Any gain arising from the transfer of a capital asset during a previous year is chargeable to tax under the head “Capital Gains” in the assessment year immediately following the previous year unless it is eligible for exemption under sections 54, 54B, 54D, 54EC, 54F, 54G, 54GA, and 54GB. For a gain to be taxed under capital gains, the following conditions must be fulfilled. There must be a capital asset, the capital asset must be transferred by the assessee, the transfer must take place during the previous year, a profit or gain must result from the transfer, and the profit or gain must not be exempt under the relevant sections. If all these conditions are satisfied, the capital gain is taxable in the relevant assessment year.
What Is Included and Excluded from Capital Assets
A capital asset is defined under section 2(14) and includes property of any kind, whether movable or immovable, tangible or intangible, fixed or circulating. It includes rights in or about an Indian company, securities held by a Foreign Institutional Investor as per SEBI regulations, and any unit-linked insurance plan issued on or after February 1, 2021, where exemption under section 10(10D) is not available due to premiums exceeding the prescribed limit.
Assets excluded from the definition of capital assets include stock-in-trade, personal effects, agricultural land in rural areas in India, specified gold bonds, and certificates under certain schemes.
Stock-in-Trade Is Not a Capital Asset
Stock-in-trade, consumable stores, or raw materials held for business or profession are not capital assets. Surplus arising from their sale is taxable as business income under section 28. The classification of an asset as stock-in-trade depends on the nature of the taxpayer’s business. For instance, for a real estate developer, properties are stock-in-trade, and profits on sale are taxed as business income. However, if a doctor sells a property, the gain is taxed under capital gains.
Personal Effects Are Not Capital Assets
Movable property, such as apparel or furniture, held for personal use or use by dependent family members, is not considered a capital asset. However, items like jewellery, archaeological collections, drawings, paintings, sculptures, and works of art are capital assets even if held for personal use.
Agricultural Land in a Rural Area Is Not a Capital Asset
Agricultural land in India that is located in a rural area is not treated as a capital asset and is therefore excluded from capital gains tax provisions.
Classification into Short-Term and Long-Term Capital Assets
Capital assets are categorized as short-term or long-term based on the period of holding. As of July 23, 2024, an asset held for more than 24 months is considered long-term, except for certain assets where the threshold is 12 months. These include listed securities, units of equity-oriented mutual funds, listed units of debt-oriented mutual funds, and zero-coupon bonds.
Before July 23, 2024, the general threshold for a long-term asset was more than 36 months, with exceptions at 24 or 12 months for specific assets.
Determination of Holding Period
The Income-tax Act provides specific rules to determine the period of holding for various cases. The holding period classification affects the tax rate, with long-term capital gains generally taxed at a lower rate than short-term capital gains.
Treatment of Depreciable Assets
When a depreciable asset is transferred, the resulting gain is always treated as short-term capital gain, regardless of the period of holding. An exception exists for power-generating units eligible for straight-line depreciation.
Meaning of Transfer under Section 2(47)
Transfer, about a capital asset, includes sale, exchange, relinquishment of the asset, extinguishment of rights, or compulsory acquisition under any law. This wide definition ensures various transactions are covered under the capital gains framework.
Transactions Not Regarded as Transfer
Certain transactions are not treated as a transfer under section 45. These include distribution of assets by companies upon liquidation, partition of Hindu Undivided Families, transfer under a gift or will, transfers between holding and subsidiary companies when the transferee is an Indian company, transfers under schemes of amalgamation or demerger, and conversion-related transfers involving firms, companies, and LLPs under prescribed conditions. Also excluded are specified securities transactions between non-residents and certain transfers of Sovereign Gold Bonds, works of art to institutions, or conversions related to Gold Receipts.
When Transfer Is Complete and Effective
For immovable property, transfer is recognized when a conveyance deed is executed and registered. If documents are not registered, transfer may still be recognized under section 53A of the Transfer of Property Act if there is a registered agreement to sell, the transferee has paid consideration or is willing to perform the contract, and possession has been taken.
For movable property, transfer is complete when the property is delivered under a sale contract. Book entries are not relevant in determining the date of transfer for movable assets.
Computation of Capital Gains under Section 48
The computation of capital gains depends on whether the asset is a short-term or long-term capital asset. For both, the following steps are applied. Determine the full value of consideration received or receivable, deduct expenditure incurred exclusively in connection with the transfer, deduct the cost of acquisition, and deduct the cost of improvement.
For short-term capital gains, after making the above deductions, the remaining amount is taxed as short-term capital gain. For long-term capital gains, the applicable exemptions under sections 54, 54B, 54D, 54EC, 54EE, 54F, 54G, 54GA, and 54GB are also deducted before arriving at the taxable gain.
Capital Gains Not Chargeable to Tax
Certain capital gains are exempt from tax under section 10. These include gains from the transfer of US64 units after April 1, 2002, long-term gains on specific BSE-500 index shares bought between March 1, 2003, and March 1, 2004, and gains from the compulsory acquisition of urban agricultural land if the land was used for agriculture and compensation is approved by the Central Government or RBI.
Also exempt are gains from compensation received under the Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act, 2013. Another exemption is available under section 115JG(1) for capital gains arising from the conversion of an Indian branch of a foreign bank into an Indian subsidiary, subject to RBI guidelines and government notifications.
Full Value of Consideration
The full value of consideration is the total amount received or receivable by the seller for transferring the asset. It may be in cash or kind. If consideration is in kind, the fair market value of the property received is considered. The market value of the transferred asset is not the basis unless specifically mandated.
In cases where the stamp duty value of land or building exceeds 110 percent of the declared sale consideration, the stamp duty value is deemed the full value of consideration. If consideration is not determinable, the fair market value of the asset is used as the full value.
It does not matter whether the consideration has been received during the previous year. The gain is taxable in the year of transfer regardless of when payment is made.
Expenditure on Transfer
Expenditure wholly and exclusively incurred in connection with the transfer is deductible. This includes brokerage or commission for finding a buyer, registration fees and stamp duty borne by the seller, travel expenses related to the transaction, and litigation costs for enhanced compensation in compulsory acquisition cases.
Cost of Acquisition
The cost of acquisition is the price paid to acquire the asset, including capital expenses for acquiring or completing title. Interest on borrowed funds used to acquire the asset is included in the acquisition cost.
Mortgage repayment is deductible if the mortgage was created by someone other than the assessee. For example, if a widow inherits a mortgaged house and clears the dues before selling it, the repayment is added to her acquisition cost. However, if the assessee created the mortgage herself, the repayment is not deductible.
Interest deducted under section 24(b) or Chapter VI-A cannot be included again in the cost of acquisition.
Transfer of Capital Assets
The term “transfer” about a capital asset includes sale, exchange, relinquishment, or extinguishment of rights therein. It also includes the compulsory acquisition of an asset, conversion of capital asset into stock-in-trade, maturity or redemption of a zero-coupon bond, and allowing possession of any immovable property in part performance of a contract as per Section 53A of the Transfer of Property Act, 1882. It also includes any transaction involving the allowing of possession of immovable property or any transaction under a development agreement. However, certain transfers are not regarded as “transfer” for capital gains purposes, such as distribution of assets on partition of a Hindu Undivided Family, transfer under gift or will or an irrevocable trust, transfer of capital asset by a company to its 100% subsidiary or vice versa (subject to certain conditions), and any transfer in a scheme of amalgamation or demerger (also subject to conditions).
Types of Capital Gains
There are two types of capital gains: short-term capital gains (STCG) and long-term capital gains (LTCG). The classification is based on the holding period of the capital asset. For listed equity shares and equity-oriented mutual funds, if the holding period is more than 12 months, the gain is long-term; otherwise, it is short-term. For immovable property like land and buildings, if the holding period is more than 24 months, the gain is long-term; otherwise, it is short-term. For all other assets, the holding period threshold for long-term capital gain is 36 months.
Computation of Capital Gains
Capital gain is computed as the difference between the full value of consideration received or accruing as a result of the transfer of the capital asset and the aggregate of expenditure incurred wholly and exclusively in connection with such transfer, and the cost of acquisition and the cost of improvement. In case of long-term capital gain, the cost of acquisition and cost of improvement are indexed by applying the cost inflation index (CII) to adjust for inflation. In case of short-term capital gains, the indexation benefit is not available. The formula for computing capital gains is as follows: Capital Gains = Full Value of Consideration – (Expenditure on Transfer + Indexed Cost of Acquisition + Indexed Cost of Improvement) for LTCG. For STCG, the formula is the same except that indexation is not applied.
Cost Inflation Index (CII)
The Cost Inflation Index is notified by the government every financial year. It reflects the increase in inflation and is used to index the cost of acquisition and improvement for long-term capital assets. For example, if an asset was acquired in 2001-02 at Rs. 1,00,000 and sold in 2023-24, and the CII for 2001-02 and 2023-24 are 100 and 348, respectively, the indexed cost of acquisition would be Rs. 1,00,000 x (348/100) = Rs. 3,48,000. This helps in reducing the capital gain and the corresponding tax liability. The base year for CII has been changed from 1981 to 200,1, effective from Assessment Year 2018-19.
Exemptions under Section 54 and Others
The Income-tax Act provides various exemptions from capital gains tax if the gains are invested in specific assets. Section 54 provides s exemption on long-term capital gains arising from the transfer of a residential house property, provided the assessee invests the gains in the purchase or construction of another residential house within the prescribed time. Section 54F extends similar benefits to capital gains arising from the transfer of any long-term capital asset (other than n residential house), if the net sale consideration is invested in a residential house. Section 54EC provides an exemption if the capital gains are invested in specified bonds issued by NHAI or REC within six months of transfer. The maximum investment under Section 54EC is Rs. 50 lakhs. Section 54B allows exemption for capital gains arising from the transfer of agricultural land if the proceeds are used to purchase another agricultural land. Each section has its conditions, time limits, and eligibility criteria that must be strictly followed to avail the exemptions.
Taxability of Short-Term and Long-Term Capital Gains
Short-term capital gains on the sale of equity shares or units of equity-oriented mutual funds that are subject to securities transaction tax (STT) are taxed at a special rate of 15% under Section 111A. Other short-term capital gains are added to the total income and taxed at normal slab rates. Long-term capital gains on listed equity shares and equity-oriented mutual funds exceeding Rs. 1 lakh in a financial year are taxed at 10% without indexation under Section 112A. For other long-term capital assets, the gains are taxed at 20% with indexation. In some cases, like zero-coupon bonds or foreign exchange assets, special rates apply. Surcharge and health and education cess are levied over and above the basic tax rates.
Special Provisions for Non-Residents
For non-residents, special provisions apply for capital gains. In case of shares or debentures of an Indian company acquired in foreign currency, the first and second provisions of Section 48 are applied. These allow computation of capital gains in foreign currency after converting the sale consideration, cost of acquisition, and expenses on transfer into the same foreign currency. The capital gain is then converted into Indian rupees. Indexation benefit is not available in such cases. Tax on LTCG for non-residents on listed securities is 10% without indexation, and on unlisted securities, 20% with applicable provisions. Treaty benefits under Double Taxation Avoidance Agreements (DTAAs) may also apply.
Capital Gains Account Scheme (CGAS)
If the capital gains are not utilized before the due date of filing the return of income, the assessee can deposit the unutilized amount in a Capital Gains Account Scheme with a nationalized bank to claim exemption under Sections 54, 54F, or 54B. The deposited amount must be utilized within the stipulated period (2 years for purchase or 3 years for construction of a house under Section 54). Failure to utilize the amount within the specified period results in the withdrawal being treated as capital gains of the year in which the period expires.
Set-Off and Carry Forward of Capital Losses
Capital losses can be set off only against capital gains. Short-term capital loss (STCL) can be set off against both STCG and LTCG, whereas long-term capital loss (LTCL) can be set off only against LTCG. If capital losses cannot be fully set off in the same year, they can be carried forward for eight assessment years and set off in subsequent years in the same manner. Filing of return within the due date is mandatory to carry forward such losses.
Tax Deduction at Source (TDS) on Capital Gains
Certain transactions involving capital gains attract Tax Deducted at Source. For example, in case of sale of immovable property by a resident, the buyer is required to deduct TDS at 1% under Section 194-IA if the consideration exceeds Rs. 50 lakhs. For non-residents, TDS is applicable under Section 195 on capital gains from the sale of property, shares, or other assets. The buyer must obtain a certificate from the Assessing Officer for appropriate deduction. Failure to comply may result in penal consequences.
Reporting of Capital Gains in Income Tax Return
Taxpayers are required to report capital gains on their income tax return under the relevant schedule. Short-term and long-term capital gains must be reported separately. All details,, includingthe ature of asset, date of acquisition, date of transfer, cost of acquisition, indexed cost (if applicable), sale consideration, and exemption claimed,, must be furnished accurately. Supporting documents such as purchase agreement, sale deed, brokerage receipts, and proof of investment for exemption must be preserved.
Fair Market Value and Deemed Consideration
In certain cases, the fair market value (FMV) of the asset aas ofa specific date is considered as the cost of acquisition. For example, for assets acquired before 1st April 2001, the FMV as on that date can be taken as the cost of acquisition. Also, the Income-tax Act contains provisions for the deemed full value of consideration. If the declared sale consideration is less than the stamp duty value of the property, the stamp duty value is deemed to be the full value of consideration under Section 50C. Similar provisions exist under Section 50CA for unlisted shares.
Tax Planning and Capital Gains
Capital gains offer various opportunities for tax planning. Investing in specified bonds or residential property to claim exemption, choosing the right time for sale, and correctly classifying the asset as short-term or long-term can lead to substantial tax savings. Choosing mutual fund schemes and equities with STT to take advantage of concessional tax rates, or utilizing losses to offset gains,, are important strategies. Proper documentation and understanding of legal provisions are essential for efficient tax planning.
Exemptions Related to Capital Gains under the Income-tax Act
The Income-tax Act provides certain exemptions from capital gains tax, subject to the satisfaction of prescribed conditions. These exemptions are typically aimed at encouraging investments in specified assets, promoting reinvestment, or providing relief in special circumstances. These exemptions are contained in sections 54 to 54GB of the Act.
Exemption under Section 54 – Sale of Residential House Property
Section 54 provides an exemption to an individual or Hindu Undivided Family (HUF) on the long-term capital gains arising from the transfer of a residential house property. The exemption is allowed if the taxpayer purchases or constructs another residential house property within the specified time frame. The conditions are that the capital gain must arise from the transfer of a long-term residential house, the taxpayer must purchase another residential house either one year before or two years after the date of transfer, or construct one within three years from the date of transfer, and the exemption is limited to the amount invested in the new house or the capital gain, whichever is lower. With effect from Assessment Year 2021-22, the exemption is available in respect of investment in two residential house properties, provided the amount of capital gain does not exceed Rs. 2 crore. This option can be exercised only once in a lifetime.
Exemption under Section 54B – Sale of Agricultural Land
This section provides an exemption to individuals or HUFs on the capital gains arising from the transfer of agricultural land, provided the proceeds are invested in acquiring another agricultural land. The land sold must have been used by the individual or his parents for agricultural purposes in the two years immediately preceding the date of transfer. The new agricultural land must be purchased within two years from the date of transfer. The exemption is limited to the amount of capital gain or the amount invested, whichever is lower.
Exemption under Section 54EC – Investment in Specified Bonds
Section 54EC provides an exemption from long-term capital gains tax on the transfer of any long-term capital asset (land or building or both), provided the taxpayer invests the gains in notified bonds within six months from the date of transfer. The bonds must be of National Highways Authority of India (NHAI), Rural Electrification Corporation (REC), or other notified institutions. The maximum amount that can be invested in such bonds is Rs. 50 lakh during a financial year. The bonds must be held for at least five years to retain the exemption.
Exemption under Section 54F – Sale of Any Asset Other Than Residential House
This section applies when long-term capital gains arise from the transfer of a long-term capital asset (other than a residential house), and the taxpayer invests the net consideration in purchasing or constructing a residential house. The taxpayer must not own more than one residential house property on the date of transfer, other than the new house being purchased. The new house must be purchased within one year before or two years after the date of transfer, or constructed within three years. If the entire net consideration is invested, the whole capital gain is exempt; otherwise, the exemption is proportionate.
Exemption under Section 54D – Compulsory Acquisition of Land and Building
This exemption applies when a land or building used for industrial purposes is compulsorily acquired and the capital gain is invested in acquiring land or building for industrial purposes. The exemption is allowed only if the new asset is acquired within three years from the date of receipt of compensation. The exemption is limited to the amount of capital gain or investment made, whichever is lower.
Exemption under Section 54G – Transfer of Asset Due to Industrial Shift
Section 54G applies when a capital asset is transferred in the course of shifting an industrial undertaking from an urban area to a non-urban area. The capital gain is exempt if the proceeds are used to purchase land, building, plant, or machinery in the new location. The investment must be made within a specified time. The exemption is limited to the amount of capital gain or the amount invested, whichever is lower.
Exemption under Section 54GA – Transfer in Special Economic Zone
This section applies when a capital asset is transferred due to shifting an industrial undertaking from an urban area to any Special Economic Zone (SEZ). The exemption is granted if the capital gain is invested in the purchase of land, building, plant, or machinery in the SEZ. Conditions similar to section 54G apply.
Exemption under Section 54GB – Investment in Eligible Start-ups
Section 54GB provides an exemption from capital gains arising from the transfer of a residential property (house or plot of land), if the net consideration is invested in equity shares of an eligible start-up company or eligible small or medium enterprise (SME). The company must utilize the investment to purchase new assets like plant and machinery within a stipulated time. This exemption encourages investments in small businesses and start-ups. The exemption is proportionate to the investment made and has to be held for at least five years.
Withdrawal of Exemption
If the new asset, for which exemption has been claimed, is transferred within a specified period (usually three years), the exemption claimed earlier is withdrawn, and the capital gains become taxable in the year of transfer. For instance, if a new residential house purchased under section 54 is sold within three years, the earlier exemption is revoked and added back to income as short-term capital gain.
Capital Gains Accounts Scheme (CGAS)
Sometimes, the taxpayer may not be able to invest the capital gains before the due date of filing the return. To ensure that the exemption is still available, the Income-tax Act allows the taxpayer to deposit the capital gains in a Capital Gains Accounts Scheme before the due date of filing the return under section 139(1). The deposited amount must then be used for the specified investment within the required time frame. If the amount remains unutilized even after the allowed time, it becomes taxable as capital gain in the year when the allowed time expires.
Tax on Capital Gains in Case of Non-Residents
Non-residents are also subject to capital gains tax on the transfer of capital assets situated in India. Special provisions apply for the computation of capital gains for non-residents, particularly in respect of shares and debentures of Indian companies. The gains may be short-term or long-term, and tax rates vary accordingly. For listed securities and mutual funds, tax treaties between India and other countries may provide relief or concessional rates.
Double Taxation Avoidance Agreements (DTAA)
India has entered into Double Taxation Avoidance Agreements (DTAAs) with many countries. These agreements often provide for special provisions regarding the taxation of capital gains, such as taxing rights being allocated to one country or another, or providing relief by way of exemption or credit. If the DTAA provisions are more beneficial to the taxpayer than the domestic law, the taxpayer can opt for DTAA provisions.
Grandfathering Provisions
The Finance Act, 2018, introduced a provision for the grandfathering of capital gains on equity shares and equity-oriented mutual funds. According to this, any gains accrued up to 31st January 2018 are exempt from tax. Only gains accruing after this date are subject to long-term capital gains tax at 10% without indexation, provided the gain exceeds Rs. 1 lakh. For computing such gains, the cost of acquisition is taken as the higher of the actual cost or the fair market value as on 31st January 2018, subject to other conditions.
Tax Deducted at Source (TDS) on Capital Gains
In certain cases, tax is required to be deducted at source on the capital gains arising from the transfer of assets. For example, in case of sale of immovable property exceeding Rs. 50 lakh, TDS at the rate of 1% is required under section 194-IA. In case of non-resident sellers, TDS is applicable on capital gains under section 195, and the buyer has to obtain a certificate for computation of capital gains before deducting the correct TDS amount.
Set-off and Carry Forward of Capital Losses
Capital losses can be set off against capital gains as per the provisions of the Income-tax Act. Long-term capital losses can be set off only against long-term capital gains. Short-term capital losses can be set off against both short-term and long-term capital gains. Unabsorbed capital losses can be carried forward for eight assessment years and set off in subsequent years subject to the same restrictions.
Special Provisions for Specified Transactions
Certain special provisions apply in specific situations. For example, conversion of capital asset into stock-in-trade is treated as a transfer, and capital gains are computed accordingly. Similarly, in case of slump sale or amalgamation/demerger, special rules for computation of capital gains are provided under sections 50B and 47, respectively.
Capital Gains in Case of Transfer of Depreciable Assets
When a depreciable asset forming part of a block of assets is transferred, the capital gain is calculated based on the block concept. If all the assets in a block are transferred during the year and no asset remains in the block, and the sale consideration exceeds the opening WDV plus the cost of acquisitions made during the year, the difference is treated as short-term capital gain. In case some assets remain in the block, no capital gain is computed unless the block ceases to exist.
Capital Gains in Case of Slump Sale
In the case of a slump sale, the gain is classified as capital gain and not business income. Slump sale means the transfer of an undertaking as a going concern for a lump sum consideration without assigning values to individual assets and liabilities. The capital gain is computed as the difference between the sale consideration and the net worth of the undertaking. It is always considered a long-term capital gain if the undertaking is held for more than 36 months. Indexation benefit is not available in such cases.
Capital Gains in Case of Compulsory Acquisition
If an asset is compulsorily acquired under any law, the consideration is deemed to be received in the year in which it is first received. However, the transfer is treated as taking place in the year of compulsory acquisition. The capital gain is charged to tax in the year in which the compensation is first received. Enhanced compensation is taxed in the year of receipt as capital gain after deducting the cost of acquisition and expenses incurred exclusively in connection with such transfer.
Capital Gains on Conversion of Capital Asset into Stock-in-Trade
When a capital asset is converted into stock-in-trade, it is treated as a transfer under the Income-tax Act. The capital gain arising from such conversion is charged to tax in the year in which such stock-in-trade is sold. The capital gain is computed as the difference between the fair market value on the date of conversion and the cost of acquisition. Further, the difference between the sale price and the fair market value on the date of conversion is treated as business income.
Taxability of Capital Gains in Case of Non-Residents
In the case of non-residents, capital gains are taxed by the provisions of the Income-tax Act as well as the Double Taxation Avoidance Agreements (DTAAs) where applicable. Capital gains on shares and securities of Indian companies are taxed in India. Special provisions apply to investment income and long-term capital gains for foreign institutional investors (FIIs) and other non-residents.
Capital Gains on Transfer of Agricultural Land
Capital gains arising from the transfer of agricultural land situated in rural areas are exempt from tax. Rural agricultural land is not considered a capital asset. However, capital gains on the sale of urban agricultural land are taxable. If the proceeds are reinvested in another agricultural land, exemption may be available under Section 54B, subject to certain conditions.
Capital Gains on Sale of Bonus Shares
Bonus shares are allotted free of cost, so their cost of acquisition is taken as nil for computing capital gains. When such shares are sold, the entire sale consideration is treated as capital gains. If they are held for more than 12 months (in case of listed shares), the gain is long-term; otherwise, it is short-term.
Tax Planning through Capital Gains
Taxpayers can plan their investments and disposals of capital assets in such a manner that they minimize tax liability. This includes choosing the right time to sell, investing in specified bonds or residential property to claim exemptions, and holding assets for the long term to benefit from lower tax rates.
Anti-Avoidance Provisions
To prevent the misuse of exemptions and loopholes, the Income-tax Act contains anti-avoidance provisions. Transactions that are not genuine or are entered into to avoid tax can be scrutinized. The General Anti-Avoidance Rule (GAAR) empowers tax authorities to deny tax benefits in cases of impermissible avoidance arrangements.
Conclusion
Capital gains taxation is a significant aspect of the Indian Income-tax Act. It covers a broad spectrum of transactions and assets. Proper understanding of the rules related to classification, computation, exemptions, and special cases is essential for accurate tax planning and compliance. By staying informed and utilizing available exemptions judiciously, taxpayers can ensure lawful tax efficiency while avoiding penalties.