be notified in this regard to avoid any controversy.