Grandfathering rule for LTCG on listed equity

The grandfathering rule for long-term capital gains (LTCG) is the transitional tax provision in the Indian Income Tax Act, 1961, that protects equity investors from being taxed on gains that accrued before 1 February 2018, the date on which Section 112A reintroduced LTCG on listed equity after a 14-year exemption. Under the rule, the cost of acquisition for computing LTCG on listed equity shares and equity-oriented mutual fund units acquired on or before 31 January 2018 is deemed to be the higher of the actual purchase price and the fair market value (FMV) on 31 January 2018, subject to a cap that the deemed cost cannot exceed the actual sale price. The mechanism has the effect of treating all pre-1-February-2018 appreciation as outside the taxable base, while gains that accrue after that date are taxed under Section 112A.

The grandfathering provision is anchored in Section 55(2)(ac) of the Income Tax Act, 1961, inserted by the Finance Act, 2018. The provision sits inside the broader Section 112A regime for LTCG on listed equity and equity-oriented mutual funds and applies whenever the asset was acquired on or before 31 January 2018 and is now being sold under the post-1-April-2018 regime. The Finance (No. 2) Act, 2024, raised the Section 112A rate from 10 per cent to 12.5 per cent effective 23 July 2024 and increased the LTCG exemption threshold from Rs 1 lakh to Rs 1.25 lakh per year, but left the grandfathering mechanism itself unchanged. The grandfathering rule therefore continues to apply for all sales of pre-2018-acquired listed equity and equity-oriented mutual funds, with the post-2024 rates applied to the residual taxable gain.

The rule originated as a political compromise. The 2018 Budget proposal to reintroduce LTCG on listed equity was politically contentious because investors had, since 2004, planned long-term holdings on the basis of the Section 10(38) exemption introduced alongside the Securities Transaction Tax (STT). Reimposing tax on gains that had accumulated over 14 years in the expectation of permanent exemption was viewed as a breach of legislative expectation. The grandfathering provision was the Finance Minister’s mechanism for addressing this concern, drawing on the well-established legislative practice of substituting the fair-market-value at the regime-change date as a deemed cost. The mechanism effectively wiped out all pre-1-February-2018 appreciation from the taxable base while preserving the prospective taxation of post-1-February-2018 gains.

Legislative history

Pre-2004 regime

For most of the period from 1961 to 2004, LTCG on listed equity was taxable at the slab rate or at concessional rates that varied across decades. The 1999 Kelkar Committee on direct tax reform had recommended a flat concessional rate; this was partially adopted through 2003 to 2004 amendments. The detailed pre-2004 regime is historically interesting but rarely relevant to current practice.

2004: Section 10(38) and STT introduction

The Finance (No. 2) Act, 2004, made a structural policy choice to replace the LTCG tax on listed equity with a transaction-level Securities Transaction Tax. Section 10(38) was inserted to exempt LTCG on listed equity shares and equity-oriented mutual funds, provided STT had been paid on both the acquisition and the sale. The trade-off was a small, broad-based STT (initially 0.075 per cent on equity delivery) in exchange for a complete exemption on LTCG. The 2004 regime stood for 14 years and produced the structural framework of the modern Indian equity market.

2018: LTCG reintroduction

The Finance Act, 2018, presented on 1 February 2018, withdrew Section 10(38) and inserted Section 112A, imposing LTCG at 10 per cent on listed equity and equity-oriented mutual fund gains exceeding Rs 1 lakh in a financial year, effective 1 April 2018. The withdrawal was justified by the Finance Minister on the basis of revenue and parity arguments: the LTCG exemption had produced significant revenue foregone (estimated at Rs 3,67,000 crore in cumulative LTCG over 2004 to 2017) and had created inequality in the tax treatment of different investor classes.

Section 55(2)(ac): the grandfathering mechanism

To avoid retrospective taxation of accrued pre-2018 gains, Section 55(2)(ac) was simultaneously inserted by the same Finance Act, 2018. The provision substitutes the fair market value on 31 January 2018 as a deemed cost of acquisition where this exceeds the actual cost, with a cap that the deemed cost cannot exceed the actual sale consideration. The mechanism is a standard regime-change FMV substitution, comparable in form to the Section 55(2)(b) provision for the optional substitution of the 1 April 2001 FMV for assets acquired before that date.

2024: rate and threshold update

The Finance (No. 2) Act, 2024, effective 23 July 2024, made two changes that affect the grandfathering computation:

• The Section 112A rate was raised from 10 per cent to 12.5 per cent.
• The LTCG exemption threshold was raised from Rs 1 lakh to Rs 1.25 lakh per year.

The grandfathering mechanism itself was not amended; the 31 January 2018 FMV substitution and the cap continue to apply as before. The effect is that pre-2018 acquired equity sold on or after 23 July 2024 is taxed at the higher rate above the higher threshold, on the gain computed using the deemed cost.

Computation method

For listed equity shares and equity-oriented mutual fund units acquired on or before 31 January 2018, the deemed cost of acquisition is determined under Section 55(2)(ac) as follows:

Step 1: Identify the actual cost of acquisition

The price actually paid by the investor, including brokerage and other transaction costs. STT is excluded (STT is not part of the cost base; it is treated separately under the equity tax framework).

Step 2: Identify the fair market value on 31 January 2018

For listed equity shares, the FMV is the highest price of the share on a recognised stock exchange on 31 January 2018. Where the share was not traded on that date, the FMV is the highest price on the last preceding date on which the share was traded.

For units of equity-oriented mutual funds, the FMV is the net asset value (NAV) published by the AMC for the relevant scheme and plan as on 31 January 2018.

Step 3: Apply the FMV cap (sale price as ceiling)

The deemed cost cannot exceed the actual sale consideration. This cap ensures that the grandfathering provision can never produce a deemed capital loss out of pre-2018 appreciation that has subsequently reversed.

Step 4: Compute the deemed cost

The deemed cost is the higher of (Step 1) and (Step 2), subject to the cap from (Step 3). In practical terms:

Deemed cost = min(max(actual cost, FMV on 31 January 2018), sale price)

Step 5: Compute the gain

Taxable LTCG = Sale consideration minus Deemed cost of acquisition

Aggregated across all equity and equity-MF LTCG in the financial year, the result is reduced by the Rs 1.25 lakh exemption threshold (Rs 1 lakh for sales before 23 July 2024). The net taxable amount is taxed at 12.5 per cent (10 per cent for sales before 23 July 2024).

Worked examples

Example 1: Gain situation, post-2024 rates

An investor purchased 500 shares of Company A in March 2015 at Rs 120 per share, a total cost of Rs 60,000. On 31 January 2018 the share’s highest traded price was Rs 350. The investor sells all 500 shares in September 2024 at Rs 600 per share, receiving Rs 3,00,000.

The entire gain falls within the exempt threshold and no tax is payable.

Example 2: Larger gain

Same investor, same actual cost, same 31 January 2018 FMV, but the sale price is Rs 900 per share.

The pre-1-February-2018 appreciation of Rs 1,15,000 (Rs 1,75,000 minus Rs 60,000) is entirely outside the taxable base. Only the post-31-January-2018 appreciation of Rs 2,75,000 is taxed.

Example 3: FMV cap activated

The same investor purchased shares in January 2018 at Rs 320 per share. The 31 January 2018 FMV was Rs 350. The investor subsequently sold the shares in 2024 at Rs 280 per share due to a market decline.

The cap prevents a deemed loss from being created where the sale price has fallen below the 31 January 2018 FMV. The actual economic loss of Rs 20,000 (Rs 1,40,000 minus Rs 1,60,000) is preserved as a capital loss against the actual cost basis, eligible for set-off and carry-forward under the general LTCG loss rules.

Example 4: FMV lower than actual cost (no grandfathering uplift)

An investor purchased shares in January 2018 at Rs 500 per share. Due to a temporary market decline, the FMV on 31 January 2018 was Rs 480. The actual cost (Rs 500) exceeds the FMV (Rs 480), so the deemed cost equals the actual cost of Rs 500. The grandfathering provision provides no uplift in this scenario; the actual cost continues to be the cost basis.

FMV determination methodology

Listed equity shares

The FMV is the highest price of the share on a recognised stock exchange on 31 January 2018. If the share traded on both NSE and BSE on that date, the higher of the two highest prices is used. If the share did not trade on 31 January 2018 (which can happen for illiquid scrips), the highest price on the last preceding date on which the share was traded is used. For shares listed on or after 1 February 2018 but acquired before that date through an off-market route, special rules apply that are addressed in CBDT Circular No. 2 of 2018.

Equity-oriented mutual fund units

The FMV is the net asset value of the relevant scheme and plan on 31 January 2018. The AMCs publish the historical NAV for that date on their websites and have filed the data with AMFI for the industry record. Investors retrieving the FMV should match the scheme name, the plan (Direct or Regular), and the option (Growth or IDCW). The IDCW option NAV reflects the cumulative distribution history and is typically lower than the corresponding Growth option NAV.

Stock exchanges and AMFI sources

The principal sources for retrieving the 31 January 2018 reference values are:

• National Stock Exchange (NSE) historical data portal for listed equity prices.
• Bombay Stock Exchange (BSE) historical data portal for listed equity prices (where the share’s principal exchange is BSE).
• AMC websites and the AMFI NAV history portal for equity-mutual-fund NAVs.
• Capital gains statements generated by CAMS and KFin Technologies for mutual fund holdings; these pre-populate the 31 January 2018 NAV.

Applicability conditions

The grandfathering provision under Section 55(2)(ac) applies only where all the following conditions are met:

1. Eligible asset class

The asset must be either a listed equity share on a recognised stock exchange or a unit of an equity-oriented fund. An equity-oriented fund is defined under Section 112A and the SEBI categorisation framework as a fund investing at least 65 per cent of its corpus in equity shares of domestic companies. Debt mutual funds, gold ETFs, REITs, InvITs, bonds, and unlisted shares are not covered by Section 112A and therefore not eligible for grandfathering.

2. STT paid on acquisition

Securities Transaction Tax must have been paid on the purchase. For shares acquired through an IPO allotment, ESOP exercise, scheme of amalgamation, gift, or other off-market route, the STT-on-acquisition requirement is generally relaxed by CBDT Notification No. 60 of 2018 and subsequent notifications, which specify the eligible exceptions.

3. STT paid on sale

STT must be paid on the sale transaction. This is automatic for sales through a recognised stock exchange; off-market sales generally do not qualify for Section 112A treatment.

4. Holding period

The asset must be held for more than 12 months to qualify as a long-term capital asset under Section 2(42A) read with Section 112A.

5. Acquisition date

The asset must have been acquired on or before 31 January 2018. Assets acquired on or after 1 February 2018 use their actual purchase price as the cost of acquisition, with no FMV substitution.

Reporting in the income tax return

Grandfathered transactions are reported in Schedule 112A of ITR-2 or ITR-3 (where applicable). Schedule 112A requires scrip-wise disclosure for each transaction:

The income tax e-filing portal’s pre-filled return data and the broker-generated and AMC-generated capital gains statements (CAMS-KFin capital gains statement , Zerodha ITR capital gains statement , how to download capital gains statement on Zerodha ) populate Schedule 112A automatically, with the 31 January 2018 FMV pre-filled. The investor must verify the FMV against the exchange records or the AMC’s published NAV for accuracy.

Common errors

The most frequent grandfathering computation errors are:

• Using actual cost instead of the higher of actual cost and FMV: The most common error; produces over-statement of taxable gain and consequent over-payment of tax.
• Missing the FMV cap: Continuing to substitute the FMV even when the sale price is below the FMV, producing an artificial loss that may be disallowed in scrutiny.
• Wrong FMV source: Using the close price instead of the high price for listed equity, or using the IDCW NAV when the holding is in the Growth option.
• STT verification gaps: Failing to confirm that STT was paid on acquisition; certain pre-2004 acquired listed equity may not have STT and would not qualify.
• Mixing grandfathered and post-2018 lots: Where the investor accumulated the same scrip over multiple dates, the FIFO method requires separate computation for pre-1-February-2018 lots (with grandfathering) and post-1-February-2018 lots (without).
• Off-market transfer treatment: Shares acquired through gift or inheritance from a pre-2018 holder retain the original holder’s cost basis under Section 49(1) but may have a different FMV reference date depending on the transfer details.

The CBDT FAQs on Section 112A (released February to April 2018) and subsequent CBDT circulars address most of the marginal cases.

Interaction with the 2024 reform

The Finance (No. 2) Act, 2024, raised the Section 112A rate to 12.5 per cent and the LTCG exemption threshold to Rs 1.25 lakh, effective 23 July 2024. The grandfathering mechanism is unchanged; the post-2024 rates apply to the residual taxable gain after the FMV substitution.

For sales straddling the 23 July 2024 date, the rate applicable is determined by the date of the sale transaction, not by the date of the underlying acquisition. Investors who pre-planned LTCG realisation in 2024 to 2025 should accordingly compute their tax liability at 12.5 per cent for any post-23-July-2024 sales.

Policy debates and litigation

Equity of the regime change

The 2018 reintroduction of LTCG on listed equity, despite the grandfathering provision, was politically contentious. Industry commentary at the time argued that the cap on the deemed cost (sale-price ceiling) was an unnecessary erosion of the regime-change protection, since it converted some pre-2018 paper appreciation into a non-recognisable cost. The counter-argument from CBDT was that the cap was necessary to prevent the artificial creation of capital losses out of pre-2018 paper gains that had subsequently reversed.

Off-market acquisition

A persistent area of dispute has been the treatment of off-market acquisitions, particularly ESOPs exercised before 2018 and inherited shares from pre-2018 holders. CBDT Notification No. 60 of 2018 attempted to address the principal categories, but residual ambiguity has produced periodic litigation, particularly around the treatment of shares allotted under bonus issue, rights issue, or scheme of amalgamation made before 31 January 2018.

Listed status and exchange suspension

Where a share was listed on 31 January 2018 but has subsequently been delisted, the FMV reference is preserved at the 31 January 2018 value, but the Section 112A regime may not apply to the subsequent sale (since the sale would typically be off-market and STT would not be paid). The interaction between Section 112A applicability and the grandfathering reference is one of the more technical points that arises in scrutiny.

Tax-listing-day gains

The treatment of listing-day gains for shares allotted in pre-2018 IPOs and sold post-2018 follows a related but distinct computation that takes the IPO allotment price as the actual cost.

International comparison

The Indian grandfathering provision is a standard regime-change protection mechanism, comparable in form to the United States “stepped-up basis” rule for inherited assets and the United Kingdom’s 31 March 1982 rebasing provision for capital gains. The Indian mechanism is distinctive in three respects:

1. The substitution is at the regime-change date (31 January 2018), not at the asset transfer date, comparable to the United Kingdom 1982 rebasing.
2. The cap (sale price as ceiling) is somewhat unusual; most peer regimes either allow free FMV substitution or use the lower of FMV and a derived value.
3. The grandfathering applies prospectively to all sales from 1 April 2018 onwards with no sunset, which is unusual; most peer regime-change protections have time limits or phase out.

Recent developments

CBDT FAQ updates

The CBDT has issued periodic FAQ updates on Section 112A and the grandfathering rule, most recently in November 2024 following the Finance (No. 2) Act, 2024. The FAQs address the rate transition, the threshold update, and the continuation of the grandfathering mechanism in unchanged form.

Pre-filled return improvements

The income tax e-filing portal’s pre-filled return data now substantially auto-populates Schedule 112A for sales transacted through SEBI-registered brokers and mutual fund RTAs. The 2024 to 2025 enhancements have extended this to include capital gains statements from CAMS and KFin with the 31 January 2018 NAV pre-filled.

Annual Information Statement integration

The Annual Information Statement (AIS) framework now includes capital gains data that incorporates the grandfathering computation. Discrepancies between the taxpayer’s Schedule 112A and the AIS aggregate flag for review in the compliance portal.

See also

• Section 112A (LTCG on listed equity and equity MF)
• Section 111A (STCG on listed equity and equity MF)
• LTCG equity mutual fund Section 112A
• STCG equity mutual fund Section 111A
• Equity MF grandfathering of January 2018
• How to compute LTCG with grandfathering on Zerodha
• Capital gains tax in India
• Annual Information Statement (AIS)
• Securities Transaction Tax
• Tax treatment of listing-day gains
• ITR-2
• ITR-3
• CAMS-KFin capital gains statement
• Mutual fund ITR capital gains statement
• Zerodha ITR capital gains statement
• How to download capital gains statement on Zerodha
• Mutual fund
• Mutual fund industry in India
• CAMS
• KFin Technologies

References

1. Income Tax Act, 1961, Section 55(2)(ac), deemed cost of acquisition under the grandfathering provision.
2. Income Tax Act, 1961, Section 112A, tax on LTCG on equity, as inserted by Finance Act, 2018 and amended by Finance (No. 2) Act, 2024.
3. Income Tax Act, 1961, Section 10(38) (since repealed), exemption of LTCG on equity (2004 to 2018).
4. Finance Act, 2004, introduction of Securities Transaction Tax and Section 10(38).
5. Finance Act, 2018, Clauses introducing Section 112A and Section 55(2)(ac).
6. Finance (No. 2) Act, 2024, Sections amending Section 112A rate and threshold.
7. CBDT Notification No. 60/2018 dated 1 October 2018, exceptions to STT-on-acquisition requirement.
8. CBDT Circular No. 2/2018 and subsequent circulars on FMV determination and Section 112A operation.
9. CBDT FAQ on Section 112A, Central Board of Direct Taxes, February 2018 and subsequent updates.
10. AMFI, NAV history data for 31 January 2018, Association of Mutual Funds in India.
11. National Stock Exchange of India, historical data portal for 31 January 2018 highest prices.