Compile by Anup A. Mohabansi
Profit from the transfer or sale of a capital asset is chargeable to tax under the head "Capital Gain" in the year in which capital asset is sold or transferred. Capital asset means property of any kind i.e. movable or immovable, tangible or intangible. However the following assets cannot be treated as capital assets:-
• Raw material, stock, spares and other inventories used for the purpose of the assessee's business or profession.
• Personal Assets i.e. movable property used for personal use of the assessee or of his family members dependent on him. However personal effects does not include jewellery. In other words, though Jewellery is a movable property held for personal use, it will still be treated as capital asset.
• Agricultural land situated in rural areas
• Special Bearer Bonds, 1991 issued by the Central Government
• 6 1/2 per cent Gold Bonds, 1977 issued by the Central Government
• 7 per cent Gold Bonds, 1980 issued by the Central Government
• National Defense Gold Bonds issued by the Central Government
• Gold deposit Bonds issued under the Gold Deposit Scheme., 1999
In certain case, though a capital asset is transferred i.e. the ownership of the asset changes, the transfer will not be subject to capital gains tax. The following transactions are not regarded as transfers i.e. such transfers do not invite any taxable capital gain:-
1. Distribution of assets in kind by a company to its shareholders on liquidation
2 .Distribution of capital assets in kind by an Hindu Undivided Family to its members at the time of total or partial partition
3. Transfer of capital asset under a gift or will or irrevocable trust. However, this exemption will not apply to transfers under gift or irrevocable trust of securities allotted to employees under ESOP schemes under Central Government guidelines.
4. Transfer of a capital asset by a company to its wholly owned Indian subsidiary company.
5. Transfer of a capital asset by wholly owned subsidiary company to its Indian holding company.
6. Any transfer in the scheme of amalgamation of a capital asset by an amalgamating company to the amalgamated company if the transferee company is an Indian company.
7. Any transfer of shares in an Indian company held by a foreign company to another foreign company in pursuance of scheme of amalgamation between two foreign companies in which at least 25 per cent shareholders of the amalgamating company continue to remain shareholders of the amalgamated company and such amalgamation does not attract capital gains tax in the country in which the amalgamated country is incorporated.
8. Any transfer by a shareholder, in a scheme of amalgamation, of shares held by a shareholder in the amalgamating company if the transfer is made against allotment of shares of the amalgamating company and the amalgamating company is an Indian company.
9) Any transfer made by a non-resident of such foreign currency convertible bonds or shares as may be specified by the Central Government to another non-resident where the transfer is made outside India.
10. Any transfer by way of conversion of bonds or debentures or deposits in any form of a company into shares or debentures of that company.
11. Any transfer of a capital asset which is a work of art or of archaeological, scientific or artistic importance to the government or to a university or to the National Art Gallery or any other such public museum or art gallery as may be notified by the Central Government. for example Indira Gandhi National Center of Art.
12. Any transfer made on or before 31/12/1998 by a person who is a member of a recognised stock exchange to a company of his membership rights in the stock exchange to company incorporated for this purpose
13.Any transfer of land by a sick industrial company under the scheme prepared by BIFR where such sick industrial company is being managed by its workers cooperative, provided such transfer is made during the period of sickness.
14 .Conversion of a partnership into a company
Where a partnership firm is succeeded by a company and in the course of which any capital asset is transferred to the company from the firm, there will not be any taxable capital gains if the following conditions are satisfied:-
• All assets and liabilities relating to the business of the firm before the succession become the assets and liabilities of the company.
• All partners of the firm become shareholders in the company in the same proportion in which their capital accounts stood in the books of the firm.
• The partners do not receive anything apart from shares in the aforesaid company for agreeing to the succession.
• The aggregate shareholding of the partners in the company does not fall below 50 per cent of the total voting power in the company for at least five years from the date of succession.
15. Conversion of sole proprietorship concern into a company
Where a sole proprietorship concern is succeeded by a company in the course of which any capital asset is transferred to the company from the sole proprietorship concern, there will not be any taxable capital gains if the following conditions are satisfied:-
• All assets and liabilities relating to the business of the sole proprietorship concern before the succession become the assets and liabilities of the company.
• The sole proprietor becomes a shareholder in the company.
• The sole proprietor does not receive anything apart from shares in the aforesaid company for agreeing to the succession.
• The aggregate shareholding of the sole proprietor in the company does not fall below 50 per cent of the total voting power in the company for at least five years from the date of succession.
16. Where there is a demerger, any transfer of a capital assets by the demerged company to the resulting company will not lead to any taxable capital gains provided the resulting company is an Indian company.
17. Any transfer in a demerger, of shares held in an Indian company by the demerged foreign company to the resulting foreign company will not lead to any taxable capital gains, if the following conditions are satisfied:-
• at least 75per cent of the share holders of the demerged foreign company continue to remain shareholders of the resulting foreign company ; and
• such transfer does not attract capital gains tax in the country in which the demerge foreign company is incorporated.
18. Any transfer or issue of share by the resulting company in a scheme of demerger to the shareholder of the demerged company will not lead to a taxable capital gains if the transfer or issue is made in consideration of demerger of the undertaking.
19.Corporatization of Stock Exchanges : Where any recognised stock exchange is corporatized which leads to transfer of any capital asset to the corporate entity, there will not be any taxable capital gains if the following conditions are satisfied:-
• All assets and liabilities relating to the business of the stock exchange before the corporatization become the assets and liabilities of the company.
• The corporatization is carried out in accordance with a scheme for corporatization approved by SEBI.
Withdrawal of Exemption
In the following situations though generally the transfer is treated as non taxable transfer, the exemption will be withdrawn:-
1. (Refer Point 12 above) Where at any time before the expiry of three years from the date of transfer of membership rights in a stock exchange to the company, the transferor sells the shares in the company so that his share holding stands reduced. It will be treated as taxable transfer in the year of such sale.
2. (Refer Points 4 & 5 above) Where a capital asset has been transferred by an Indian holding company to a 100per cent Indian subsidiary company or vice versa then it will not be generally treated as taxable transfer. However if the parent company transfers any shares in the subsidiary company within a period of eight years from the date of transfer of the capital asset or the transferee company treats the capital asset as stock-in- trade within the aforesaid period of eight years, then the exemption granted earlier will be withdrawn.
3. (Refer Points 14 & 15 above) Where at any time before the expiry of five years from the date of succession, the conditions specified in points 14 or 15 as the case may be are contravened, the capital gains which were not taxed will be taxed in the hands of the company.
Capital Assets can be divided into two types:
1. Long Term Capital Assets and
2. Short Term Capital Assets.
When a long-term capital asset is transferred, it gives rise to long term capital gain or capital loss. When a short-term capital asset is transferred, it gives rise to short term capital gain or capital loss.
Short-term capital asset means a capital asset held by an assessee for less than 36 months before it is transferred. However in case of shares held in a company or any other listed securities or units of the UTI or any units of a recognised mutual fund, the period of 36 months is substituted by 12 months ie if such shares, debentures or units are held for 12 months, they become long term capital assets. In determining the period for which the capital asset has been held by the assessee the following are the important rules -
1. In case of share held in company liquidation the period subsequent to the date of liquidation will not be counted.
2. In case capital assets have become the property of the assessee in circumstances mentioned in 49(1) [See Para on Section 49 (1) below ], in determining the period, the period for which the capital asset was held by the previous owner will also be counted.
3. In case of shares in an Indian company which become the property of the assessee against shares of an amalgamated company, the period for which the shares in the amalgamated company were held by the assessee will also be counted.
4. In case of rights issue of shares or other securities subscribed to by the assessee on the basis of his rights to subscribe the counting of the period shall start from the date of allotment.
5. In case of renunciation of a rights issue, for the person who has acquired the rights, the period shall be reckoned from the date of the offer of such rights by the company or institution.
6. In case of a bonus issue, allotted without payment on the basis of holding of any other financial asset, period shall be reckoned form the date of allotment of such financial asset.
7. Sometimes a company may allot shares or securities to its employees under a stock option scheme. When such shares or securities are sold by the employee, the employee will be liable to capital gains tax on the sale value less cost of acquisition / indexed cost of acquisition.
8. Where the company buys back its own shares in accordance with the provisions of section 77A of the Companies Act, 1956, the difference between the cost of acquisition / index cost of acquisition and the value of a consideration received by the shareholders will be deemed to be capital gains in the hands of the shareholders in the year of buyback.
9. Cost of acquisition of shares in the resulting company in case of a demerger shall be determined as follows:-
Cost of shares of the demerged company x Net book value of assets Net worth of demerged company before demerger and the cost of acquisition of the original shares in the demerge company shall be reduced by the amount calculated as above
Method of computing long term capital gains
In order to obtain the amount of long term capital gain on sale of a long term capital asset, from the sale proceeds the expenses on transfer are to be reduced. From the balance amount the indexed cost of acquisition and indexed cost of improvement are to be deducted to get the amount of taxable capital gains or capital loss.
Indexed cost for acquisition means the cost of acquisition of the capital asset indexed by the cost inflation index of the year of sale divided by the cost inflation index of the year of acquisition. The central government notifies index number for each previous year having regards to the consumer price index for urban non-manual employees in each year.
The following are the cost inflation indices notified by the government:-
|Financial Year||Index||Financial Year||Index|
For example if the asset was acquired on 31 May 1994 for Rs10,000, it is substantially improved on 30 June 1996 for Rs5,000 and it is sold on 10 December 1998 for Rs75,000, indexed cost of acquisition will be Rs13,552 (10,000*351/259), indexed cost of improvement will be Rs5,755 (5,000*351/305) and long term capital gains will be Rs. 55693 (75,000-13,552-5,755)
If the asset was acquired prior to 1/4/81, the index of the year of acquisition will be taken to be 100.
However in respect of bonds and debentures even though they may qualify to be called long term capital assets, no indexation benefits will be available to the assessee. This is because bonds and debentures are normally issued and redeemed at par and if benefit of indexation is given, it will always give capital loss.
Option available to assessee in calculating long term capital gains on sale of listed securities.
When an assessee has made long term capital gain on sale of listed securities he has two options (He may choose that option where tax payable is lower)
He may compute long term capital gains as follows and pay tax @ 20 per cent thereon.
Less: Expenses on transfer
Less: Indexed cost of acquisition
Less: Indexed cost of improvement
Tax on LTCG @ 20 per cent
He may compute long term capital gains as follows and pay tax @ 10per cent thereon.
Less: Expenses on transfer
Less: Cost of acquisition
Less: Cost of improvement
Tax on LTCG @ 10 per cent
Method of computing short term capital gains
In order to obtain the amount of short term capital gains or loss, from the amount of sales proceeds deduct the expenses incurred on transfer. From the balance, deduct cost of acquisition and cost of improvement. to obtain the short term capital gains or loss. No indexation will be available in respect of short-term capital gains or capital loss.
A concessional rate on income tax is chargeable on long term capital. As far as short-term capital gains is concerned it is treated as normal income and normal rates of income tax are applicable. Long term capital gains are taxable at a flat rate of 20 per cent after claiming indexation of cost or 10 per cent without claiming cost indexation.
Section 49 (1)
Cost to the previous owner and situations where the holding period of the previous owner must also be considered
The cost to the previous owner as well as the period for which the capital asset was held by the previous owner must be considered in following cases ie the cost of previous owner will be considered as cost of the current assessee for determining the profit or loss on transfer of a capital asset:-
• Acquisition of property on distribution of assets on the total or partial partition of any HUF. ie the cost of the capital asset to the HUF will be considered as cost in the hands of the assessee in determining his profit when he transfers such a capital asset. Similarly, the period for which the asset was held by the HUF will also be considered. for example An HUF acquired a flat on 30 June 1994 for Rs500,000. The HUF was partitioned on 31 May 1997 and the flat was allotted to Mr A as his share in HUF property. Mr A sells the flat for Rs. One million on 1 April 1998. In this case, on partition of HUF, if any property is alloted to any family members, there is no taxable transfer in the hands of the HUF (See exempt transfers above) Therefore, though there is a change in ownership of the flat from HUF to Mr A on 31 May 1997, there will not be any capital gains tax in the hands of HUF. When Mr A sells the flat, cost of the flat for him will be taken to be Rs500,000 though he has not paid any price for the flat. Similarly it will be treated as if he had acquired the flat on 30 June 1994 though he became the owner only on 31 May 1997. Therefore, it will be treated as if he held the flat for 45 months. Consequently, it will give rise to long term capital gains.
• Acquisition of property under a gift or will. However, this will not apply to gift or transfer through an irrevocable trust of shares, debentures or warrants allotted by a company directly or indirectly to its employees under a Central Government approved employees stock option scheme. In such cases, the market value of the shares, debentures or warrants gifted or transfered to the irrevocable trust on the date of transfer will be treated as the sale proceeds for the purpose of capital gains.
• Acquisition of property by succession, inheritance or devolution.
• Acquisition of property on distribution of assets on liquidation of company.
• Acquisition of property under a revocable or irrevocable trust.
• Acquisition of property on transfer by a wholly owned Indian subsidiary company from its holding company and by a parent company to its 100 per cent Indian subsidiary company.
• Acquisition of property on any transfer in scheme of amalgamation by the amalgamated company from the amalgamating company.
• Acquisition of property by Hindu undivided family where one of the members has converted its self acquired property into a joint family property.
Cost of acquisition in case of advance money received
In computing the cost of acquisition in a case where the capital asset was on an earlier occasion subject to negotiation for its transfer and any advance or other money, whether by way of earnest money or otherwise, was received and forfeited by the assessee because the negotiation failed, such money forfeited is be deducted from the cost of acquisition of the capital asset in computing the capital gains when the capital asset is ultimately sold. eg Mr A had acquired a capital asset on 31 May 1995 for Rs. one million. He wanted to sell the asset in 1996 and entered negotiation for this purpose. The prospective buyer gave him advance money of Rs100,000 at that time. However, the negotiations failed and Mr A forfeited the Rs100,000 advance money. Subsequently, he actually sold the asset in 1998 for Rs two million. In this case, cost of acquisition for Mr A will be Rs900,000 (Cost less money forfeited)
Cost of acquisition where debentures are converted into shares
In case debentures, debenture stocks or deposit certificates in any form of a company are converted into shares or debentures, such conversion will not be treated as a taxable transfer. However, when the shares obtained on conversion are sold, the cost of acquisition of the shares sold will be that part of the cost of debenture stock or debenture stock, debenture certificate which has been appropriated towards the shares.
Cost of acquisition of bonus shares
Cost of acquisition of bonus shares will be treated as nil. However if the bonus shares have been acquired prior to 1/4/81, then the share market value of bonus shares as on 1/4/81 will be treated as the cost of acquisition.
Substitution of fair market value as on 1/4/81
Fair market value in relation to a capital asset means the price that the capital asset would ordinarily fetch on sale in the open market on the relevant date. If the assessee has acquired the asset prior to 1/4/81, he has the option of substituting the fair share market value of the asset as on 1/4/81 instead of actual cost of acquisition. However this option is available to the assessee only when the asset has been acquired prior to 1/4/81.
Cost of Improvement
Cost of Improvement means any expenditure or cost incurred by the assessee for substantially improving or raising the value of the capital asset. Cost of improvement includes all expenditure of capital nature incurred by an assessee in making addition to capital asset after date of acquisition. It also includes any expenditure incurred to protect or complete the title of the capital asset or to cure such title or remove any defect from the title. Cost of improvement in relation to capital asset means:-
• Where the capital asset becomes the property of the assessee in circumstances mentioned in section 49(1), all capital expenditure incurred in making alterations in the capital asset by the assessee or previous owner.
• In case of a capital asset acquired prior to 1/4/81, where the fair market value of the capital asset as of 1/4/81 is substituted in place of cost of acquisition, all capital expenditure incurred assets by the assessee or the previous owner after 1/4/81 in making any additions or alterations to capital asset. However, cost of improvement incurred prior to 1/4/81 will be ignored in all cases.
• In any other case all capital expenditure incurred in making in additions or alterations to the capital asset by the assessee after it become his property.
Conversion of capital asset into stock-in-trade
When the assessee converts a capital asset held by him into stock-in-trade, it will be treated as taxable transfer giving rise to notional capital gains or loss. For this purpose, the fair market value of the capital asset on the date of conversion is treated as notional sale proceeds from which the cost of acquisition / indexed cost of acquisition is deducted in order to get the capital gain. Later, when this converted capital asset is sold there will be business profit or loss i.e. actual sale proceeds less notional fair market value taken, as cost will be the taxable business profit or loss. However business income as well as capita gains are chargeable to tax only in the year of actual sale to a third party.
Introduction of capital asset by a partner in a partnership firm as his capital contribution will give rise to capital gains in the hands of the partner. For this purpose, the amount credited to the partner's capital account on account of this capital asset will be treated as sales proceeds in the hands of the partner from which the cost or indexed cost of acquisition will be reduced to get the amount of taxable capital gains or loss.
Takeover of assets by the partner on dissolution of the partnership firm
In such a case, there will be taxable capital gains in the hands of the firm. The fair market value of the capital asset on the date of dissolution of the firm will be treated as sales proceeds from which the cost of acquisition or indexed cost of acquisition, as the case may be, will be reduced to get the amount of taxable capital gains in the hands of the firm.
Compulsory acquisition of capital asset
Where there is compulsory acquisition of capital asset by the government or any government authority under law, there will be a taxable capital gain or loss in the year of such compulsory acquisition. However such capital gain will be chargeable only in the year in which the consideration is received. If the compensation is enhanced later, then the receiver of such additional amount is chargeable to capital gains in the previous year in which such additional capital gains is received.
Capital gains on transfer of self generated assets
Self-generated assets are assets which are created in the course of business and profession and for which the assessee has not incurred any substantial capital expenditure. For example patents, copyrights, goodwill, tenancy rights, etc. Generally when a self-generated asset is sold, the law provides that there will not be any capital gain. However if the following self generated capital assets are sold, there will be taxable capital gains:-
• Goodwill of a Business
• Trade Mark or Brand Name associated with a business
• Tenancy Rights
• Loom Hours
• Route Permits
• Right to manufacture or produce any process any article
Cost of acquisition on sale of the aforesaid self-generated assets will be treated nil. In other words, the entire sale proceeds less expenses on transfer will be treated as capital gain. In case such assets have been acquired for a price from some other person, they cannot be called self-generated assets and therefore the other normal provisions of the Income Tax Act apply.
Capital gain on amount received by shareholder at the time of liquidation of the company
Out of the money received by the shareholder, a part of the amount will be treated as deemed dividend under section 2(22) (Refer chapter on "Income from Other Sources") and the remaining amount less the indexed cost of acquisition or cost of acquisition, as the case may be, is taxable as capital gains on sale of the shares.
Capital gain in respect of depreciable assets
In respect of sale of a capital asset on which depreciation has been charged, capital gain will arise only if the full value of sale price exceeds the aggregate of the following:-
• Incidental expenses on transfer
• The written down value of the block at the beginning of the previous year.
• Cost of acquisition of the asset falling in that block of assets during the previous year
The resulting figure, if gain would be short term capital gain if loss would be short term capital loss.
Capital Gains on a Slump Sale
Slump sale means the transfer of one or more undertakings by way of sale for a lumpsum consideration without assigning values to individual assets and liabilities of the undertaking. In such cases of slump sale, the undertaking itself will be treated as a capital asset. When the undertaking is sold, it will give rise to long term or short-term capital gain depending on how long the business is owned by the assessee. In such cases, the net worth of the undertaking will be treated as the cost of acquisition and the cost of improvement of the undertaking for the purpose of calculation of capital gain. No indexation will be allowed in case of long-term capital gains.
Capital Gains on Sale of Shares under Depository System
Where an assessee has any depository account and any shares are sold from the depository account, then such cost of acquisition of the shares sold will be determined on FIFO i.e. on first in first out basis. It will be assumed that the assessee is shares deposited in the account first were sold first and accordingly the cost of acquisition, date of acquisition and the period of holding will be calculated.
The CBDT has come out with a circular that any share given under the stock-lending scheme approved by SEBI in this behalf will not give rise to any taxable capital gain.
Corporatization of Stock Exchanges
In case any person transfers equity shares alloted to him as member of a recognised stock exchange in India under a SEBI approved scheme of corporatization of stock exchanges, his original cost of acquisition of membership of the stock exchange will be the cost of acquisition for computation of capital gains on those shares.
Deductions from Capital Gains
In respect of certain types of capital gains, certain deductions are made available to assessee if he satisfies the conditions mentioned in the relevant sections for this purpose. The balance amount, which is remaining after claiming the deductions, will be the amount of taxable capital gain. Let us discuss the various deductions available to the assessee.
Capital gains on transfer of residential building and land appurtenant thereto - Section 54
The following are the conditions to be satisfied:-
• There must be a long-term capital gain on sale of a residential house property.
• The property should be a residential property.
• This exemption is available to individuals and HUF only and not to other assessees such as firms and companies.
• Investment must be made in another residential property within 1 year before or two year after the date of transfer or if the property is to be constructed, the construction is to be completed within three years from the date of transfer.
In order to claim this deduction, where the assessee has not already acquired the new house property, the amount of deduction proposed to be claimed must be temporarily deposited before the due date for filing the return of income in a "Capital Gains Account" with a nationalised bank specified by the government and the amount so deposited must be used for the purpose of making investment in new house within the allowed time. The new property must be held for at least 36 months before it is sold; otherwise the gain on transfer of the new property becomes chargeable to tax as short-term capital gain and for calculating the gain on new property, cost of acquisition of the new property will be actual cost less deductions which has been claimed in respect of the original transfer. Such a transfer will be treated as short-term capital gain for the previous year in which the new property is sold if it is sold within 36 months. If the amount deposited in the bank is not used at all or the entire amount is not so used, the unutilised balance will be taxable as long term capital gain of the previous year in which the period of three years expires.
1. A sells a residential house property in Mumbai for Rs1.5 million on May 15, 1996 which was purchased by him on June 11, 1982 for Rs200,000. On June 15, 1996 he purchases House I for Rs200,000 and further he deposits in the Deposit account Rs700,000 on June 30, 1997. Out of the deposit account he acquires House II on May 10, 1998 for Rs 400,000.
2. On June 10, 1998 X sells House I for Rs400,000. Further on March 8, 1999 he sells House II for Rs800,000.
3. Out of the Deposit account, he does not purchase any other house.