Capital Gains

Chargeability [Sec.45(1)]

• Any profits or gains arising from the transfer of a capital asset effected in the previous year shall, save as otherwise provided in sections 54, 54B, 54D, 54E, 54EA, 54EB, 54F , 54G and  54H be chargeable to income-tax under the head "Capital gains", and shall be deemed to be the income of the previous year in which the transfer took place.

Capital Gains Liability arises only when following conditions are satisfied

1. There should be capital asset.

2. The capital is transferred by the assessee.

3. Such transfer takes place during the previous year.

4. Any profit or gain as a result of transfer of asset.

5. Such profit or gain is not exempt from tax under section 54, 54B, 54D, 54E, 54EA, 54EB, 54F , 54G and  54H

Exclusion from the definition of capital asset sec. 2(14)

• Exception1: Any stock in trade, consumables stores or raw material held for the purposes of the business or profession.

• Exception 2: Personal effects of the assessee, that is to say, movable property including wearing apparel and furniture held for his personal use or for the use of any member (it does not include jewellery, archaeological collections, drawings, paintings, sculptures, or any work of art.)

• Exception 3: Agricultural land in India provided it is not situated-

a. In any area within the territorial jurisdiction of a municipality.

b. In any notified area

Difference between short term and long-term capital assets

• Capital gains are classified into two types, namely, long term and short term. Capital assets which are held for a period more than 36 months are known as long-term capital assets, whereas capital assets held for a period less than 36 months are termed as short-term capital assets. Capital assets also include shares, debentures and units of mutual funds, but the period of holding in case of these assets is only 12 months and not 36 months. Profit on sale/transfer of long-term capital assets is tax-free whereas profit on short-term capital assets is taxable as regular income.

How to determine period of holding??

• Refer Page No. 453 Direct taxes By V.K.Singhania

Examples

• X purchases a house property on march 10, 2006 and transfers it on June 6, 2008.

• Y purchases shares in an Indian company on March 10, 2006 and transfers it on June 6, 2008.

• Z acquires units of a mutual fund on July 7, 2007 and he transfers these units on July 10, 2008.

• A purchases diamonds on September 12, 2005 and gifts the same to his friend B on December 31, 2006. B transfers the asset on October 20, 2008.

Answers

• Short term

• Long term

• Long term

• Long term. In case of gift the period of holding is determined with reference from the previous owner.

Transfer of capital asset sec. 2(47)

• Definition is not exhaustive - The definition of ‘transfer’ under section 2(47) is merely inclusive and does not exhaust other kinds of transfer - Sunil Siddharthbhai v. CIT/Kartikeya V. Sarabhai v. CIT [1985] 156 ITR 509 (SC).

• Definition of ‘transfer’ in section 2(47) is an inclusive one and does not exclude the contextual or the ordinary meaning of the word ‘transfer’ - There are different shades of meaning of the word ‘transfer’, viz, ‘to make over possession of to another’, ‘a delivery of title or property from one person to another’, ‘to displace from one surface to another’, ‘removal’, ‘displace’. Definition of ‘transfer’ in section 2(47) is an inclusive one and does not exclude the contextual or the ordinary meaning of the word ‘transfer’ - CIT v. Narang Dairy Products [1996] 85 Taxman 375/219 ITR 478 (SC).

Transfer includes sale of capital asset [sec. 2(47) (i)]

• Transfer includes sale. A sale may be defined as a contract founded on money consideration by which absolute or general property in the subject of sale is transferred from the seller to the buyer. The essential of sale are;

(a) Mutual agreement.(b) Competent parties.(c) A money consideration.

Transfer includes Exchange

• Transfer of ownership must be mutual - An exchange involves the transfer of property by one person to another and reciprocally the transfer of property by the other to the first person. There must be a mutual transfer of ownership of one thing for the ownership of another - CIT v. Rasiklal Maneklal (HUF) [1989] 177 ITR 198/43 Taxman 259 (SC).

Transfer includes Relinquishment

• Relinquishment is included within the meaning of the word ‘transfer’ only for the purpose of levying capital gain tax - Relinquishment is included within the meaning of the word ‘transfer’ only for the purpose of assessment to be made for levying capital gain tax and not for other purposes - Tamil Nadu Civil Supplies Corporation Ltd. v. CIT [1997] 228 ITR 399 (Mad.).

• Property must continue to exist - A relinquishment takes place when the owner withdraws himself from the property and abandons his rights thereto; it presumes that the property continues to exist after the relinquishment - CIT v. Rasiklal Maneklal (HUF) [1989] 177 ITR 198/43 Taxman 259 (SC).

Transfer includes Relinquishment

• When agreement for purchase of property is later cancelled, there is relinquishment of right - Where the assessee initially paid advance under an agreement for the purchase of a property, reserving right to specific performance of the agreement, and later received consideration under another agreement under which the earlier agreement was cancelled and the vendor was allowed to sell the property to any person at any price, there was a relinquishment of right by the assessee which amounted to ‘transfer’, and the resulting gain was assessable as capital gains. Since the assessee had paid a sum for acquiring the right to acquire the sale deed, it could not be said that there was no cost of acquisition so as to take the view that there could be no assessment to capital gains - K.R. Srinath v. Asstt. CIT [2004] 141 Taxman 268 (Mad.).

Other Transfers…

• Transfer includes compulsory acquisition of an asset [sec. 2(47)(iii)]

• Transfer includes conversion of a capital asset into stock in trade [sec. 2(47) (iv)]

• Transfer includes redemption of zero coupon bonds

• Transfer includes giving possession of immovable properties under part performance of a contract [sec.2(47) (v)]

TRANSACTIONS NOT REGARDED AS TRANSFER.

• Nothing contained in section 45 shall apply to the following transfers : 

(i) Any distribution of capital assets on the total or partial partition of a Hindu undivided family;

(iii) Any transfer of a capital asset under a gift or will or an irrevocable trust;

(iv) Any transfer of a capital asset by a company to its subsidiary company, if -  (a) The parent company or its nominees hold the whole of the share capital of the subsidiary company; and (b) The subsidiary company is an Indian company; 

(v) Any transfer of a capital asset by a subsidiary  company to the holding company, if -  (a) The whole of the share capital of the subsidiary company is held by the holding company, and (b) The holding company is an Indian company :

• Provided that nothing contained in clause (iv) or clause (v) shall apply to the transfer of a capital asset made after the 29th day of February, 1988, as stock-in-trade;

(vi) Any transfer, in a scheme of amalgamation, of a capital asset by the amalgamating company to the amalgamated company if the amalgamated company is an Indian company; 

(via) Any transfer, in a scheme of amalgamation, of a capital asset being a share or shares held in an Indian company, by the amalgamating foreign company to the amalgamated foreign company, if -  (a) At least twenty-five per cent of the shareholders of the amalgamating foreign company continue to remain shareholders of the amalgamated foreign company, and

(vib) Any transfer, in a demerger, of a capital asset by the demerged company to the resulting company, if the resulting company is an Indian company;

(vic) Any transfer in a demerger, of a capital asset, being a share or shares held in an Indian company, by the demerged foreign company to the resulting foreign company, if - (a) At least seventy-five per cent of the shareholders of the demerged foreign company continue to remain shareholders of the resulting foreign company; and

(vid) Any transfer or issue of shares by the resulting company, in a scheme of demerger to the shareholders of the demerged company if the transfer or issue is made in consideration of demerger of the undertaking;

(vii) Any transfer by a shareholder, in a scheme of amalgamation, of a capital asset being a share or shares held by him in the amalgamating company, if -  (a) The transfer is made in consideration of the allotment to him of any share or shares in the amalgamated company, and

(viii) Any transfer of agricultural land in India effected before the 1st day of March, 1970; 

(ix) Any transfer of a capital asset, being any work of art, archaeological, scientific or art collection, book, manuscript, drawing, painting, photograph or print, to the Government or a University or the National Museum, National Art Gallery, National Archives or any such other public museum or institution as may be notified 753 by the Central Government in the Official Gazette to be of national importance or to be of renown throughout any State or States.

(xii) Any transfer of a capital asset, being land of a sick industrial company, made under a scheme prepared and sanctioned under section 18 of the Sick Industrial Companies (Special Provisions) Act, 1985 (1 of 1986) where such sick industrial company is being managed by its workers' co-operative :

Examples• State giving reasons capital gains is chargeable:• A house property is purchased by a Hindu Undivided

Family in 1950 for Rs. 40,000. It is given to one of the family members in 2008-09 at the time of partition of the family.

• Y purchases gold in 1974 for Rs. 10,000. In 2008-09 it is gifted to his son at the time of his marriage.

• Z purchases 10 convertible debentures in 1985 which are converted into 100 shares in 2008 by the company.

• A Ltd. is 100 percent holding company of B Ltd. A Ltd. transfers a capital asset (acquired in 1947 for Rs. 50,000) to B Ltd. on June 16, 2008 for Rs.2,70,000. B Ltd. is an Indian company, while A Ltd. is a foreign company. The capital asset is transferred as capital asset.

• Suppose in 4 the capital asset is transferred as stock in trade.

Answers…

• No. Hindu Undivided Family.

• No. Gift.

• No. conversion of bonds into shares.

• No. transfer between holding co’ and subsidiary co’.

• Yes.

Computation of Capital Gains

• Full Value of Consideration• Less: Cost of Acquisition*(COA)• Cost of Improvement*(COI)• Expenditure on transfer• Capital Gains• Less: Exemption U/S 54• Taxable Capital Gains* To be indexed in case of LTCA

Full Value of Consideration

• Full value of consideration means & includes the whole/complete sale price or exchange value or compensation including enhanced compensation received in respect of capital asset in transfer. The following points are important to note in relation to full value of consideration.

• The consideration may be in cash or kind.• The consideration received in kind is valued at its fair

market value.• It may be received or receivable.• The consideration must be actual irrespective of its

adequacy.

Cost of Acquisition

• Cost of Acquisition (COA) means any capital expense at the time of acquiring capital asset under transfer, i.e., to include the purchase price, expenses incurred up to acquiring date in the form of registration, storage etc. expenses incurred on completing transfer.In other words, cost of acquisition of an asset is the value for which it was acquired by the assessee. Expenses of capital nature for completing or acquiring the title are included in the cost of acquisition.

• Indexed Cost of Acquisition = COA X (CII* of Year of transfer / CII of Year of acquisition)

*Cost Inflation Index (CII)

Cost of Acquisition• Cost of improvement is the capital expenditure incurred by an

assessee for making any addition or improvement in the capital asset. It also includes any expenditure incurred in protecting or curing the title. In other words, cost of improvement includes all those expenditures, which are incurred to increase the value of the capital asset.

• Indexed Cost of improvement = COA X (CII of Year of transfer / CII of Year of improvement)

• Any cost of improvement incurred before 1st April 1981 is not considered or it is ignored. The reason behind it is that for carrying any improvement in asset before 1st April 1981, asset should have been purchased before 1st April 1981. If asset is purchased before 1st April we consider the fair market value. The fair market value of asset on 1st April 1981 will certainly include the improvement made in the asset.

Expenditure on transfer

• Expenditure incurred wholly and exclusively for transfer of capital asset is called expenditure on transfer. It is fully deductible from the full value of consideration while calculating the capital gain. Examples of expenditure on transfer are the commission or brokerage paid by seller, any fees like registration fees, and cost of stamp papers etc., travelling expenses, and litigation expenses incurred for transferring the capital assets are expenditure on transfer.

Note: Expenditure incurred by buyer at the time of buying the capital assets like brokerage, commission, registration fees, cost of stamp paper etc. are to be added in the cost of acquisition before indexation.

Example

• X purchased a house property for Rs. 1,00,000 on 31st July 2000. He constructed the first floor in March 2003 for 1,10,000. The house property was sold for Rs.5,00,000 on 1st April 2005. The expenses incurred on transfer of asset were Rs.10,000. Find the capital gain.

Answer…• Since the house property is a capital Asset therefore the capital gain will be

computed. The house property was sold after 36 months of its acquisition therefore the capital gain will be long term capital gain (LTCG). Date of improvement (i.e., additional construction of first floor) is irrelevant.

• Full Value of Consideration 5,00,000

• Less: Indexed Cost of Acquisition (COA) 1,00,000x 497/406 1,22,413• Indexed Cost of Improvement (COI) 1,10,000x497/447 1,22,304• Expenditure on transfer 10,000• Long Term Capital Gains

2,45,283• Less: Exemption U/S 54 Nil• Taxable Long Term Capital Gains 2,45,283

Example

• If in the above question the property was acquired by Mr. X on 31st January 2003,then what will be your answer?

• In this case the house property was sold before 36 months of its acquisition therefore the capital gain will be short-term capital gain (STCG). Date of improvement (i.e., additional construction of first floor) is irrelevant.

Answer…

• Full Value of Consideration 5,00,000• Less: Cost of Acquisition (COA)1,00,000 1,00,000• Cost of Improvement (COI)1,10,000 ----• Expenditure on transfer 10,000• Short Term Capital Gains 3,90,000• Less: Exemption U/S 54 -----• Taxable Short Term Capital Gains 3,90,000

Situation 1: This situation covers the case where capital asset is acquired by the assessee before April 1, 1981.

Example: X purchases a house property for Rs.76,000 on June 30, 1967. The following expenses are incurred by him for making addition/alteration to the house property:

Cost of construction of first floor in 1975-76 Rs.1,10,000Cost of construction of second floor in 1982-83 Rs.4,40,000Alteration of the property in 1989-90 Rs.2,90,000Fair Market Value of the property on April 1, 1981 is

Rs.6,50,000. The house property is sold by X on June 15, 2009 for Rs.80,00,000 (expenses incurred on transfer Rs.50,000)

Sale Consideration Rs.80,00,000

Less:

Expenses on transfer Rs.50,000

Indexed Cost of Acquisition Rs.41,08,000

(Rs.6,50,000 x 632/100*)

Indexed Cost of Improvement

Cost of construction of first floor ---

Cost of Const. of second floor Rs.2551192

(Rs.4,40,000 x 632 / 109)

Alteration / Reconstruction Rs.1065581 Rs.77,74,773

Long Term Capital Gains Rs.2,25,226

*Fair Market Value on April 1, 1981 (actual cost of acquisition is ignored as it is lower than fair market value on April 1, 1981)

Situation 2: This situation covers the case where capital asset is acquired by the assessee on or after April 1, 1981.

Shares Self Generated Goodwill

House Property

Sale Consideration 9,50,000 15,00,000 3,15,700

Year of Acquisition 1991-92 N.A. 1983-84

Cost of Acquisition 2,90,000 Nil 18,000

Cost of improvement(1989) - - 10,000

Shares Self Generated Goodwill

House Property

Sale Consideration 9,50,000 15,00,000 3,15,700

Indexed Cost of acquisition

9,21,055 Nil **98,069

Indexed Cost of improvement

Nil Nil ***36,744

LTCG 28,995 15,00,000 1,80,887

*2,90,000 x 632/199

**18,000 x 632 / 116

***10,000 x 632/172

Situation 3: This situation covers the case where capital asset is acquired by the assessee before April 1, 1981 in one of the circumstances specified by section 49(1) and the same is originally acquired by the previous owner prior to April 1 ,1981.

X purchases for Rs.26,000 a house property on May 10, 1962. He gets the first floor of the house constructed in 1967-68 by spending Rs. 40,000. He dies on September 12, 1978. The property is transferred to Mrs. X by his will. Mrs X spends Rs. 30,000 and Rs.36,700 during 1979-80 and 1984-85 respectively for renewals of the property. Mrs. X sell the house property for Rs.24,50,000 on March 15, 2010(brokerage paid by Mrs.X is Rs.24,500). The fair market value of the house on April 1, 1981 is Rs.2,68,000

Sale Consideration 24,50,000

Less:

Expenditure on transfer 24,500

Indexed Cost of Acquisition

(2,68,000 X 632 / 100) 16,93,760

Indexed Cost of Improvement

(36,700 X 632 / 125) 1,85,555 19,03,815

5,46,185

Situation 4 : This situation covers the case where capital asset is acquired by the assessee on or after April 1, 1981 in one of the modes referred in to in section 49(1) but it was originally acquired by the previous owner before April 1, 1981.

.

ExampleX purchases a property on April 1, 1976 for Rs.95,000. He enters into

an agreement for sale of the property to A on November 1, 1982. and receives Rs.10,000 as advance. A could not, however, keep his promise and advance of Rs. 10,000 given by him is forfeited by X. Later on he gifts the property to his friend Y on May 15, 1984. The following expenses are incurred by X and Y for renewal of the property.

Addition of two rooms by X during 1978-79 35,000Addition of the first floor by X during 1982-83 45,000Addition of the second floor by Y during 1989-90 1,25,000Fair Market Value of the property on April 1, 1981 is Rs.2,45,000Y enters into an agreement to sell the property for Rs. 8,50,000 to B on

April 1, 1994 after receiving an advance of Rs. 50,000. B could not pay the balance within the stipulated time of two months and Y forfeits the advance of Rs.50,000 as per agreement with B. Ultimately Y finds buyer C to whom property is transferred for Rs.23,75,000 on December 1, 2009. Compute the capital gain chargeable to tax in the hands of Y for the assessment year 2010-11.

Sale Consideration 23,75,000

Less:

Indexed Cost of Acquisition

(65,000* x 582 / 133) 2,84,436 2,84,436

Indexed cost of improvement

(40,000 x 582 / 116) 2,00,960

(1,15,000 x 582 / 133) 3,67,747 5,68,437

22,127

*1,15,000 – 50,000 = Rs. 65,000

• Section 5: This situation covers the case where capital asset is acquired by the assessee on or after April 1, 1981 in one of the modes referred to in section 49(1) and it was originally acquired by the previous owner on or after April 1, 1981

Capital Gains exempt from taxSection 54Subject to the provisions of sub-section (2), where, in the

case of an assessee being an individual or a Hindu undivided family], the capital gain arises from the transfer of a long-term capital asset , being buildings or lands appurtenant thereto, and being a residential house, the income of which is chargeable under the head “Income from house property” (hereafter in this section referred to as the original asset), and the assessee has within a period of [one year before or two years after the date on which the transfer took place purchased], or has within a period of three years after that date constructed, a residential house, then], instead of the capital gain being charged to income-tax as income of the previous year in which the transfer took place, it shall be dealt with in accordance.

(i) if the amount of the capital gain 92[is greater than the cost of 93[the residential house] so purchased or constructed (hereafter in this section referred to as the new asset)], the difference between the amount of the capital gain and the cost of the new asset shall be charged under section 45 as the income of the previous year; and for the purpose of computing in respect of the new asset any capital gain arising from its transfer within a period of three years of its purchase or construction, as the case may be, the cost shall be nil; or

(ii) if the amount of the capital gain is equal to or less than the cost of the new asset, the capital gain shall not be charged under section 45; and for the purpose of computing in respect of the new asset any capital gain arising from its transfer within a period of three years of its purchase or construction, as the case may be, the cost shall be reduced by the amount of the capital gain.

Section 54B[Subject to the provisions of sub-section (2), where

the capital gain arises] from the transfer of a capital asset being land which, in the two years immediately preceding the date on which the transfer took place, was being used by the assessee or a parent of his for agricultural purposes 3[(hereinafter referred to as the original asset)], and the assessee has, within a period of two years after that date, purchased any other land for being used for agricultural purposes, then, instead of the capital gain being charged to income-tax as income of the previous year in which the transfer took place, it shall be dealt with in accordance with the following provisions of this section, that is to say,—

(i) if the amount of the capital gain is greater than the cost of the land so purchased (hereinafter referred to as the new asset), the difference between the amount of the capital gain and the cost of the new asset shall be charged under section 45 as the income of the previous year; and for the purpose of computing in respect of the new asset any capital gain arising from its transfer within a period of three years of its purchase, the cost shall be nil; or(ii) if the amount of the capital gain is equal to or less than the cost of the new asset, the capital gain shall not be charged under section 45; and for the purpose of computing in respect of the new asset any capital gain arising from its transfer within a period of three years of its purchase, the cost shall be reduced, by the amount of the capital gain.]

Section 54EC

Investment in Certain Bonds such as Bonds of National Highways Authority of India or Rural Electrification of India.

Conditions:

1.Investment should be done within 6 months from the date of transfer.

2. Amount of investment or amount of capital gain whichever is lower is exempted.

Benefits of other section for exemption

• Section 54D

• Section 54F

• Section 54G

• Section 54GA