capital gains theory-ay0910

Mensa Commerce Classes CA-Final (Income Tax)

Capital Gains 1

ChapterChapterChapterChapter 7

CAPITAL GAINS

7.1 CHARGE UNDER THE HEAD CAPITAL GAINS [Section 45

Capital gains are charged to tax by virtue of Section 45 of the Income Tax Act,

1961. Capital gains mean the profits or gains arising from the transfer of a capital

asset. According to Section 45, the charge of income under the head Capital Gains

arises if the following conditions are fulfilled:

(1) There is a capital asset. [The asset must be a capital asset at the time of transfer]

(2) There is a transfer of such capital asset.

(3) The transfer of such capital asset has been effected during the previous year.

(4) Profits or gains arise from the transfer of such capital asset affected during the previous year. (Profit or gain includes negative profit or gain i.e. loss also)

(5) Such profits or gains are not exempt from tax u/s 54, 54B, 54D, 54EC, 54F, 54G and 54H.

CAPITAL ASSET [Section 2(14)]:

According to Section 2(14), capital asset means property of any kind held by an

assessee, whether or not connected with his business or profession, but does not

include

(1) Any stock-in-trade, consumable stores or raw materials held for purpose of his business or profession.

(2) Personal effects i.e. movable property (including wearing apparel and furniture but excluding jewellery, archaeological collections, Drawings, Paintings,

Sculptures and any work of art) held for personal use by assessee or his family

member dependent on him.

Jewellery is a capital asset. It includes

(a) Ornaments made of gold, silver, platinum or any other precious metal or any alloy containing one or more of such precious metals, whether or not

containing any precious or semi-precious stones and whether or not

worked or sewn into any wearing apparel;

(b) Precious or semi-precious stones whether or not set in any furniture, utensil or other article or worked or sewn into any wearing apparel.

(3) Rural agricultural land i.e. Agricultural land in India not being a land situated

(c) Within the jurisdiction of a municipality or a cantonment board having a population of 10,000 or more according to the last preceding census; or

(d) In any notified area within 8 kms from the local limits of any municipality or cantonment board.

(4) Gold Bonds issued by Central Government including the Gold Deposit Bonds issued under the Gold Deposit Scheme, 1999.

(5) Special Bearer Bonds, 1991.


Capital Gains 2

SHORT TERM AND LONG TERM NATURE OF CAPITAL ASSETS:

(1) Short-term Capital Asset [Section 2(41A)] : Short-term Capital Asset means a capital asset held by assessee for not more than 36 months

immediately preceding the date of its transfer. However, in case of -

(a) Equity or Preference Shares in a company These assets shall be treated as short-term

capital assets if they are

held for not more than 12

months immediately

preceding the date of

transfer.

(b) Other securities listed in recognized stock exchange in India

(c) Units of UTI or Units of mutual fund specified u/s 10(23D)

(d) Zero Coupon Bonds

Note: An asset held exactly for 36 months or 12 months, as the case may be,

will also be a short-term capital asst. For computing the period of 36 months or

12 months, as the case may be, the date on which the asset was acquired is to

be included while the date on which the asset is transferred is to be excluded.

(2) Long-term Capital Asset [Section 2(29A)]: Any capital asset other than a short-term capital asset is a long-term capital asset. In other words, a capital

asset held for more than 36 months (12 months in case of specified assets

given in table above) shall be a long-term capital asset.

(3) Determination of Long-Term or Short-Term Nature of a Capital Asset: In determining the short-term or long-term nature of a capital asset, the period of

holding shall be determined as follows:

Mode Determination of period of holding

1. Shares held in a company in liquidation

Any period subsequent to the date on which the

company goes into liquidation shall be excluded

2. Assets acquired under Section 49(1) modes

Period for which the asset was held by the

previous owner shall be included

3. Share(s) in Indian amalgamated company,

which became property of

assessee in amalgamation

Period, for which the shares in the

amalgamating company were held by the

assessee, shall be included.

4. Bonus shares or other securities

Period of holding will start from the date of

allotment thereof.

5. Right shares or other securities

Period of holding will start from the date of

allotment thereof.

6. Right entitlements renounced

Period of holding taken from date of offer made

by company.

7. Equity Shares in a company, or Trading or

clearing rights of a RSE;

acquired pursuant to

demutualisation or corporati-

sation of such RSE

Period for which such person was member of

Recognised Stock Exchange (RSE) in India prior

to such demutualisation or corporatisation

shall be included.

8. Shares of resulting company acquired in case of

demerger

Period of holding of shares in demerged

company shall be included.

9. Asset which was not Entire period of holding from date of initial


Capital Gains 3

held as capital asset initially

but is a capital asset at the

time of transfer.

acquisition upto date of transfer will be

considered to decide nature of capital asset.

[Keshavji Karsondas v. CIT [1994] 207 ITR 737

(Bom.]

10. Capital asset being a flat allotted to a member of a

co-operative housing society

Period of holding to be calculated from date of

allotment of shares in society and not from date

on which possession of the flat is obtained

because right of possession and use of flat is an

incidental right flowing from the ownership of

shares. [CIT v. Jin-Das Pan-Chand Gandhi

[2005] 279 ITR 552 (Guj.)]

Property constructed on a land purchased earlier: if land is held by the assessee for more than 36 months and building constructed over it is held for not more than

36 months, in that case, the gains arising from the sale of the land would be long-

term capital gains, and gains arising from sale of building will be short term capital

gains.

The Central board of direct taxes has issued Circular no. 704 dated 28.4.95

clarifying as follows:

a) If securities are transacted through stock exchanges, the date of brokers note

should be treated as the date of transfer provided the transaction is followed

up by delivery of shares and also the transfer deeds. Similarly, in respect of

the purchase of the securities, the holding period shall be reckoned from the

date of the brokers note for purchase on behalf of the investors.

b) In case the transaction take place directly between the parties and not

through stock exchanges, the board has clarified that the date of contract of

sale as declared by the parties shall be treated as the date of transfer

provided it is followed up by actual delivery of shares and the transfer deeds.

c) In cases where the shares are purchased in several lots at different points of

time and the delivery of which are taken in one lot and subsequently sold in

parts, in the absence of correlation of the dates of purchase and sale through

specific numbers of the scripts, it is difficult to determine the period of

holding of the shares which are sold in parts. In this regard, board has

clarified that first-in-first-out (FIFO) method shall be adopted to reckon the

period of holding. Therefore, the shares acquired first will always be treated

as sold first and the shares acquired last will be taken to be remaining with

the assessee.

This CBDT has issued an exclusive circular no.768 dated 24-06-1998 (232 ITR 5

St.) in respect of transactions in securities held in dematerialized form u/s.45 (2A)

for determination of date of transfer and period of holding as detailed below:

a) The FIFO method will be applied only in respect of the dematerialized

holdings, because in the case of sale of dematerialized securities, the

securities held in physical form cannot be construed to have been sold as


Capital Gains 4

they continue to remain in the possession of the investor and are identified

separately.

b) In the depository system, the investor can open and hold multiple accounts.

In such a case, where an investor has more than one security account, the

FIFO method will be applied account wise. This is because in case where a

particular account of an investor is debited for sale of securities, the

securities lying in his other account cannot be construed to have been sold as

they continue to remain in that account.

c) If in an existing account of dematerialized stock, old physical stock is

dematerialized and entered at a later date, under the FIFO method, the basis

for determining the movement out of the account is the date of entry into the

account.

Notes:

(A) Modes specified in Section 49(1): Where the capital asset became the property of the assessee -

(a) On any distribution of assets on the total or partial partition of a Hindu Undivided Family;

(b) Under a gift or will; or by succession, inheritance or devolution; or

(c) On any distribution of assets on the liquidation of a company; or

(d) Under a transfer to a revocable or an irrevocable trust, or

Under any such transfer as is referred to in clause (iv)/ (v)/ (vi)/ (via)/ (viaa) of

Section 47;

TRANSFER [Section 2(47)]:

Transfer, in relation to capital asset, includes

(a) sale, exchange or relinquishment of the asset;

(b) extinguishment of any rights therein;

(c) compulsory acquisition thereof under any law;

(d) maturity or redemption of zero coupon bond;

(e) conversion or treatment of such asset by the owner into stock in trade of business carried on by him;

(f) Any transaction involving allowing of possession of an immovable property to be taken or retained in part performance of a contract of the nature referred

u/s 53A of Transfer of Property Act, 1882.

(g) any transaction (whether by way of acquiring shares in, or by way of becoming a member of, a co-operative society, company or other AOP or by way of any

arrangement or agreement or in any other manner) that has the effect of

transferring or enabling the enjoyment of, any immovable property.

Case Laws:

(1) Reduction in face value of shares and consequent payment to the shareholder towards such reduction amounts to transfer, as it results in extinguishment


Capital Gains 5

of right in the shares held by the shareholder. Kartikeya Sarabhai v. CIT

[1997] 228 ITR 163 (SC).

(2) Surrender of Preference Shares on redemption thereof amounts to transfer as there is relinquishment by the shareholder of his rights in Preference Shares.

Anarkali Sarabhai v. CIT [1997] 224 ITR 422 (SC).

(3) Family arrangement entered into by compromising doubtful/disputed rights for preserving family property/peace, doesnt amount to transfer. CIT v. A.L.

Ramanathan [2000] 245 ITR 494 (Mad.)

TRANSACTIONS THAT ARE NOT REGARDED AS TRANSFER [Section 47]:

(1) Distribution of assets by a company to its shareholders on its liquidation. [S. 46(1)]

(2) Distribution of capital assets on total or partial partition of HUF. [S. 47(i)]

(3) Capital asset transferred under will or gift or an irrevocable trust. [S. 47(iii)]

However, transfer under a gift or an irrevocable trust of shares, debentures or

warrants allotted to the assessee under Employee Stock Option Plan as per

prescribed guidelines, shall constitute transfer. Its fair market value on date

of such gift/irrevocable trust shall be treated as full value of consideration.

(4) Transfer of a capital asset (not held as stock in trade) by a holding company to its 100% subsidiary company or vice versa, provided the transferee company is

Indian company. [S. 47(iv)/(v)]

(5) Transfer of capital asset by an amalgamating company to Indian amalgamated company. [S. 47(vi)]

(6) Transfer of share(s) held in an Indian company by amalgamating foreign company to amalgamated foreign company if (a) at least 25% of shareholders

of the amalgamating foreign company continue to remain shareholders of the

amalgamated foreign company; and (b) such transfer does not attract capital

gains tax in the country in which the amalgamating company is incorporated.

[S. 47(via)]

(7) Transfer of capital asset by an amalgamating banking company to the amalgamated banking institution, under a scheme of amalgamation

sanctioned by the Central Government. [S. 47(viaa)]

(8) Transfer of capital asset by a demerged company to the resulting company. [S.47(vib)]

(9) Transfer of share(s) held in an Indian company by demerged foreign company to the resulting company if (a) shareholders holding 75% or more of value of

shares of demerged foreign company continue to remain shareholders of

resulting foreign company; and (b) such transfer does not attract capital gains

tax in the country in which demerged foreign company is incorporated.

[S.47(vic)]

(10) Any transfer or issue of shares by resulting company, in a scheme of demerger to the shareholders of the demerged company in consideration of demerger.

[S.47(vid)]

(11) Transfer of share(s) held by shareholder in amalgamating company, if such transfer is in consideration of allotment to him of share(s) in the amalgamated

Indian company. (S.47(vii)


Capital Gains 6

However, if besides share(s) in amalgamated company, the shareholder is allotted

something more, say bonds or debentures, in consideration of such transfer; the

transfer will not be exempt. Composite consideration is not covered by Section

47(vii). CIT v. Gautam Sarabhai Trust [1988] 173 ITR 216 (Guj.)]

(12) Any transfer, in an amalgamation/demerger, of a capital asset by the predecessor co-operative bank to the successor cooperative bank. [s.47 (vica)].

(13) Any transfer by shareholder, in an amalgamation/ demerger, of share(s) held by him in predecessor co-operative bank if the transfer is made in

consideration of the allotment to him of any share(s) in the successor co-

operative bank.[S.47(vicb)]

(14) Transfer of bonds or Global Depository Receipts [referred to in Section 115AC (1)] of a public sector company made outside India by a non-resident to

another non-resident. [S.47(viia)]

(15) Conversion of bonds referred to in sec 115 AC (1) (a) into shares or debentures of any company; [S.47 (xa)] (inserted by the Finance act, 2008 w.r.e.f 1-4-

2008).

(16) Transfer of any work of art, archaeological, scientific or art collection, book, manuscript, drawing, painting, photograph or print, to Government/

University/National Museum/National Art Gallery/National Archives or any other

notified public institution/museum. [S. 47(ix)]

(17) Conversion of bonds or debentures, debenture-stock or deposit certificates in any form, of a company into shares or debentures of that company. [S.47(x)]

(18) Transfer of land of sick industrial company (being managed by workers co-operative) made under scheme prepared u/s 18 of Sick Industrial Companies Act,

1985, if such transfer is made during the period starting from previous year in

which such company has become sick and ending with the previous year during

which its entire net worth becomes equal to or exceeds accumulated losses. [S.

47(xii)]

(19) Transfer of (a) a capital asset or intangible asset by a predecessor firm to its successor company; or (b) a capital asset to successor company in course of

demutualisation/corporatisation of predecessor recognized stock exchange in India

(being an Association of Persons or Body of Individuals) [S. 47(xiii)]

(a) All the assets and liabilities of the firm/AOP/BOI relating to their business immediately before the succession become the assets and

liabilities of the company;

(b) In case of firm, all its partner become shareholders of the company in the same proportion in which their capital accounts stood in the books of the

firm on the date of the succession;

(c) In case of firm, the partners receive consideration only by way of allotment of shares in company.

(d) In case of firm, the partners shareholding in the company in aggregate is 50% or more of its total voting power and continue to be as such for 5

years from the date of succession; and

(e) The demutualisation or corporatisation of a recognized stock exchange in India is carried out in accordance with a scheme for demutualisation or

corporatisation, which is approved by the SEBI.


Capital Gains 7

(20) Transfer of a membership right held by a member of a recognized stock exchange in India for acquisition of shares and trading or clearing rights acquired

by such member in that stock exchange in accordance with demutualisation or

corporatisation scheme approved by the SEBI. [S.47 (xiiia)]

(21) Transfer of capital asset or intangible asset to the successor company by its predecessor proprietary concern, if the following conditions are fulfilled [S.47 (xiv)]

(a) All the assets and liabilities of the sole proprietary business immediately before the succession become the assets and liabilities of the company.

(b) Sole proprietors shareholding in the company is 50% or more of the total voting power and continues to be as such for 5 years from the date of

succession; and

(c) The sole proprietor receives the consideration only in form of allotment of shares in the company.

(22) Any transfer under Securities Lending Scheme, 1997 for lending of securities under an agreement or arrangement, which is entered into by the assessee with

borrower of such securities and which is subject to guidelines issued by SEBI or

RBI. [S.47 (xv)]

Note: In respect of Section 47(xiii) and 47(xiv), the exemption is available only in respect of the firm/sole proprietor carrying on a business, not in case of profession.

Further, this exemption is available only in respect of transfer of capital assets or

intangible assets, not in respect of any stock in trade.

(23) Any transfer of a capital asset in a transaction of reverse mortgage under a scheme made and notified by the central government[S.47(xvi)](inserted by the

Finance act, 2008 w.r.e.f 1-4-2008).

WITHDRAWAL OF EXEMPTION:

Where the capital gain arising on the transfer of a capital asset from the holding

company to the subsidiary company or vice-versa was exempt from capital gains tax

by virtue of Sec.47 and if any other following events occur within a period of 8 years

from the date of transfer, the capital gains so exempted would be chargeable to tax

in the year in which the transfer took place-

i) The holding company does not continue to hold the whole of the share capital of

the subsidiary company;

ii) The transferee company converts or treats the capital asset into/as stock- in-

trade.

In the case of a transaction between holding company and subsidiary company, the

following additional points need to be borne in mind:

a) If the provisions of section 47 are applicable to a transfer, then the assessment

shall be reopened in respect of the assessment year relevant to the previous year in

which original transfer took place u/s.155 (7B), to amend the order so as to charge

the capital gains to tax.

b) if the transferee company subsequently sells the asset without attracting the

provision of section 47A, then for computation of capital gains the cost to the

transferor company shall be adopted as cost to the transferee company- sec 49 (1).

c) if the asset is sold after attracting the provisions of section 47A, then the cost to

the transferee company shall be the actual cost incurred by that company to

acquire the asset from the transferor company-sec.49(3).


Capital Gains 8

The capital gain arising on transfer of a capital asset in the nature of membership

of a recognized stock exchange exempted by virtue of sec.47, shall be chargeable to

tax if the shares allotted to the transferor in exchange thereof are transferred before

the expiry of a period of 3 years. The capital gain shall be deemed, in such a case,

as the income chargeable during the previous year in which the shares are

transferred.

If the conditions stipulated regarding the succession of a proprietary concern or a

firm by a company are not complied with, the benefits availed by the sole proprietor

or the firm, as the case may be, shall be deemed to be profit and gains of the

successor company chargeable to tax in the year in which infringement takes place.

COMPUTATION OF CAPITAL GAINS SHORT TERM AND LONG TERM

Short term capital gains [S. 2(42B)] means capital gains arising from transfer of

a short-term capital asset. Long term capital gains [S. 2(29B)] means capital gains

arising from transfer of a long-term capital asset.

Mode of Computation of Capital Gains [Section 48]

Short Term Capital Gains Long Term Capital Gains

Full Value of Consideration

Less : Expenses incurred wholly

and exclusively for such transfer

XX

XX

Full Value of Consideration

Less : Expenses incurred wholly and

exclusively for such transfer

XX

XX

Net Consideration XX Net Consideration XX

Less : Cost of acquisition XX

Cost of improvement XX

XX

Less : Indexed cost of acquisition XX

Indexed cost of improvement XX

XX

Short term capital gain

Less : Exemption u/s 54B, 54D,

54G, 54GA

XX

XX

Long term capital gain

Less : Exemptions u/s 54, 54B, 54D,

54EC, 54F, 54G, 54GA

XX

XX

Taxable Short Term Capital Gain XX Taxable Long Term Capital Gain XX

Notes:

(1) Any sum paid on account of securities transaction tax is not deductible in computing Capital Gains.

(2) Indexed cost of acquisition or improvement shall be computed as follows :

Indexed Cost

of Acquisition

or

Improvement

=

Cost of acquisition or improvement Cost Inflation index of the year of transfer

Cost Inflation Index (CII) for (i) the first year in which

the asset was held by the assessee or for the year

beginning on 1.4.1981, whichever is later, or (ii) the year

in which improvement took place

Cost Inflation Indices: The cost inflation indices as notified by the Central

Government are as follows:

Financial CII Financial CII Financial CII Financial CII


Capital Gains 9

year year year year

1981-82

1982-83

1983-84

1984-85

1985-86

1986-87

1987-88

100

109

116

125

133

140

150

1988-89

1989-90

1990-91

1991-92

1992-93

1993-94

1994-95

161

172

182

199

223

244

259

1995-96

1996-97

1997-98

1998-99

1999-2000

2000-01

2001-02

281

305

331

351

389

406

426

2002-03

2003-04

2004-05

2005-06

2006-07

447

463

480

497

519

7.4 COST OF ACQUISITION AND COST OF IMPROVEMENT IN CERTAIN CASES

[Section 49 and 55]

(1) Cost of Acquisition (COA) and Cost of Improvement (COI) in case of a capital asset acquired before 1.4.1981:

Mode of Acquisition COA COI

Where the assessee himself acquired the capital asset

before 1.4.1981

FMV on 1.4.1981 or

cost of property,

whichever is higher

Capital expenditure

incurred by the

previous owner or the

assessee in making any

additions/ alterations

to the capital asset on

or after 1.4.1981.

Capital asset acquired by assessee under any of the

modes given in Section 49(1)

and the previous owner

acquired the same before

1.4.1981

Cost to the previous

owner or FMV on

1.4.1981 whichever is

higher.

(2) Cost of Acquisition and Improvement in some special cases:

Mode Cost of Acquisition or Improvement

1. Shares held in a company in liquidation.

Actual cost of acquisition of such shares.

2.Assets acquired under any of the modes specified in Section 49(1)

Cost = Cost to previous owner + Cost of

improvement incurred by previous owner

or assessee

3. Share(s) in Indian amalgamated company, which becomes the property of

assessee in a scheme of amalgamation.

Cost of acquisition of shares in

amalgamated company = Cost of

acquisition of the shares in the

amalgamating company [Sec. 49(2)]

4. Conversion of bonds or debentures, debenture-stock or deposit certificates in

any form, of a company into shares or

debentures of that company.

Cost of acquisition of new shares or

debentures = Total cost of bonds,

debenture, debenture-stock or deposit

certificates Part of such bonds, debenture, debenture-stock or deposit

certificates so converted [Sec. 49(2A)]

5.Conversion of bonds or debentures, debenture-stock on deposit certificates

in any form, of a company into shares or

debentures of that company (i.e. exempt

transfers referred u/s 47(x) & 47(xa))

Cost of acquisition of new shares or

debentures = total cost of bonds,

debentures, debenture-stock or deposit

certificates * part of such bonds,

debenture, debenture-stock or deposit


Capital Gains 10

Certificates so converted [sec.49A(2A)]

[Amdt. by Finance Act, 08 w.r.e.f 1-4-08]

6. Bonus shares or other securities If allotted before 1.4.1981, Cost = Fair market value as on 1.4.1981, otherwise

cost = Nil.

7. Right shares or other securities If purchased by original shareholder : Cost = Purchase Price

If purchased by person in whose favour

right was renounced : Cost = Purchase

Price paid to company + Amount paid for

renouncement in his favour

8. Rights entitlements renounced Cost = NIL

9. Shares of resulting company

acquired in case of demerger

Cost of shares in resulting company =

Cost of shares in demerged company Net Book Value of assets transferred to

resulting company Net worth of the company before demerger.

Cost of shares in demerged company =

Total cost of shares Cost of shares in

resulting company computed above.

10. Equity Shares & trading/clearing rights in recognized stock exchange

acquired on demutualisation/

corporatisation thereof

Cost of Equity Shares = Cost of

acquisition of membership card of stock

exchange.

Cost of trading or clearing rights = NIL

11. Share/stock of company acquired on (a) Consolidation & division of share

capital into shares of larger or smaller

amount, (b) conversion of shares into

stock or vice versa, (c) conversion of one

kind of shares in other

Cost of acquisition of such share or

stock = Cost calculated with reference to

the cost of acquisition of the shares or

stock from which such share or stock is

derived.

12.Shares Acquired under an ESOP scheme or acquire as sweat equity

shares

Cost of acquisition of such share or

stock = Fair Market Value which has

been taken into account while

computing value of Fringe Benefits u/s

115WC(i)(ba)

(3) Cost of acquisition and cost of improvement in case of certain intangible assets:

Capital asset being - COI COA

Goodwill of business, right to

manufacture/produce/process any

article/thing, or right to carry

business

NIL If self-generated: Nil.

If purchased from

previous owner :

Purchase Price

Trademark/brand name associated

with business or tenancy rights or

stage carried permits/loom hours

Expenses incurred by

assessee or previous

owner after 31.3.1981


Capital Gains 11

(4) Cost of Improvement in any other case: Cost of improvement means all capital expenditure incurred in making any additions or alterations to capital

asset by the assessee after it became his property, and where capital asset

became property of the assesee by any of modes specified u/s 49(1), by the

previous owner.

Exclusions from Cost of Improvement: Cost of improvement does not include

any expenditure, which is deductible in computing the income chargeable

under the head Income from House Property, Profits and Gains of Business

or Profession, or Income from Other Sources.

Notes:

(A) In case of HUF-assessee, by conversion of members individual property

into HUF property.

(B) Previous Owner: Previous Owner means the last previous owner of the asset who acquired it by a mode of acquisition other than that referred to

under Section 49(1).

(C) When cost to previous owner not ascertainable [Sec. 55(3)] : Where the cost for which the previous owner acquired the property cannot be

ascertained, the cost of acquisition to the previous owner means the fair

market value on the date on which the capital asset became the property

of the previous owner.

(5) Indexed cost of acquisition v/s. indexed cost of improvement:

It needs mention that in the case of assets acquired in any of the modes specified in

section 49 (1), the benefit of indexation for cost of acquisition can be claimed only

from the first year in which the asset was held by the assessee. However, in the

case of indexation of cost of improvement, the benefit of indexation can be availed

from the year in which improvement to the asset was made.

(6) Conversion of debentures into shares:

Similarly, if debentures are converted into shares, it is not regarded as transfer by

virtue of section 47(x). If these shares are sold subsequently, the cost of acquisition

would be the cost incurred to acquire the debentures on conversion of which the

shares were obtained as provided in section 49 (2A). Nevertheless, there is no

provision to enable the assessee to take the period of holding of the debentures in

determination of the long-term nature of the shares and again the possibility of

claiming the indexation benefit for the period for which debentures were held is

ruled out.

(7) Conversion of investment into stock -in- trade:

in the case of conversion of capital asset in to stock-in-trade the provisions of

sec.45 (2) explicitly provide for deferring the chargeability till the year of sale of

stock-in-trade. While computing the capital gains of sale of the stock-in-trade, the

assessee will have to index the cost of acquisition only up to the year of conversion

and not up to the year of chargeability since indexation stops in the year of transfer

and does not extend to the year in which the computation is made and taxability

arises.


Capital Gains 12

(8) Compulsory acquisition:

Again, when compulsory acquisition is the instance of transfer in the assessee's

case, section 45(5) provides for charging the capital gain only in the year of receipt

of the compensation and not in the year of compulsory acquisition. Nevertheless,

indexation benefit would not run up to the year of receipt of compensation but

would be confirmed only up to the year of compulsory acquisition.

Case Laws:

(1) Amount paid to clear mortgage: Where property has been mortgaged by previous owner during his life-time and the assessee, after inheriting the same,

has discharged mortgage debt, then by discharging the mortgage debt, the

assessee acquires the interest of the mortgagee in the property. The amount

so paid shall be treated as cost of acquisition. R.M. Arunachalan v. CIT [1997]

227 ITR 222 (SC).

However, where after acquiring a property, the assessee himself created a

mortgage and cleared off the same out of sale proceeds of property, he couldnt

be allowed deduction of payment of mortgage debt as cost of acquisition/

improvement u/s 48 because in that case, he did not acquire any interest in

property subsequent to his acquiring the same. VSMR Jagdishchandran v.

CIT [1997] 227 ITR 240 (SC)

(2) Kist deducted from proceeds of mortgaged property: The Government auctioned the mortgaged property of assessee for kist amount due by him to

the State, and paid the balance amount (after deducting kist) to the assessee.

The assessee claimed deduction for kist amount in computing capital gains.

Held that, since the price received in auction entirely belonged to the assessee,

the amount deducted towards kist was not diverted at source but was applied

in discharge of an obligation after it was received by the assessee. Therefore,

kist amount was not deductible in computing capital gains. CIT v. Attili N.

Rao [2001] 252 ITR 880 (SC).

(3) No charge, when computation not possible : If, on the facts of a particular case, computation u/s 48 is not possible, then capital gains shall not be

charged to tax. Thus, if no cost can be envisaged in acquisition of an asset,

capital gains cannot be charged. CIT v. B.C. Srinivasa Setty [1981] 128 ITR

294 (SC).

(4) Amount embezzled while effecting sale of property will not constitute expenditure in connection with transfer and is, therefore, is not deductible u/s

48(1) Mr. G.Y. Chenoy v. CIT [1999] 234 ITR 89 (AP).

(5) In CIT v/s C.V. Sounderajan, 150 ITR 80(mad) the amount paid to the mother having right of residence in the property, for obtaining relinquishment of such

right was held deductible in computing the capital gains.

(6) When Loan is borrowed and invested in any asset, interest expenditure

incurred thereon can be claimed as deduction from the income derived from

such asset. If the assessee desires to capitalize the interest, is it possible to

treat it as part of the cost of acquisition and claim it as deduction in the

computation of capital gains is an issue which has been favourably considered

by courts. So long as the loan has been exclusively borrowed and utilised for

acquisition of an asset, capitalisation of interest is possible as held in the case


Capital Gains 13

of CIT v/s Mithlesh Kumari, 92 ITR 9 (DEL) of Addl. CIT v/s K.S.Gupta, 119 ITR

372 (AP). Similar analogy can be inferred from the decisions rendered in CIT v/s

Maithreyi Pai, 152 ITR 247 (Kar) and Saharanpur Electric Supply Co. v/s

CIT, 194 ITR 294(SC).

7.5 CASES WHERE BENEFIT OF INDEXATION IS NOT AVAILABLE EVEN IN CASE

OF LONG-TERM CAPITAL ASSETS:

(1) Transfer of a bond or a debenture other than capital indexed bonds issued by the Government.

(2) Transfer of undertaking or division in a slump sale under Section 50B.

(3) Transfer of shares/debentures of an Indian company purchased by a non-resident in foreign currency.

(4) Transfer of units purchased in foreign currency by an assessee covered under Section 115AB.

(5) Transfer of bonds or shares purchased in foreign currency by an assessee covered u/s 115AC.

(6) Transfer of global depository receipts by a resident employee of an Indian company u/s 115ACA.

(7) Transfer of securities by foreign institutional investors under Section 115AD.

(8) Transfer of a foreign exchange asset by a non-resident Indian under Section 115D.

7.6 SCOPE AND YEAR OF CHARGEABILITY OF CAPITAL GAINS [Section 45]

S.45 Transaction Full Value of Consideration

Year of Chargeability

(1) Transfer of capital asset Agreed consideration

(subject to Sec.50C and

Sec.55A)

Previous year in which

transfer took place.

(1A) Damage to, or destruction

of, any capital asset.

[Note 1]

Insurance compensation

i.e. Money + Fair market

value (on date of receipt) of

other assets received


money or other asset is

received from the

insurance company.

(2) Conversion of a capital

asset into stock in trade

Note 2]

The fair market value as

on the date of conversion.


stock in trade is sold.

(2A) Transfer of shares held in

depository (FIFO basis)

Agreed consideration Previous year in which

transfer took place

(3) Transfer of capital asset

as capital contribution or

otherwise by a partner or

member to Firm/AOP/

BOI

Amount at which such

asset is recorded in books

of the Firm/AOP/BOI.



(4) Distribution of capital

asset on dissolution or

otherwise of Firm/AOP/

Body of Individuals

Fair market value as on

the date of transfer [Note

3]




Capital Gains 14

(5) Compulsory acquisition

under any law; or any

transfer, whose

consideration is deemed or

approved by Central Govt.

or RBI.

Compensation awarded;

or amount of compensa-

tion as determined or

approved by Central

Government/RBI

The year in which such

compensation or part

thereof is first received.

[Note 4]

Notes:

(1) Section 45(1A) applies only when the damage/destruction is due to

(a) Flood, typhoon, hurricane, cyclone, earthquake or other convulsion of

nature; or

(b) Riot or civil disturbance; or

(c) Accidental fire or explosion; or

(d) Action by enemy or action taken in combating an enemy (whether with or

without declaration of war).

However, where damage/destruction is not attributable to any of the reasons

aforesaid, there will be no charge of capital gains, as there can be no transfer

without existence of capital asset at the time of transfer. Vania Silk Mills P.

Ltd. v. CIT [1991] 191 ITR 647 (SC).

Computation of capital gains in respect of such assets: As per the CBDTs

circular issued in this behalf, capital gains would be worked out in respect of

assets which get destroyed, etc. as per the provisions of Sections 48 and 50, as

the case may be, by taking the insurance money or the market value of the

asset received from the insurer as the full value of consideration. Further,

adjustment for cost inflation index will be made for non-depreciable assets and

for depreciable assets, the written down value of such assets will be reduced

from the block of assets as provided for in Section 43(6).

(2) In this case, transfer takes place in the year of conversion. So, CII of the year of conversion is used for computation of capital gains. Further, such fair

market value will be taken as cost of converted stock.

(3) When the partners or members transfer the capital assets, the agreed consideration will be taken as their cost of acquisition.

(4) (a) In case of enhanced compensation : In case the compensation is enhanced or further enhanced by the Court, Tribunal or other authority, the capital

gains shall be chargeable to tax in the year when the enhanced

compensation is received. The amount of enhanced compensation will be

the full value of consideration and the cost of acquisition and cost of

improvement in that case shall be nil. If the enhanced compensation is

received by any other person due to the death of the transferor or due to

any other reason, the amount will be deemed to be capital gain of the

recipient.

(b) Reduction in compensation : In case the initial compensation or the

enhanced or further enhanced compensation is reduced by the court or

Tribunal or any other authority, such assessed capital gain for that year

shall be recomputed by taking the compensation or consideration as so

reduced by the court, tribunal or other authority to be the full value of

consideration.


Capital Gains 15

Some Issues:

(1) Payment, by way of cash or otherwise, to retiring partner over and above balance in his capital account : So far as retiring partner is concerned, the amount

received by such partner from the firm in excess of capital and profits standing

to his credit cannot be considered as capital gains, as there is no transfer.

The amount received by him is not consideration for transfer of his interest to

the continuing partners; he only receives his share in partnership. CIT v. R.

Lingmallu Raghukumar [2001] 247 ITR 801 (SC).

However, so far as the firm is concerned, it has been held in CIT v. A.N. Naik

Associates [2004] 265 ITR 346 (Bom), that distribution of asset by the firm to a

partner on his retirement shall come within the expression otherwise (as

appearing in Section 45(4) and amounts to transfer of capital assets within the

meaning of Section 45(4) and therefore, is liable to capital gains tax in the

hands of the firm.

(2) Distribution to partner on dissolution v. Gift of land to Partner: So far as registration is concerned, gift of land to partner is required to be registered

under Registration Act, 1908, but the distribution of land to partner on

dissolution of the firm, doesnt require registration, as decided in N. Khadervali

Saheb v. N. Gudu Sahib [2003] 261 ITR 1 (SC). So far as taxability is concerned,

gift of capital asset being a land, is exempt u/s 47(iii), but distribution of land

on dissolution is taxable u/s 45(4). Thus, decision as to gift or distribution on

dissolution is to be taken after taking this into consideration.

(3) Interest on enhanced compensation: Interest received on enhanced compensation in case of compulsory acquisition or the transfer referred to in

Section 45(5), will be taxable as income from other sources as per the method

of accounting followed by assessee. If assessee follows cash system, it will be

taxable in the year of receipt. However, if assessee follows mercantile system,

such interest shall be spread on an annual basis over the period right from the

date on which asset was acquired to the date on which the order for

enhancement is made by the Court. [Rama Bai v. CIT [1990] 181 ITR 480 (SC)].

CAPITAL GAINS ON DISTRIDUTION OF ASSETS BY COMPANY IN LIQUIDATION

[SEC.46]

(1) In hands of company: distribution of assets by a company on its liquidation is

not regarded as transfer.

(2 in the hands of shareholder: Receipts of any money or other assets by the

shareholder from the company on its liquidation shall be chargeable to tax as

Follows-

Cash received or market value of the assets received on

liquidation

Less: deemed dividend u/s 2(22) (c) to the extent of accumulated

profit as on the date of liquidation.

Full value of consideration for the purposes of section 48.

Less: indexed cost of acquisition (or cost of acquisition) of the

shares held in that company

X

X

----

X

X


Capital Gains 2

Long-term capital gains or short-term capital gains X

(3) Cost of Acquisition of assets received on liquidation in hands of shareholders

[Sec.55 (2)]:

Where any capital received by assessee on liquidation of a company, which had

been assessed u/s 46, is transferred by him, the cost of acquisition in of such asset

will be the fair market value as on the date of distribution.

7.8 CAPITAL GAINS ON BUY-BACK OF SHARES OR OTHER SPECIFIED

SECURITIES [Section 46A]

Any consideration received by a holder of shares or other specified securities

from any company under a scheme of buy back shall constitute transfer and the

difference between such consideration and the cost (or indexed cost) of acquisition

shall be chargeable to tax as capital gains in the previous year in which such buy-

back takes place. Payment made by a company on buy-back doesnt constitute

dividend u/s 2(22) (d).

7.9 CAPITAL GAINS IN CASE OF DEPRECIABLE ASSETS [Section 50 & 50A]

(1) Capital gains in case of transfer of asset on which depreciation has been allowed under Section 32(1)(ii) in respect of block of assets [Section 50] : The capital

gains shall be computed as follows :

(a) Block of assets does not cease to exist but WDV of block is reduced to zero

[Section 50(1)]:

Full value of consideration

Less : (1) Expenses on transfer

(2) WDV of asset on 1st day of the previous year

(3) Cost of assets acquired during the previous year and

falling within that block

XXX

XXX

XXX

XXX

Short Term Capital Gains XXX

(b) Block of assets ceases to exist due to the sale of all assets falling within that

block [Section 50(2)]:


Less : (1) Expenses on transfer

(2) WDV of asset on 1st day of the previous year

(3) Cost of assets acquired during the previous year and

falling within that block

XXX

XXX

XXX

XXX

Short Term Capital Gains/Loss XXX

(2) Transfer of capital assets of Power sector units on which depreciation allowed u/s 32(1) (i) [Section 50A]:

(a) If WDV of the asset exceeds Moneys Payable on transfer of such assets:

Terminal depreciation under Section 32(1) (iii) = WDV of such asset

Moneys Payable


Capital Gains 2

(b) If Moneys Payable exceeds WDV of the asset: Then, if -

Moneys payable doesnt exceed actual cost : Balancing charge u/s 41(2) = Money Payable WDV

Moneys payable exceeds Actual Cost : Balancing Charge u/s 41(2) = Actual Cost WDV; and Short-term/Long-term Capital Gains =

Moneys Payable Actual Cost

7.10 SLUMP SALE MEANING AND COMPUTATION OF CAPITAL GAINS

[Section 50B]

Slump Sale [Sec. 2(42C)] : It means transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to the

individual assets and liabilities in such sales.

Charge and Nature of Capital Gains: Profits or gains arising from slump

sale shall be taxable as Capital Gains in previous year in which slump sale is

effected. If the capital asset, being one or more undertakings, was owned and held

by the assessee for not more than 36 months, the capital gains will be short term

capital gains. In any other case, it shall result into long-term capital gains.

Mode of computation of capital gains: The capital gains shall be computed

in the following manner


Less : Expenses wholly and exclusively in connection with such transfer

Less : Cost of acquisition and cost of improvement being net worth** of

the undertaking (no indexation benefit even in case of long-term

capital asset)

XXX

XXX

XXX

Short Term/Long Term Capital Gains XXX

** The net worth of the undertaking shall be computed in the following manner

Aggregate value of total assets of the undertaking or division (ignoring any

change in the value of assets on account of revaluation of assets)

In case of depreciable assets, the WDV of the block as per Sec. 43(6) XXX

In case of other assets, the book value XXX

Less : Value of liabilities of such undertaking or division as appearing in its

books

XXX

XXX

XXX

Net Worth of the undertaking or division XXX

Certificate of a Chartered Accountant: In case of slump sale, every assessee

shall furnish along with the return of income a report of an accountant in

prescribed form indicating the computation of net worth and certifying that the net

worth of the undertaking or division has been correctly arrived at.

Illustration 1: Computation of Capital gains in case of slump sale

Balance Sheet of X Ltd. as on December 31, 2006 reads as under Paid up

capital: Rs.552 lakhs.

(All amounts in Rs. lakhs)

Unit A Unit B


Capital Gains 3

Land

Fixed Assets (other than land)

Debtors

Liabilities

Stock-in-trade

Reserves

Share Premium

Revaluation Reserve on account of Revaluation of land

200

100

100

28

50

170

150

75

50

25

148

22

70

The company acquired Unit B on December 31, 2003. It made certain capital

additions in the form of generator set and additional building, etc. of Rs.25 lakhs

during the year 2004-05. The members of the company have authorized the Board

in their meeting held on October 28, 2006 to dispose off the Unit B. The company

decides to sell the Unit B by way of slump sale for Rs.325 lakhs as consideration.

The buyer has agreed with the vendor company to give time for putting

through the sale but not later than March 31, 2007 subject to discount of 1% on

agreed sale consideration. However, this discount is not applicable if the sale is

completed after December 31, 2006. The company now approaches you to advise

them as a measure of tax planning to determine the date of sale keeping in view of

the capital gains tax. The WDV of the Fixed Assets under Section 43(6) is Rs.120

lakhs.

Solution: The computation of capital gains shall be in accordance with Section

50B of the Income Tax Act, 1961.

Computation of net worth of Unit B: Rs. (in lakhs)

WDV of Fixed Assets under Section 43(6) being depreciable

assets

Land (170 70 i.e. book value after ignoring revaluation)

Debtors and Stock (75 + 25 i.e. at book value)

120

100

100

320

Less : Liabilities at Book Value 50

Net Worth (being cost of acquisition and improvement) 270

Case I: Where the slump sale takes place on or before December 31, 2006 In this

case, the period of holding of Unit B will be not more than 36 months. Therefore,

Unit B will be a short-term capital asset.

(Rs. in lakh)

Sale Consideration

Less : Discount @ 1%

Less : Net Worth

325.00

3.25

270.00

Short Term Capital Gains 51.75

Tax payable (30% + Surcharge 10% + EC @ 2% on Tax and Surcharge) 17.42

Case II : Where Unit B is sold after December 31, 2006 : In this case, period of

holding is for more than 36 months and therefore, it is a long-term capital asset.

Sale Consideration

Less : Net Worth

325

270

Long Term Capital Gains 55

Tax payable = 20% + Surcharge 10% + EC @ 2% on Tax and Surcharge 12.34


Capital Gains 4

Conclusion: Since the tax payable is less in Case II, X Ltd. is advised to sell Unit B

by way of slump sale after December 31, 2006 so as to minimize the tax liability.

7.11 FULL VALUE OF CONSIDERATION WHEN STAMP VALUE EXCEEDS SALE

PRICE [Section 50C]

Full Value of Consideration : Where the consideration for transfer of land or

building or both, is less than the value adopted by Stamp Valuation Authority for

payment of stamp duty, the value so adopted by stamp valuation authority shall be

deemed to be full value of consideration for the purpose of Section 48.

Reference to Valuation Officer: The Assessing Officer may refer valuation

thereof to Valuation Officer if

(a) The assessee claims before the Assessing Officer that the value adopted or

assessed by the Stamp Valuation Authority exceeds the fair market value of

the property as on the date of transfer, and

(b) The value adopted or assessed by the Stamp Valuation Authority has not been

disputed in any appeal or revision or no reference has been made before any

other authority, court or the High Court.

In case reference is made to Valuation Officer, the full value of consideration shall

be lower of (a) Value as determined by the Valuation Officer; or (b) Value assessed

or adopted by the Stamp Valuation Authority.

7.12 CAPITAL GAINS WHEN ADVANCE OR OTHER MONEY FORFEITED

[Section 51]

Where any capital asset was on any previous occasion the subject of

negotiations for its transfer, and advance or other money received and retained by

the assessee in respect of such negotiation shall be deducted from the cost for

which the asset was acquired, or the WDV of the asset or the FMV in computing the

cost of acquisition of the capital asset. [Note: Only amount forfeited by assessee is

deducted, amount forfeited by the previous owner shall not be considered. Further,

indexation applies only after such reduction from cost.]

It has been held in Travancore Rubber & Tea Co. Ltd. v. CIT [2000] 243 ITR 158

(SC) that the phrase other money would cover deposits made by purchaser for

guaranteeing due performance of contracts. Therefore, forfeiture of earnest money

and the compensation awarded to the assessee for breach by the prospective

purchaser of contract for purchase of property would go to reduce the cost of

acquisition as per Section 51.

Illustration 2 Right to specific performance:

R entered into an agreement with L for the purchase of a property for Rs.10

lakhs and paid Rs.10, 000 as earnest money. On L failing to execute a conveyance

in respect of the property, a suit for specific performance was filed by R. The suit

was compromised and R agreed to receive Rs.50, 000 by way of damages and gave

up his right to specific performance. What will be the position of this amount?

Solution: It was held in K.R. Srinath v. ACIT [2004] 268 ITR 436 (Mad.) that a right

to acquire a property i.e. right to specific performance is itself a capital asset. In

this case, Rs.50, 000 received by R is consideration for relinquishment of right to


Capital Gains 5

specific performance and Rs.10, 000 is its cost of acquisition. R is therefore, liable

to capital gain tax on Rs.40, 000 subject to deduction of the legal expenses incurred

for enforcing this right.

7.13 EXEMPTIONS IN RESPECT OF CAPITAL GAINS AVAILABLE ONLY TO

INDIVIDUAL AND/OR HUF ASSESSEES [Section 54, 54B and 54F]

Provisions Section 54 Section 54B Section 54F

1. Assessee Individual/HUF Individual Individual/HUF

2. Asset

transferred

Residential house

property being

buildings or lands

appurtenant thereto.

Agricultural land used

by individual or his

parent for agricultural

purposes during 2

years preceding date

of transfer.

Any capital asset not

being residential

house property. [Note :

Exemption is not

available if assessee

(a) owns more than 1

residential house (other

than new) on date of

transfer of original

asset; or (b) purchases a residential house,

other than new asset,

within 1 year from date

of transfer of original

asset]

3. Nature of

Asset

Long Term Short/Long Term Long Term

4. New asset

to be

purchased/

constructed

Residential house

property i.e. buildings

or lands appurtenant

thereto

Agricultural land

(urban or rural)

Residential house

property i.e. buildings

or lands appurtenant

thereto

5. Time-limit

for purchase/

construction

Purchase : Within 1

year before or 2 years

after the date of

transfer

Construction : Within

3 years from date of

transfer

Purchase within 2

years from the date of

transfer

Purchase : Within 1

year before or 2 years

after date of transfer;

and

Construction : Within

3 years from date of

transfer

6. Deposit

Scheme

(discussed

later)

Applicable Applicable Applicable

7. Amount of

Exemption

Lower of Capital

Gains or Investment in

new asset

Lower of Capital

gains or cost of new

asset

Cost of new house Capital Gains Net consideration being

Full value of

consideration less

Expenses on transfer

8. Withdrawal

of exemption

on

Transfer of the new

asset within 3 years

from its purchase/

construction

Transfer of the new

asset within 3 years

from its purchase

(a) assessee purchases

within 2 years or

constructs within 3

years from date of

transfer of original


Capital Gains 6

asset, a residential

house other than new

house; or

(b) Transfers new asset

within 3 years from

date of its purchase/

construction.

9. Taxability

on withdrawal

Amount of exemption

claimed earlier shall

be reduced from the

cost of acquisition of

new asset

Exemption claimed

earlier shall be

reduced from cost of

acquisition of new

asset

Amount exempted

earlier shall be taxable

as long-term capital

gains in previous year

in which (a) another

residential house is

purchased or

constructed; or (b) the

new asset is

transferred.

Note: Important points on exemption under Section 54 and 54F

(1) Purchase/Construction of a Portion: Purchase or consideration of a portion of the house is eligible for exemption CIT v. Chandanben Maganlal [2000] 245

ITR 182 (Guj.). E.g. If an assessee purchases 15% undivided share in a house

property, exemption will be available.

However, mere construction by way of extension of old existing house is not

eligible for exemption. CIT v. Pradeep Kumar [2006] 153 Taxman 138 (Mad.)

(2) Purchase of co-owners interest : In case of property owned by co-owners, the payment made by one co-owner to get the full ownership by release of the

interest of other co-owners amounts to purchase by such co-owner and is

eligible for exemption. CIT v. Aravinda Reddy [1979] 120 ITR 46 (SC).

(3) Registration not pre-condition: If assessee has purchased house and acquired its possession and control, he will be eligible for exemption even if such

purchase is not registered as per Registration Act, 1908.

EXEMPTIONS IN RESPECT OF CAPITAL GAINS AVAILABLE TO ALL ASSESSEES [Section 54D, 54EC, 54G and 54GA]:

Provisions Section 54D Section 54EC Section 54G Section 54GA

1. Assessee Any person Any person Any person Any person

2. Asset

transferred

Compulsory

acquisition of

land or building

which was used

in the business

of industrial

undertaking

during 2 years

prior to date of

transfer.

Any long term

capital asset.

Transfer of

plant,

machinery or

land or building

for shifting

industrial

undertaking

from urban area

to rural area.

Transfer of

plant,

machinery or

land or building

for shifting

industrial

undertaking

from urban area

to Special

Economic Zone.

3. Nature of

Asset

Short term/

Long term

Long term Short term/

Long term

Short term/

Long term

4. New asset to

be purchased/

New land or

building for the

Bonds,

redeemable

(a) Purchase/

Constructio

(a) Purchase/

constructio


Capital Gains 7

constructed industrial

undertaking

after 3 years

issued

(a) by National

Highway

Authority of

India; or

(b) By Rural

Electrificatio

n Corp.

(Amendment by

the Finance Act,

2006)

n of plant,

machinery,

land or

building in

such rural

area or,

(b) Shifting

original

assets to

that area, or

(c) Incurring

notified

expenses

n of plant,

machinery,

land or

building in

such SEZ,

or

(b) Shifting the

original

assets to

SEZ, or

(c) Incurring

notified

expenses

5. Time-limit for

purchase/

construction of

new asset

Within 3 years

from date of

receipt of initial

compensation

Within 6

months from

the date of

transfer of

original asset

Within 1 year

before or 3

years after the

date of transfer

Within 1 year

before or 3

years after the

date of transfer

6. Deposit

Scheme

Applicable -- Applicable Applicable

7. Amount of

exemption

Lower of

capital gains or

investment in

new asset

Lower of

Capital gains or

investment in

new asset or

Rs.50 lacs

Lower of

Capital gains or

cost incurred for

(a) to (c) of point

4.

Lower of

Capital gains or

cost incurred for

(a) to (c) of point

4.

8. Withdrawal of

Exemption

Transfer of new

asset within a

period of 3

years from the

date of its

acquisition or

construction

Transfer of new

asset,

conversion

thereof in

money or taking

loan or advance

on its security

within 3 years

from date of its

acquisition.

Transfer of new

or shifted asset

within a period

of 3 years from

the date of its

acquisition or

construction or

shifting.

Transfer of new

or shifted asset

within a period

of 3 years from

the date of its

acquisition or

construction or

shifting.

9. Taxability on

withdrawal of

exemption

Amount of

exemption

claimed earlier

shall be reduced

from the cost of

acquisition of

new asset.

Exempted

capital gain will

be taxable as

long-term

capital gains in

previous year in

which such

transfer/

conversion

takes place.

Amount of

exemption

claimed earlier

shall be reduced

from the cost of

acquisition of

new or shifted

asset.

Amount of

exemption

claimed earlier

shall be reduced

from the cost of

acquisition of

new or shifted

asset.

Note: If exemption has been claimed u/s 54EC in respect of investment in a new asset,

no deduction shall be allowed u/s 80C with reference to the amount of investment for

which exemption has been claimed.

Transfer of depreciable assets held for more than 36 months

Exemption u/s 54EC available: Section 50 nowhere mentions that the

depreciable assets are short term capital assets but only states that capital gains


Capital Gains 8

arising from transfer of depreciable asset shall be deemed to be arising out of

transfer of short term capital asset. Section 54EC is independent section and

exemption therein is available if there is a transfer of long term capital asset and

consideration is invested in specified assets within time limit. Therefore,

depreciable assets held for more than 36 months are long-term capital assets and

capital gains arising therefrom will be eligible for the benefit envisaged u/s 54EC

CIT v. Assam Petroleum Industries P. Ltd. [2003] 131 Taxman 699 (Gau.)

Extension of time in case of compulsory acquisition [Section 54H] :

Where transfer of original assets referred to in Sections 54, 54B, 54D, 54EC and

54F, is by way of compulsory acquisition under any law, the period for acquiring

new asset referred to in those sections or the period available under those sections

for depositing or investing the amount of capital gain in relation to such

compensation, which is not received on the date of the transfer, shall be reckoned

from the date of receipt of such compensation.

Capital Gains Accounts Scheme, 1988: This scheme applies to all assessees who are eligible for exemption under Section 54, 54B, 54D, 54F and 54G.

The tax implications of this scheme are as follows

(1) Exemption available if amount deposited: Exemptions u/s 54, 54B, 54D, 54F and 54G are available if the investment in new asset is made within time

allowed in those sections. If the amount of capital gains or net consideration

could not be fully or partly reinvested for the purposes specified in said

sections before the due date of furnishing return of income, then exemption

will be available in respect of the amount deposited before the due date of

furnishing return of income in the said deposit account as if the amount so

deposited had been invested in new asset.

(2) Withdrawal out of deposit account: The amount in deposit account can be withdrawn for purposes specified in respective Sections 54, 54B, 54D, 54F and

54G. However, if the said amount is not utilized wholly or partly for purchase

of new asset within stipulated period specified under said sections, then

(a) In case exemption was claimed u/s 54, 54B, 54D and 54G : Amount not so utilized shall be chargeable to tax as Capital Gains of previous year in

which period specified under those section expires.

(b) In case exemption was claimed under Section 54F : The following amount shall be taxable as capital gains of previous year in which the period

under Section 54F expires

asset original of transfer ofrespect in ion considerat saleNet

exemption) claiming (before Gains Capital Original utilised sonot Amount

Gains

CapitalTaxable

=

(3) If the individual dies before expiry of stipulated period u/s 54, 54B, 54D, 54F and 54F, the unutilized amount cannot be taxed in the hands of the deceased,

also not in hands of legal heirs, as the unutilized portion is not income but is

only a part of the estate devolving upon them. (Circular 743 dt. 06.05.1996)

Illustration 3 Exemption u/s 54 and 54F:

Mr. A owns a self-occupied residential house and a plot of land. (He has no

other house). He sells the house on 31.1.2007 and the plot on 15.2.2007 for Rs.6,

50,000 and Rs.5, 00,000 respectively. The house was purchased on 31.1.2002 for

Rs.4, 00,000 and the plot on 30.3.2002 for Rs.2, 00,000. A has purchased a new


Capital Gains 9

residential house on 25.4.2007 for Rs.5, 00,000 and claims exemption in respect of

such house. On 31.1.2008, he transfers the said residential house for Rs.7, 50,000

and purchases a new house on 31.3.2008 for Rs.10, 00,000. Compute the capital

gains for relevant years.

Solution: Computation of Capital Gains for assessment year 2007-08

Sale of residential house (Rs.)

Sale of Plot (Rs.)


Less : Indexed cost of acquisition

6,50,000

4,87,324 (4,00,000 519/426)

5,00,000

2,43,662 (2,00,000 519/426)

Long term capital gains

Less : Exemption u/s 54 & 54F

1,62,676

1,62,676

2,56,338

1,72,938 (2,56,338 3,37,324 5,00,000)

Taxable Capital Gains Nil 83,400

Computation of Capital Gains on sale of residential house (amount in Rs.)

Sale price of the residential house (acquired on 25.4.2007)

Less : Cost of Acquisition (5,00,000 Exemption claimed u/s 54 i.e. 1,62,676)

7,50,000

3,37,324

Short-term Capital Gains for assessment year 2008-09 4,12,676

Long-term Capital Gains (Exemption claimed u/s 54F shall be chargeable as

long-term capital gains of the year in which the house is transferred i.e.

assessment year 2007-08)

1,72,938

Note: No exemption will be available in respect of second new house acquired on 31.3.2008. Exemption u/s 54 or 54F cannot be claimed because the house

transferred on 31.1.2008 is a short-term capital asset.

7.14 REFERENCE TO VALUATION OFFICER [Section 55A]

With a view to ascertaining the Fair Market Value of a capital asset, the

Assessing Officer may refer the valuation of a capital asset to a Valuation Officer in

following cases

(1) In case the value of asset claimed by assessee accords with the estimate made by Registered Valuer: If the Assessing Officer is of the opinion that the value so

claimed is less than it is Fair Market Value.

(2) In any other case : If the Assessing Officer is of the opinion that

(a) [Fair Market Value of the asset Value claimed by the assessee] exceeds

(i) Rs.25,000; or (ii) 15% of the value claimed by the assessee; or

(b) Having regard to the nature of the asset and relevant circumstances, it is

necessary to make a reference to the Valuation Officer.

7.15 CAPITAL GAINS EXEMPT FROM TAX [Section 10]

Sec. Exempted Income Conditions/Remarks

10(33) Capital gains on transfer of units of

US 64

Exempt if transferred on or after 1.4.2002.

10(37) Any Capital Gains arising to

individual or HUF from transfer of

urban agricultural land by way of

compulsory acquisition under any

Such land must have been used by individual or his parents or

the HUF for agricultural purposes

during two years preceding the


Capital Gains 10

law or transfer the consideration of

which is determined or approved by

Central Government/RBI.

date of transfer.

Compensation or consideration for transfer (or enhanced or

further enhanced compensation)

is received by the assessee on or

after 1.4.2004.

10(38) Long-term capital gains arising from

transfer of Equity Shares in a

company or a unit of equity oriented

fund, if such transaction has been

charged to securities transaction

tax.

However, the income by way of long-term capital gains of a

company shall be taken into

account in computing the book

profits and income-tax payable

under Section 115JB.

(Amendment by Finance Act, 2006

w.e.f. 1.4.2007)

7.16 COMPUTATION OF TAX ON SHORT TERM AND LONG TERM CAPITAL GAINS

(1) Short-term Capital Gains (STCG) on transfer of an equity share of a company or

a unit of an equity-oriented fund on which securities transaction tax has been

charged[s.111A]: tax is computed on such capital gains at a flat rate of 15%

(amendment by Finance act, 2008 w.e.f 1-4-2009).

However, in case of resident individual or resident HUF, if-

a) other income (i.e. total income-such STCG) is less than' basic exemption

limit.'

b) Then, such STCG shall be reduced by such shortfalls and

c) Tax on balance of STCG shall be computed @15%.

d) Accordingly, tax on such STCG = 15%*[Such STCG (basic exemption limit-

other income)

Further, where gross total income of an assessee includes any such short-term

capital gains, the deduction under chapter VIA shall be allowed from the gross

total income as reduced by such gains.

(2) Other short-term capital gains: they are taxed at the normal rates applicable to

the assessee.

(3) Long - term Capital gains [ sec. 112]: tax is computed thereon at a flat rate of

20%.However, in case of resident individual or resident HUF, if-

a) Other income (i.e. Total income -such LTCG) is less than' basic

exemption limit',

b) then, such, LTCG shall be reduced by such shortfall and

c) Tax on balance of LPCG shall be computed@20%.

d) Accordingly, tax on such LTCG= 20% *[such LTCG-(basic exemption

limit-other income)].

Other points are:-

a) Deduction under section 80C to 80U are not available in respect of

long-term capital gains.

b) Tax payable in case of listed securities, etc. not to exceed 10%: in case of

long-term capital gains arising from transfer of listed securities, units

of UTI or mutual funds specified in sec 10(23D) or zero coupon bonds,

the tax payable of such capital gains shall be lower of the following-


Capital Gains 11

(i) 10% Grass Capital Gains (without indexation and without giving

benefit of basic exemption limit);

(ii) 20% of taxable LTCG as computed above.

Illustration 4 Capital Gains on transfer of listed securities:

Mr. X bought 10,000 Equity Shares of TT Ltd. listed in stock exchange in India

and abroad on 15th March, 2006 @ Rs.2,250 per share. He sold the shares at Rs.5,

000 per share on 31st December, 2008. The brokerage and securities transactions

tax deducted were at 0.5% and 0.1% respectively. Examine the liability of Mr. X to

income tax. Will your answer be different, if instead of selling the shares in the

market, Mr. X privately transferred the shares to his son at the same price?

Solution: Tax Liability of Mr. X for the assessment year 2009-10:

(1) Sale transaction on which securities transaction tax has been charged: As per Section 10(38) any long-term capital gains arising out of transfer of Equity

Shares in a company shall be exempt from income tax if such transaction is

chargeable to securities transaction tax. Hence, in this case, LTCG will be

exempt.

(2) When shares are privately transferred to his son: Since the shares are not transferred through recognized stock exchange, it will not be exempt u/s

10(38). Capital gains will be computed as under :

(Amounts in Rs.)

Full value of consideration [Rs.5,000 10,000]

Less : Brokerage @ 0.5% (Assuming that brokerage is payable for

effecting private transfer also)

5,00,00,000

2,50,000

Net consideration

Less : Indexed cost of acquisition [2,250 10,000 519 463]

4,97,50,000

2,52,21,382

Long Term Capital Gains 2,45,28,618

Income Tax on LTCG : [Lower of (a) or (b)]

(a) 20% of (2,45,28,618 1,50,000, basic exemption limit assuming

that X has no other income)

(b) 10% of (4,97,50,000 2,25,00,000), benefit of basic exemption

limit is not available

48,75,724

27,25,000

Therefore, amount of income tax on LTCG

Add : Surcharge @ 10%

27,25,000

2,72,500

Income tax plus surcharge

Add : Education Cess @ 2%

29,97,500

59,950

Tax Liability of Mr. X 30,57,450

Provisions to curb tax avoidance by certain transactions in securities or prevention of dividend Stripping and Bonus-Stripping Transaction [sec 94].

1) Loss on sale of securities or units to be ignored in cases of dividend stripping

[S.94 (7)]: If a person-


Capital Gains 12

a) buys/acquires any securities or units within a period of 3 months prior to

record date,

b) sales/transfers the same within 3 months (9 months in case of unit) after

record date, and

c) the dividend/income on such securities or unit received or receivable by

him is exempt,

Then, the loss, if any arising to him on account of such purchase and sale, to the

extent of dividend or income from securities/unit, shall be ignored while computing

his income chargeable to tax.

2) Loss arising in case of bonus stripping of units to be ignored [S. 94(8)]: in case a

person-

a) buys/acquires any units (' original units'), within a period of 3 months

prior to record date;

b) He is allotted bonus units on the basis of holding of such units on such

date; and

c) he sells or transfers all or any of the original units referred to in (a) within a

period of 9 months after such date, while continuing to hold all or any of the

bonus units referred to in (b),

Then-

(a)The loss, if any, arising to him on account of purchase and sale of original

units shall be ignored in computing his total income, and

(b) The loss so ignored shall be deemed to be the cost of purchase or

acquisition of such bonus units referred to in (b) as are held by him on the

date of such sale or transfer.

Record date: record date means the date fixed by a company for entitlement of

dividend, or by a mutual fund/administration/specified company for entitlement of

dividend of bonus units.

7.17 TREATMENT OF INCOME FROM DEEP DISCOUNT BONDS (DDBs) [Circular

No. 2 dated 18.02.2002]

DDBs are to be valued on 31st March of each financial year. If they are held as

investments, the income therefrom shall be interest income or capital gains.

However, if they are held as trading assets, income therefrom shall be business

income. Tax treatment of income from deep discount bonds is as follows:

1. General

Treatment

Interest Income/Business Income = Difference between the market

valuations as on two successive valuation dates.

Where bond is acquired during the year by an intermediate


Capital Gains 13

purchaser, Interest income/Business Income = Market Value as on

valuation date Actual cost of acquisition

2. Transfer of

Bonds before

maturity

Short-term Capital Gains/Business Income = Sale Price [Cost for

which bond was acquired by the transferor + Income, if any,

already offered to tax by such transferor upto the date of transfer,

as per general treatment given above]

Note: The capital gains arising to investors shall always be short-

term capital gains.

3. Redemption

on maturity

Redeemed by Original Subscriber: Interest Income/Business Income = Redemption price Value as on last valuation date

immediately preceding the maturity date.

Redeemed by an Intermediate Purchaser : Interest Income/ Business Income = Redemption price [Cost at which bonds

were acquired by him + Income, if any, already offered to tax by

the person redeeming the bond]

TAXABILITY OF ZERO COUPON BONDS [ZCBs]

(i) According to Sec. 2(48), Zero Coupon Bonds means a bond -

(a) issued by any infrastructure capital company or infrastructure capital fund or public sector company on or after the 1st day of June, 2005;

(b) in respect of which, no payment and benefit is received or receivable before maturity or redemption from infrastructure capital company or

infrastructure capital fund or public sector company; and

(c) Which the Central Government may, by notification in the Official Gazette, specify in this behalf.

(ii) Any maturity or redemptioin of ZCBs shall be treated as transfer as per Section 2(47) and accordingly subject to tax under the head Capital Gains.

However, in case such bonds are held as stock-in-trade of the business, it

shall be chargeable to tax under the head Profits and Gains of Business or

Profession.

(iii) Any long term capital gain arising from the transfer of ZCBs shall be entitled to a concessional tax rate of 10% without the benefit of indexation or at the

rate of 20% after availing the benefit of indexation.

(iv) In case ZCBs are held for less than 12 months, it shall be considered as short term capital asset u/s 2(42A). However, concessional rate of 10% tax provided

for short-term capital gains on transfer of listed shares u/s 111A is not

applicable to ZCBs. Therefore, short term capital gains on transfer of ZCBs

shall be subject to tax as per normal rates of tax.

SPECIAL PROVISIONS FOR NON-RESIDENTS:

In the case of an assessee who is a non-resident, capital gains arising from

transfer of capital assets being the shares or debentures of an Indian company shall

be computed by converting cost of acquisition, expenses incurred for the transfer

and sale consideration into the same foreign currency as was utilized for the

purchase of shares or debentures as indicated below. The capital gains so

computed in such foreign currency shall be reconverted into Indian currency for the

purpose of further computation First proviso to Section 48 and Rule 115A.


Capital Gains 14

Items Converted/ Reconverted

Rate of Conversion/Reconversion

1. Cost of acquisition The average of telegraphic transfer selling rate and buying rate as on the date of acquisition

2. Expenses incurred for transfer

The average of telegraphic transfer selling rate and

buying rate as on the date of transfer

3. Sale consideration The average of telegraphic transfer selling rate and buying rate as on the date of transfer

4. Capital Gains

[Reconversion]

The buying rate for telegraphic transfer as on the

date of transfer

The conversion and reconversion shall be made on the basis of the rate of

exchange adopted by the State Bank of India.

The aforesaid manner of computation of capital gains shall be applicable in

respect of capital gains arising from every reinvestment thereafter in the shares or

debentures of an Indian company on the sale of such assets.

In these cases, indexation will not be available in the computation of capital gains.

Illustration:

Mr. Fedrick, a non-resident Indian, acquired in January, 2002, shares in

Indian companies for a consideration of Rs.20.50 lakhs by remitting equivalent US

Dollars. In October, 2006, he sold the entire shares for a sum of Rs.33, 00,000

after incurring Rs.66, 000 towards expenses for transfer. You are informed the

details of telegraphic transfer rates of State Bank of India herebelow:

Particulars Buying rate Selling rate

On the date of acquisition

On the date of transfer

40.50

43.50

41.50

44.50

Compute the taxable capital gains on the basis of the above information.

Ans:

Computation of Long Term Capital Gains for the assessment year 2007-08

Particulars Indian Rupees

Rate of Conversion

US $

Sale consideration

Less : Expenses for transfer

33,00,000

66,000

44.00

44.00

75,000

1,500

Net consideration

Less : Cost of acquisition

20,50,000

41.00

73,500

50,000

Capital Gain Assessable 10,22,250 43.50 23,500

capital gains theory-ay0910

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