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Taxability of Capital Gains

Computation of Capital Gains

Profits or gains arising from the transfer of a capital asset made in a previous year are taxable as capital gains under the head "Capital Gains". The important ingredients for capital gains are, therefore, existence of a capital asset, transfer of such capital asset and profits or gains that arise from such transfer. Capital Asset

Capital asset means property of any kind except the following :

1. Stock-in-trade, consumable stores or raw-materials held for the purpose of business or profession.
2. Personal effects like wearing apparel, furniture, motor vehicles etc., held for personal use of the tax payer or any member of his family. However, jewellery, even if it is for personal use, is a capital asset.
3. Agricultural land in India other than the following:
   1. Land situated in any area within the jurisdiction of municipality, municipal corporation, notified area committee, town area committee, town committee, or a cantonment board which has a population of not less than 10,000 according to the figures published before the first day of the previous year based on the last preceding census.
   2. Land situated in any area around the above referred bodies upto a distance of 8 kilometers from the local limits of such bodies as notified by the Central Government (Please see Annexure 'A' for the notification).
4. 6 1/2 per cent Gold Bonds, 1977, 7 per cent Gold Bonds, 1980, National Defence Gold Bonds, 1980 and Special Bearer Bonds, 1991 issued by the Central Government.
5. Gold deposit bonds issued under the Gold Deposit Scheme 1999 notified by the Central Government.

Though there is no definition of "property" in the Income-tax Act, it has been judicially held that a property is a bundle of rights which the owner can lawfully exercise to the exclusion of all others and is entitled to use and enjoy as he pleases provided he does not infringe any law of the State. It can be either corporeal or incorporeal. Once something is determined as property it becomes a capital asset unless it figures in the exceptions mentioned above.

Profits or gains

The incidence of tax on Capital Gains depends upon length for which the capital asset transferred was held before the transfer. Ordinarily a. capital asset held for 36 months or less is called a 'Short-Term Capital Asset' and if the period exceeds 36 months, the asset is known as Long Term Capital Asset'. However, shares of a Company, the units of Unit Trust of India or any specified Mutual Fund or security listed in any recognized Stock Exchange are to be considered as short term capital assets if held for 12 months or less and long term capital assets if held for more than 12 months.

Transfer of a short term capital asset gives rise to "Short Term Capital Gains' (STCG) and transfer of a long term capital asset gives rise to 'Long Term Capital Gains' (LTCG). Identifying gains as STCG and LTCG is a very important step in computing the income under the head Capital Gains as method of computation of capital gains and tax on the capital gains is different for STCG and LTCG.

The STCG and LTCG computed as above is taken as income under the head Capital Gains for the purposes of determining the total income. Full Value of Consideration

This is the amount for which a capital asset is transferred. It may be in money or money's worth or a combination of both.

Where the transfer is by way of exchange of one asset for another, fair market value of the asset received is the full value of consideration. Where the consideration for the transfer is partly in cash and partly in kind fair market value of the kind portion and cash consideration together constitute full value of consideration.

Cost of acquisition

Cost of acquisition of an asset is the sum total of amount spent for acquiring the asset.

Where the asset was purchased, the cost of acquisition is the price paid. Where the asset was acquired by way of exchange for another asset, the cost of acquisition is the fair market value of that other asset as on the date of exchange.

Any expenditure incurred in connection with such; purchase, exchange or other transaction e.g. brokerage paid, registration charges and legal expenses also forms part of cost of acquisition.

Sometimes advance is received against agreement to transfer a particular asset. Later on, if the advance is retained by the tax payer or forfeited for other party's failure to complete the transaction, such advance is to be deducted from the cost of acquisition. Cost of Acquisition with reference to Certain Modes of Acquisition

Where the capital asset became the property of the assessee:

1. on any distribution of assets on the total or partial partition of a Hindu undivided family;
2. under a gift or will
   • by succession, inheritance or devolution;
   • on any distribution of assets on the dissolution of a 'firm, body of individuals, or other association of persons, where such dissolution had taken place at any time before 01.04.1987;
   • on any distribution of assets on the liquidation of a company;
   • under a transfer to a revocable or an irrevocable trust;
   • by transfer in a scheme of amalgamation;
3. by an individual member of a Hindu Undivided Family living his separate property to the assessee HUF anytime after 31.12.1969.

The cost of acquisition of the asset shall be the cost for which the previous owner of the property acquired it, as increased by the cost of any improvement of the asset incurred or borne by the previous owner or the assessee, as the case may be, till the date of acquisition of the asset by the assessee.

If the previous owner had also acquired the capital asset by any of the modes above, then the cost to that previous owner who had acquired it by mode of acquisition other than the above, should be taken as cost of acquisition.

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 owner.

Where the capital asset, being a share or debenture in a company, the cost of acquisition of the asset to the assessee shall be deemed to be that part of the cost of debenture, debenture-stock or deposit certificates in relation to which such asset is acquired by the assessee. Accordingly the cost of acquisition of rights share is the amount paid by the assessee to get them and the cost of acquisition of bonus shares is nil.

Cost of Improvement

The cost of improvement means all expenditure of a capital nature incurred in making additions or alternations to the capital asset. However, any expenditure which is deductible in computing the income under the heads Income from House Property, Profits and Gains from Business or Profession or Income from Other Sources (Interest on Securities) would not be taken as cost of improvement. Cost of improvement for goodwill of a business, right to manufacture, produce or process any article or thing is NIL.

Cost of Transfer

This includes brokerage paid for arranging the deal, legal expenses incurred for preparing conveyance and other documents, cost of inserting advertisements in newspapers for sale of the asset and commission paid to auctioneer, etc. However, it is necessary that the expenditure should have been incurred wholly and exclusively in connection with the transfer. Besides an expenditure which is eligible for deduction in computing income under any other head of income, cannot be claimed as deduction in computing capital gains.

Cost of Inflation Index

Exemptions from Long Term Capital Gains

Section 54:

In case the asset transferred is a long term capital asset being a residential house, and if out of the capital gains, a new residential house is constructed within 3 years, or purchased 1 year before or 2 years after the date of transfer, then exemption on the LTCG is available on the amount of investment in the new asset to the extent of the capital gains. It may be noted that the amount of capital gains not appropriated towards purchase or construction of a new house within 3 years may be deposited in the Capital Gains Account Scheme of a public sector bank before the due date of filing of Income Tax Return. This amount should subsequently be used for purchase or construction of house.

Section 54F:

When the asset transferred is a long term capital asset other than a residential house, and if out of the consideration, investment in purchase or construction of a residential house is made within the specified time as in sec. 54, then exemption from the capital gains will be available as:

1. If cost of new asset is greater than the net consideration received, the entire capital gain is exempt.
2. Otherwise, exemption = Capital Gains x Cost of new asset/ Net consideration. It may be noted that this exemption is not available, if on the date of transfer, the assessee owns any house other than the new asset.

It may be noted that the Finance Act 2000 has provided that with effect from assessment year 2001-2002, the above exemption shall not be available if assessee owns more than one residential house, other than new asset, on the date of transfer. Investment in the Capital Gains Account Scheme may be made as in Sec.54.

Section 54EA:

If any long term capital asset is transferred before 1.4.2000 and out of the consideration, investment in specified bonds/debentures/shares is made within 6 months of the date of transfer, then exemption from capital gains is available as computed in Section 54F.

Section 54EB:

If any long term capital asset is transferred before 1.4.2000 and investment in specified assets is made within a period of 6 months from the date of transfer, then exemption would be available as computed in section 54F.

Section 54EC:

This section has been introduced from assessment year 2001-2002 onwards. It provides that if any long term capital asset is transferred and out of the consideration, investment in specified assets including bonds issued by National Bank for Agricultural & Rural Development or by National Highway Authority of India or by Rural Electrification Corporation is made within 6 months from the date of transfer, then exemption would be available as computed in Sec. 54F.

Section 54ED:

This section has been introduced from assessment year 2002-03 onwards. It provides that if a long term capital asset, being listed securities or units, is transferred and out of the consideration, investment in acquiring equity shares forming part of an eligible issue of capital is made within six months from the date of transfer, then exemption would be available as computed in Sec. 54F.

Loss under Long Term Capital Gains can not be set off against any income under any other head but can be carried forward for 8 assessment years and be set off against capital gains in those assessment.

Tax on Short Term Capital Gain Certain Cases {Sec. 111A, applicable from the assessment year 2005-06] : Section 111A is applicable if the following conditions are satisfied-

1. The taxpayer is an individual, HUF, firm, company or any other taxpayer.
2. During the previous year he has generated short-term capital gain on transfer of equity shares or units in equity-oriented mutual fund.
3. The transaction of transfer of such securities is entered into on a recognized stock exchange in India on or after 1.4.2004
4. Such transaction is chargeable to securities transaction tax.

If the above conditions are satisfied, short-term capital gain will be taxable at the rate of 10 per cent (plus surcharge plus education cess).

Note: No deduction would be available under sections 80CCC to 80U from the above-noted short-term capital gains.

Where the total income as reduced by such short-term capital gains is below the maximum amount which is not chargeable to income-tax, then, such short-term capital gains shall be reduced by the amount by which the total income as so reduced falls short of the maximum amount which is not chargeable to income-tax and the tax on the balance of such short-term capital gains shall be computed at the rate of ten per cent.

Exempt Income

The Finance Act 2003, has introduced S.10(33) and S.10(36) w.e.f. 01.04.2004 which provide that income arising from certain types of transfer of capital assets shall be treated as exempt income.

Section 10(33) of Income Tax Act provides for exemption of income arising from transfer of units of the US 64 (Unit scheme 1964).

Section 10(36) of Income Tax Act provides that income arising from transfer of eligible equity shares held for a period of 12 months or more shall be exempt.

The Finance Act 2004 has introduced section 10(38) of the Income Tax Act which provides that no capital gains shall arise in case of transfer of equity shares held as a long term capital asset by an individual or HUF w.e.f. 01.04.2005 provided such a transaction is chargeable to 'securities transaction tax'.

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