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Understanding Grandfathering Rules, Provisions: Impact And Importance
Editorial Team - Nov 3 - 9 min. read
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The process of excluding current programs, policies, or advantages from new rules or adjustments to the budget is called grandfathering in budgeting. Grandfathering rule in income tax indicates that new rules or changes will not affect the current plans, policies, and benefits.
In his 2018-2019 Union Budget Speech, the then Finance Minister, Mr. Arun Jaitley presented the new provisions related to long-term capital gains (LTCG) tax. In the budget speech, he stated that the government would tax long-term capital gains exceeding 1 lakh rupees at a rate of 10% without providing indexation benefits. However, he added that all gains up to 31 January 2018 would be ‘grandfathered’.
This gave rise to grandfathering rules. It aims to prevent any negative effects on organisations or people who have made commitments as per the current policies and their benefits.
Grandfathering rules also offer stability and ease of flow to the existing policies and programs. This blog will give you a deeper understanding of what grandfathering rules are and how they impact investors.
Table of Content
What is the rule of grandfathering provisions?
The rule of grandfathering is given to safeguard people and companies that have already invested in policies and plans as per the current rules of the same. Grandfathering rules indicate that any changes or additional rules will not affect the present policies and their benefits.
This can be considered a tool used in budgeting, especially to maintain the stability and continuity of current programs and policies. It also avoids harming investors committed to policies based on past benefits and returns.
For example, a government can grandfather the existing pension systems. So, any changes would only apply to newly hired candidates, not current employees who have been promised retirement benefits.
What is the grandfathering rule in income tax in income tax for long-term capital gains?
Grandfathering of capital gains in a long-term capital gain account scheme is the exclusion of certain assets from new tax laws or new policies. In simple terms, investments made before the new policy was adopted can be ‘grandfathered’ or excluded from the newly adopted tax policies or rules.
As a result, rather than being taxed at the latest rates, the gains on grandfathered long-term capital gain account scheme will be taxed at a prior, lower rate. For example, if the government introduced a new tax law that increases long-term capital gains tax to 20% from 15%, the new tax rates will apply to investments made after the new law was introduced.
However, investments made before the new law’s implementation can be grandfathered and subject to the previous 15% tax rate. Thus, grandfathering rules offer stability to investors who have planned and invested in long-term capital gain policies based on the old tax rates. It allows investors to enjoy reduced tax rates without the hassle of unexpected changes in their tax system.
It is important to know that the particulars of grandfathering rules in long-term capital gains differ per jurisdiction and the relevant tax regulations. Hence, one must consult a tax expert or financial counsellor to understand how the grandfathering rule in income tax applicable to their assets.
What is the impact of the grandfathering rule on income tax?
The impact of grandfathering provisions differs on the situations in which it is used. For instance, the rules usually safeguard individuals and organisations already invested in a particular policy. And it offers continuity toward the benefits of current programs or policies.
Hence, if grandfathering rules don’t apply to an individual or Company, they will be liable to pay the new tax rates or have to comply with the new laws or modifications. This can lead to a reduction in benefits, instability, and uncertainty for such investors.
The impact of grandfathering provisions also differs based on the new laws and policies introduced and on the benefit or provision being grandfathered. Apart from gaining stability for investors, assessing the benefits and downsides of applying the grandfathering rules is important.
What is the importance of the grandfathering provisions for investors?
Investors must pay attention to grandfathering rules as they impact the taxation of their assets and the gains they will earn.
One of the important features of grandfathering rules is that the investments made before the legislation is adopted can be excluded or grandfathered in from the new tax policies or regulations. Hence, instead of being taxed at the latest and higher rate, the gains on excluded investments will be liable to lower previous tax rates.
The grandfathering rules offer stability and confidence to investors, especially in cases where the investors have made long-term investments based on the previous tax and gain rates, unaware of possible changes in taxation. So, grandfathering rules stimulate these long-term investments and ensure lower risk.
Conclusion
The grandfathering rule in income tax is a provision that excludes new taxation rules or provisions from current investment policies and their benefits. While grandfathering offers continuity and stability, it also safeguards individuals and companies that have invested in specific schemes based on its low tax rates or benefits.
However, the grandfathering provisions have harmful or beneficial effects on long-term capital gains and budgeting. Depending on how resource allocation takes place and what is the ultimate cost of the policies and programs in question.
Moreover, if one sells their holdings after 31 March, they can book their long-term losses. Earlier, there was no benefit provided if one incurred a loss on equity funds or stocks held over a year. But with grandfathering rules, it is allowed.
