Mensa Commerce Classes

CA-Final (Income Tax)

Chapter
7

CAPITAL GAINS

7.1 CHARGE UNDER THE HEAD CAPITAL GAINS [Section 45

Capital gains are charged to tax by virtue of Section 45 of the Income Tax Act, 1961. Capital gains mean the profits or gains arising from the transfer of a capital asset. According to Section 45, the charge of income under the head Capital Gains arises if the following conditions are fulfilled: (1) There is a capital asset. [The asset must be a capital asset at the time of transfer] (2) There is a transfer of such capital asset. (3) The transfer of such capital asset has been effected during the previous year. (4) Profits or gains arise from the transfer of such capital asset affected during the previous year. (Profit or gain includes negative profit or gain i.e. loss also) (5) Such profits or gains are not exempt from tax u/s 54, 54B, 54D, 54EC, 54F, 54G and 54H. CAPITAL ASSET [Section 2(14)]: According to Section 2(14), capital asset means property of any kind held by an assessee, whether or not connected with his business or profession, but does not include (1) Any stock-in-trade, consumable stores or raw materials held for purpose of his business or profession. (2) Personal effects i.e. movable property (including wearing apparel and furniture but excluding jewellery, archaeological collections, Drawings, Paintings, Sculptures and any work of art) held for personal use by assessee or his family member dependent on him. Jewellery is a capital asset. It includes (a) Ornaments made of gold, silver, platinum or any other precious metal or any alloy containing one or more of such precious metals, whether or not containing any precious or semi-precious stones and whether or not worked or sewn into any wearing apparel; (b) Precious or semi-precious stones whether or not set in any furniture, utensil or other article or worked or sewn into any wearing apparel. (3) Rural agricultural land i.e. Agricultural land in India not being a land situated (c) Within the jurisdiction of a municipality or a cantonment board having a population of 10,000 or more according to the last preceding census; or (d) In any notified area within 8 kms from the local limits of any municipality or cantonment board. (4) Gold Bonds issued by Central Government including the Gold Deposit Bonds issued under the Gold Deposit Scheme, 1999. (5) Special Bearer Bonds, 1991.

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SHORT TERM AND LONG TERM NATURE OF CAPITAL ASSETS: (1) Short-term Capital Asset [Section 2(41A)] : Short-term Capital Asset means a capital asset held by assessee for not more than 36 months immediately preceding the date of its transfer. However, in case of (a) Equity or Preference Shares in a company These assets shall be as short-term (b) Other securities listed in recognized stock treated capital assets if they are exchange in India (c) Units of UTI or Units of mutual fund specified held for not more than 12 months immediately u/s 10(23D) preceding the date of (d) Zero Coupon Bonds transfer. Note: An asset held exactly for 36 months or 12 months, as the case may be, will also be a short-term capital asst. For computing the period of 36 months or 12 months, as the case may be, the date on which the asset was acquired is to be included while the date on which the asset is transferred is to be excluded. (2) Long-term Capital Asset [Section 2(29A)]: Any capital asset other than a short-term capital asset is a long-term capital asset. In other words, a capital asset held for more than 36 months (12 months in case of specified assets given in table above) shall be a long-term capital asset. (3) Determination of Long-Term or Short-Term Nature of a Capital Asset: In determining the short-term or long-term nature of a capital asset, the period of holding shall be determined as follows: Mode Determination of period of holding 1. Shares held in a Any period subsequent to the date on which the company in liquidation company goes into liquidation shall be excluded 2. Assets acquired under Period for which the asset was held by the Section 49(1) modes previous owner shall be included 3. Share(s) in Indian Period, for which the shares in the amalgamated company, amalgamating company were held by the which became property of assessee, shall be included. assessee in amalgamation 4. Bonus shares or other Period of holding will start from the date of securities allotment thereof. 5. Right shares or other Period of holding will start from the date of securities allotment thereof. 6. Right entitlements Period of holding taken from date of offer made renounced by company. 7. Equity Shares in a Period for which such person was member of company, or Trading or Recognised Stock Exchange (RSE) in India prior clearing rights of a RSE; to such demutualisation or corporatisation acquired pursuant to shall be included. demutualisation or corporatisation of such RSE 8. Shares of resulting Period of holding of shares in demerged company acquired in case of company shall be included. demerger 9. Asset which was not Entire period of holding from date of initial Capital Gains 2

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held as capital asset initially acquisition upto date of transfer will be but is a capital asset at the considered to decide nature of capital asset. time of transfer. [Keshavji Karsondas v. CIT [1994] 207 ITR 737 (Bom.] 10. Capital asset being a Period of holding to be calculated from date of flat allotted to a member of a allotment of shares in society and not from date co-operative housing society on which possession of the flat is obtained because right of possession and use of flat is an incidental right flowing from the ownership of shares. [CIT v. Jin-Das Pan-Chand Gandhi [2005] 279 ITR 552 (Guj.)] Property constructed on a land purchased earlier: if land is held by the assessee for more than 36 months and building constructed over it is held for not more than 36 months, in that case, the gains arising from the sale of the land would be longterm capital gains, and gains arising from sale of building will be short term capital gains. The Central board of direct taxes has issued Circular no. 704 dated 28.4.95 clarifying as follows: a) If securities are transacted through stock exchanges, the date of brokers note should be treated as the date of transfer provided the transaction is followed up by delivery of shares and also the transfer deeds. Similarly, in respect of the purchase of the securities, the holding period shall be reckoned from the date of the brokers note for purchase on behalf of the investors. b) In case the transaction take place directly between the parties and not through stock exchanges, the board has clarified that the date of contract of sale as declared by the parties shall be treated as the date of transfer provided it is followed up by actual delivery of shares and the transfer deeds. c) In cases where the shares are purchased in several lots at different points of time and the delivery of which are taken in one lot and subsequently sold in parts, in the absence of correlation of the dates of purchase and sale through specific numbers of the scripts, it is difficult to determine the period of holding of the shares which are sold in parts. In this regard, board has clarified that first-in-first-out (FIFO) method shall be adopted to reckon the period of holding. Therefore, the shares acquired first will always be treated as sold first and the shares acquired last will be taken to be remaining with the assessee. This CBDT has issued an exclusive circular no.768 dated 24-06-1998 (232 ITR 5 St.) in respect of transactions in securities held in dematerialized form u/s.45 (2A) for determination of date of transfer and period of holding as detailed below: a) The FIFO method will be applied only in respect of the dematerialized holdings, because in the case of sale of dematerialized securities, the securities held in physical form cannot be construed to have been sold as Capital Gains 3

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they continue to remain in the possession of the investor and are identified separately. b) In the depository system, the investor can open and hold multiple accounts. In such a case, where an investor has more than one security account, the FIFO method will be applied account wise. This is because in case where a particular account of an investor is debited for sale of securities, the securities lying in his other account cannot be construed to have been sold as they continue to remain in that account. c) If in an existing account of dematerialized stock, old physical stock is dematerialized and entered at a later date, under the FIFO method, the basis for determining the movement out of the account is the date of entry into the account. Notes: (A)

Modes specified in Section 49(1): Where the capital asset became the property of the assessee (a) On any distribution of assets on the total or partial partition of a Hindu Undivided Family; (b) Under a gift or will; or by succession, inheritance or devolution; or (c) On any distribution of assets on the liquidation of a company; or (d) Under a transfer to a revocable or an irrevocable trust, or Under any such transfer as is referred to in clause (iv)/ (v)/ (vi)/ (via)/ (viaa) of Section 47; TRANSFER [Section 2(47)]: Transfer, in relation to capital asset, includes (a) sale, exchange or relinquishment of the asset; (b) extinguishment of any rights therein; (c) compulsory acquisition thereof under any law; (d) maturity or redemption of zero coupon bond; (e) conversion or treatment of such asset by the owner into stock in trade of business carried on by him; (f) Any transaction involving allowing of possession of an immovable property to be taken or retained in part performance of a contract of the nature referred u/s 53A of Transfer of Property Act, 1882. (g) any transaction (whether by way of acquiring shares in, or by way of becoming a member of, a co-operative society, company or other AOP or by way of any arrangement or agreement or in any other manner) that has the effect of transferring or enabling the enjoyment of, any immovable property. Case Laws: (1) Reduction in face value of shares and consequent payment to the shareholder towards such reduction amounts to transfer, as it results in extinguishment

Capital Gains

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(2)

(3)

of right in the shares held by the shareholder. Kartikeya Sarabhai v. CIT [1997] 228 ITR 163 (SC). Surrender of Preference Shares on redemption thereof amounts to transfer as there is relinquishment by the shareholder of his rights in Preference Shares. Anarkali Sarabhai v. CIT [1997] 224 ITR 422 (SC). Family arrangement entered into by compromising doubtful/disputed rights for preserving family property/peace, doesnt amount to transfer. CIT v. A.L. Ramanathan [2000] 245 ITR 494 (Mad.)

TRANSACTIONS THAT ARE NOT REGARDED AS TRANSFER [Section 47]: (1) Distribution of assets by a company to its shareholders on its liquidation. [S. 46(1)] (2) Distribution of capital assets on total or partial partition of HUF. [S. 47(i)] (3) Capital asset transferred under will or gift or an irrevocable trust. [S. 47(iii)] However, transfer under a gift or an irrevocable trust of shares, debentures or warrants allotted to the assessee under Employee Stock Option Plan as per prescribed guidelines, shall constitute transfer. Its fair market value on date of such gift/irrevocable trust shall be treated as full value of consideration. (4) Transfer of a capital asset (not held as stock in trade) by a holding company to its 100% subsidiary company or vice versa, provided the transferee company is Indian company. [S. 47(iv)/(v)] (5) Transfer of capital asset by an amalgamating company to Indian amalgamated company. [S. 47(vi)] (6) Transfer of share(s) held in an Indian company by amalgamating foreign company to amalgamated foreign company if (a) at least 25% of shareholders of the amalgamating foreign company continue to remain shareholders of the amalgamated foreign company; and (b) such transfer does not attract capital gains tax in the country in which the amalgamating company is incorporated. [S. 47(via)] (7) Transfer of capital asset by an amalgamating banking company to the amalgamated banking institution, under a scheme of amalgamation sanctioned by the Central Government. [S. 47(viaa)] (8) Transfer of capital asset by a demerged company to the resulting company. [S.47(vib)] (9) Transfer of share(s) held in an Indian company by demerged foreign company to the resulting company if (a) shareholders holding 75% or more of value of shares of demerged foreign company continue to remain shareholders of resulting foreign company; and (b) such transfer does not attract capital gains tax in the country in which demerged foreign company is incorporated. [S.47(vic)] (10) Any transfer or issue of shares by resulting company, in a scheme of demerger to the shareholders of the demerged company in consideration of demerger. [S.47(vid)] (11) Transfer of share(s) held by shareholder in amalgamating company, if such transfer is in consideration of allotment to him of share(s) in the amalgamated Indian company. (S.47(vii) Capital Gains 5

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However, if besides share(s) in amalgamated company, the shareholder is allotted something more, say bonds or debentures, in consideration of such transfer; the transfer will not be exempt. Composite consideration is not covered by Section 47(vii). CIT v. Gautam Sarabhai Trust [1988] 173 ITR 216 (Guj.)] (12) Any transfer, in an amalgamation/demerger, of a capital asset by the predecessor co-operative bank to the successor cooperative bank. [s.47 (vica)]. (13) Any transfer by shareholder, in an amalgamation/ demerger, of share(s) held by him in predecessor co-operative bank if the transfer is made in consideration of the allotment to him of any share(s) in the successor cooperative bank.[S.47(vicb)] (14) Transfer of bonds or Global Depository Receipts [referred to in Section 115AC (1)] of a public sector company made outside India by a non-resident to another non-resident. [S.47(viia)] (15) Conversion of bonds referred to in sec 115 AC (1) (a) into shares or debentures of any company; [S.47 (xa)] (inserted by the Finance act, 2008 w.r.e.f 1-42008). (16) Transfer of any work of art, archaeological, scientific or art collection, book, manuscript, drawing, painting, photograph or print, to Government/ University/National Museum/National Art Gallery/National Archives or any other notified public institution/museum. [S. 47(ix)] (17) Conversion of bonds or debentures, debenture-stock or deposit certificates in any form, of a company into shares or debentures of that company. [S.47(x)] (18) Transfer of land of sick industrial company (being managed by workers cooperative) made under scheme prepared u/s 18 of Sick Industrial Companies Act, 1985, if such transfer is made during the period starting from previous year in which such company has become sick and ending with the previous year during which its entire net worth becomes equal to or exceeds accumulated losses. [S. 47(xii)] (19) Transfer of (a) a capital asset or intangible asset by a predecessor firm to its successor company; or (b) a capital asset to successor company in course of demutualisation/corporatisation of predecessor recognized stock exchange in India (being an Association of Persons or Body of Individuals) [S. 47(xiii)] (a) All the assets and liabilities of the firm/AOP/BOI relating to their business immediately before the succession become the assets and liabilities of the company; (b) In case of firm, all its partner become shareholders of the company in the same proportion in which their capital accounts stood in the books of the firm on the date of the succession; (c) In case of firm, the partners receive consideration only by way of allotment of shares in company. (d) In case of firm, the partners shareholding in the company in aggregate is 50% or more of its total voting power and continue to be as such for 5 years from the date of succession; and (e) The demutualisation or corporatisation of a recognized stock exchange in India is carried out in accordance with a scheme for demutualisation or corporatisation, which is approved by the SEBI.

Capital Gains

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(20) Transfer of a membership right held by a member of a recognized stock exchange in India for acquisition of shares and trading or clearing rights acquired by such member in that stock exchange in accordance with demutualisation or corporatisation scheme approved by the SEBI. [S.47 (xiiia)] (21) Transfer of capital asset or intangible asset to the successor company by its predecessor proprietary concern, if the following conditions are fulfilled [S.47 (xiv)] (a) All the assets and liabilities of the sole proprietary business immediately before the succession become the assets and liabilities of the company. (b) Sole proprietors shareholding in the company is 50% or more of the total voting power and continues to be as such for 5 years from the date of succession; and (c) The sole proprietor receives the consideration only in form of allotment of shares in the company. (22) Any transfer under Securities Lending Scheme, 1997 for lending of securities under an agreement or arrangement, which is entered into by the assessee with borrower of such securities and which is subject to guidelines issued by SEBI or RBI. [S.47 (xv)] Note: In respect of Section 47(xiii) and 47(xiv), the exemption is available only in respect of the firm/sole proprietor carrying on a business, not in case of profession. Further, this exemption is available only in respect of transfer of capital assets or intangible assets, not in respect of any stock in trade. (23) Any transfer of a capital asset in a transaction of reverse mortgage under a scheme made and notified by the central government[S.47(xvi)](inserted by the Finance act, 2008 w.r.e.f 1-4-2008). WITHDRAWAL OF EXEMPTION: Where the capital gain arising on the transfer of a capital asset from the holding company to the subsidiary company or vice-versa was exempt from capital gains tax by virtue of Sec.47 and if any other following events occur within a period of 8 years from the date of transfer, the capital gains so exempted would be chargeable to tax in the year in which the transfer took placei) The holding company does not continue to hold the whole of the share capital of the subsidiary company; ii) The transferee company converts or treats the capital asset into/as stock- intrade. In the case of a transaction between holding company and subsidiary company, the following additional points need to be borne in mind: a) If the provisions of section 47 are applicable to a transfer, then the assessment shall be reopened in respect of the assessment year relevant to the previous year in which original transfer took place u/s.155 (7B), to amend the order so as to charge the capital gains to tax. b) if the transferee company subsequently sells the asset without attracting the provision of section 47A, then for computation of capital gains the cost to the transferor company shall be adopted as cost to the transferee company- sec 49 (1). c) if the asset is sold after attracting the provisions of section 47A, then the cost to the transferee company shall be the actual cost incurred by that company to acquire the asset from the transferor company-sec.49(3). Capital Gains 7

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The capital gain arising on transfer of a capital asset in the nature of membership of a recognized stock exchange exempted by virtue of sec.47, shall be chargeable to tax if the shares allotted to the transferor in exchange thereof are transferred before the expiry of a period of 3 years. The capital gain shall be deemed, in such a case, as the income chargeable during the previous year in which the shares are transferred. If the conditions stipulated regarding the succession of a proprietary concern or a firm by a company are not complied with, the benefits availed by the sole proprietor or the firm, as the case may be, shall be deemed to be profit and gains of the successor company chargeable to tax in the year in which infringement takes place. COMPUTATION OF CAPITAL GAINS SHORT TERM AND LONG TERM Short term capital gains [S. 2(42B)] means capital gains arising from transfer of a short-term capital asset. Long term capital gains [S. 2(29B)] means capital gains arising from transfer of a long-term capital asset. Mode of Computation of Capital Gains [Section 48]
Short Term Capital Gains Full Value of Consideration Less : Expenses incurred wholly and exclusively for such transfer Net Consideration Less : Cost of acquisition XX Cost of improvement XX Short term capital gain Less : Exemption u/s 54B, 54D, 54G, 54GA Taxable Short Term Capital Gain XX XX XX XX XX XX XX Long Term Capital Gains Full Value of Consideration Less : Expenses incurred wholly and exclusively for such transfer Net Consideration Less : Indexed cost of acquisition XX Indexed cost of improvement XX Long term capital gain Less : Exemptions u/s 54, 54B, 54D, 54EC, 54F, 54G, 54GA Taxable Long Term Capital Gain XX XX XX XX XX XX XX

Notes: (1) Any sum paid on account of securities transaction tax is not deductible in computing Capital Gains. (2) Indexed cost of acquisition or improvement shall be computed as follows : Cost of acquisition or improvement Cost Inflation index of the year of transfer Indexed Cost of Acquisition Cost Inflation Index (CII) for (i) the first year in which = or the asset was held by the assessee or for the year Improvement beginning on 1.4.1981, whichever is later, or (ii) the year in which improvement took place

Cost Inflation Indices: The cost inflation indices as notified by the Central Government are as follows: Financial CII Financial CII Financial CII Financial CII Capital Gains 8

Mensa Commerce Classes year 1981-82 100 109 1982-83 116 1983-84 125 1984-85 133 1985-86 140 1986-87 150 1987-88

year 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95

161 172 182 199 223 244 259

year 1995-96 1996-97 1997-98 1998-99 1999-2000 2000-01 2001-02

281 305 331 351 389 406 426

CA-Final (Income Tax) year 2002-03 447 463 2003-04 480 2004-05 497 2005-06 519 2006-07

7.4 COST OF ACQUISITION AND COST OF IMPROVEMENT IN CERTAIN CASES [Section 49 and 55]

(1)

Cost of Acquisition (COA) and Cost of Improvement (COI) in case of a capital asset acquired before 1.4.1981: Mode of Acquisition COA COI expenditure Where the assessee himself FMV on 1.4.1981 or Capital cost of property, incurred by the acquired the capital asset whichever is higher previous owner or the before 1.4.1981 Capital asset acquired by Cost to the previous assessee in making any alterations assessee under any of the owner or FMV on additions/ to the capital asset on modes given in Section 49(1) 1.4.1981 whichever is or after 1.4.1981. and the previous owner higher. acquired the same before 1.4.1981

(2)

Cost of Acquisition and Improvement in some special cases: Mode Cost of Acquisition or Improvement 1. Shares held in a company in Actual cost of acquisition of such shares. liquidation. 2.Assets acquired under any of the Cost = Cost to previous owner + Cost of modes specified in Section 49(1) improvement incurred by previous owner or assessee 3. Share(s) in Indian amalgamated Cost of acquisition of shares in company, which becomes the property of amalgamated company = Cost of assessee in a scheme of amalgamation. acquisition of the shares in the amalgamating company [Sec. 49(2)] 4. Conversion of bonds or debentures, Cost of acquisition of new shares or debenture-stock or deposit certificates in debentures = Total cost of bonds, any form, of a company into shares or debenture, debenture-stock or deposit debentures of that company. certificates Part of such bonds, debenture, debenture-stock or deposit certificates so converted [Sec. 49(2A)] 5.Conversion of bonds or debentures, Cost of acquisition of new shares or debenture-stock on deposit certificates debentures = total cost of bonds, in any form, of a company into shares or debentures, debenture-stock or deposit debentures of that company (i.e. exempt certificates * part of such bonds, transfers referred u/s 47(x) & 47(xa)) debenture, debenture-stock or deposit Capital Gains 9

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CA-Final (Income Tax) Certificates so converted [sec.49A(2A)] [Amdt. by Finance Act, 08 w.r.e.f 1-4-08] If allotted before 1.4.1981, Cost = Fair market value as on 1.4.1981, otherwise cost = Nil. If purchased by original shareholder : Cost = Purchase Price If purchased by person in whose favour right was renounced : Cost = Purchase Price paid to company + Amount paid for renouncement in his favour Cost = NIL Cost of shares in resulting company = Cost of shares in demerged company Net Book Value of assets transferred to resulting company Net worth of the company before demerger. Cost of shares in demerged company = Total cost of shares Cost of shares in resulting company computed above. Cost of Equity Shares = Cost of acquisition of membership card of stock exchange. Cost of trading or clearing rights = NIL Cost of acquisition of such share or stock = Cost calculated with reference to the cost of acquisition of the shares or stock from which such share or stock is derived.

6.

Bonus shares or other securities

7.

Right shares or other securities

8. 9.

Rights entitlements renounced Shares of resulting company acquired in case of demerger

10. Equity Shares & trading/clearing rights in recognized stock exchange acquired on demutualisation/ corporatisation thereof

11. Share/stock of company acquired on (a) Consolidation & division of share capital into shares of larger or smaller amount, (b) conversion of shares into stock or vice versa, (c) conversion of one kind of shares in other 12.Shares Acquired under an ESOP Cost of acquisition of such share or scheme or acquire as sweat equity stock = Fair Market Value which has shares been taken into account while computing value of Fringe Benefits u/s 115WC(i)(ba) (3) Cost of acquisition and cost of improvement in case assets: Capital asset being COI Goodwill of business, right to NIL manufacture/produce/process any article/thing, or right to carry business Trademark/brand name associated Expenses incurred by with business or tenancy rights or assessee or previous stage carried permits/loom hours owner after 31.3.1981 Capital Gains of certain intangible

COA If self-generated: Nil. If purchased from previous owner : Purchase Price

10

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Cost of Improvement in any other case: Cost of improvement means all capital expenditure incurred in making any additions or alterations to capital asset by the assessee after it became his property, and where capital asset became property of the assesee by any of modes specified u/s 49(1), by the previous owner. Exclusions from Cost of Improvement: Cost of improvement does not include any expenditure, which is deductible in computing the income chargeable under the head Income from House Property, Profits and Gains of Business or Profession, or Income from Other Sources. Notes: (A) In case of HUF-assessee, by conversion of members individual property into HUF property. (B) Previous Owner: Previous Owner means the last previous owner of the asset who acquired it by a mode of acquisition other than that referred to under Section 49(1). (C) When cost to previous owner not ascertainable [Sec. 55(3)] : Where the cost for which the previous owner acquired the property cannot be ascertained, the cost of acquisition to the previous owner means the fair market value on the date on which the capital asset became the property of the previous owner.

(5) Indexed cost of acquisition v/s. indexed cost of improvement: It needs mention that in the case of assets acquired in any of the modes specified in section 49 (1), the benefit of indexation for cost of acquisition can be claimed only from the first year in which the asset was held by the assessee. However, in the case of indexation of cost of improvement, the benefit of indexation can be availed from the year in which improvement to the asset was made. (6) Conversion of debentures into shares: Similarly, if debentures are converted into shares, it is not regarded as transfer by virtue of section 47(x). If these shares are sold subsequently, the cost of acquisition would be the cost incurred to acquire the debentures on conversion of which the shares were obtained as provided in section 49 (2A). Nevertheless, there is no provision to enable the assessee to take the period of holding of the debentures in determination of the long-term nature of the shares and again the possibility of claiming the indexation benefit for the period for which debentures were held is ruled out. (7) Conversion of investment into stock -in- trade: in the case of conversion of capital asset in to stock-in-trade the provisions of sec.45 (2) explicitly provide for deferring the chargeability till the year of sale of stock-in-trade. While computing the capital gains of sale of the stock-in-trade, the assessee will have to index the cost of acquisition only up to the year of conversion and not up to the year of chargeability since indexation stops in the year of transfer and does not extend to the year in which the computation is made and taxability arises.

Capital Gains

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(8) Compulsory acquisition: Again, when compulsory acquisition is the instance of transfer in the assessee's case, section 45(5) provides for charging the capital gain only in the year of receipt of the compensation and not in the year of compulsory acquisition. Nevertheless, indexation benefit would not run up to the year of receipt of compensation but would be confirmed only up to the year of compulsory acquisition. Case Laws: (1) Amount paid to clear mortgage: Where property has been mortgaged by previous owner during his life-time and the assessee, after inheriting the same, has discharged mortgage debt, then by discharging the mortgage debt, the assessee acquires the interest of the mortgagee in the property. The amount so paid shall be treated as cost of acquisition. R.M. Arunachalan v. CIT [1997] 227 ITR 222 (SC). However, where after acquiring a property, the assessee himself created a mortgage and cleared off the same out of sale proceeds of property, he couldnt be allowed deduction of payment of mortgage debt as cost of acquisition/ improvement u/s 48 because in that case, he did not acquire any interest in property subsequent to his acquiring the same. VSMR Jagdishchandran v. CIT [1997] 227 ITR 240 (SC) (2) Kist deducted from proceeds of mortgaged property: The Government auctioned the mortgaged property of assessee for kist amount due by him to the State, and paid the balance amount (after deducting kist) to the assessee. The assessee claimed deduction for kist amount in computing capital gains. Held that, since the price received in auction entirely belonged to the assessee, the amount deducted towards kist was not diverted at source but was applied in discharge of an obligation after it was received by the assessee. Therefore, kist amount was not deductible in computing capital gains. CIT v. Attili N. Rao [2001] 252 ITR 880 (SC). (3) No charge, when computation not possible : If, on the facts of a particular case, computation u/s 48 is not possible, then capital gains shall not be charged to tax. Thus, if no cost can be envisaged in acquisition of an asset, capital gains cannot be charged. CIT v. B.C. Srinivasa Setty [1981] 128 ITR 294 (SC). (4) Amount embezzled while effecting sale of property will not constitute expenditure in connection with transfer and is, therefore, is not deductible u/s 48(1) Mr. G.Y. Chenoy v. CIT [1999] 234 ITR 89 (AP). (5) In CIT v/s C.V. Sounderajan, 150 ITR 80(mad) the amount paid to the mother having right of residence in the property, for obtaining relinquishment of such right was held deductible in computing the capital gains. (6) When Loan is borrowed and invested in any asset, interest expenditure incurred thereon can be claimed as deduction from the income derived from such asset. If the assessee desires to capitalize the interest, is it possible to treat it as part of the cost of acquisition and claim it as deduction in the computation of capital gains is an issue which has been favourably considered by courts. So long as the loan has been exclusively borrowed and utilised for acquisition of an asset, capitalisation of interest is possible as held in the case Capital Gains 12

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of CIT v/s Mithlesh Kumari, 92 ITR 9 (DEL) of Addl. CIT v/s K.S.Gupta, 119 ITR 372 (AP). Similar analogy can be inferred from the decisions rendered in CIT v/s Maithreyi Pai, 152 ITR 247 (Kar) and Saharanpur Electric Supply Co. v/s CIT, 194 ITR 294(SC).

7.5 CASES WHERE BENEFIT OF INDEXATION IS NOT AVAILABLE EVEN IN CASE OF LONG-TERM CAPITAL ASSETS:

(1) (2) (3) (4) (5) (6) (7) (8)

Transfer of a bond or a debenture other than capital indexed bonds issued by the Government. Transfer of undertaking or division in a slump sale under Section 50B. Transfer of shares/debentures of an Indian company purchased by a nonresident in foreign currency. Transfer of units purchased in foreign currency by an assessee covered under Section 115AB. Transfer of bonds or shares purchased in foreign currency by an assessee covered u/s 115AC. Transfer of global depository receipts by a resident employee of an Indian company u/s 115ACA. Transfer of securities by foreign institutional investors under Section 115AD. Transfer of a foreign exchange asset by a non-resident Indian under Section 115D.

7.6 SCOPE AND YEAR OF CHARGEABILITY OF CAPITAL GAINS [Section 45] S.45 (1) Full Value of Consideration Transfer of capital asset Agreed consideration (subject to Sec.50C and Sec.55A) Damage to, or destruction Insurance compensation of, any capital asset. i.e. Money + Fair market value (on date of receipt) of [Note 1] other assets received Conversion of a capital The fair market value as asset into stock in trade on the date of conversion. Note 2] Transfer of shares held in Agreed consideration depository (FIFO basis) Transfer of capital asset Amount at which such as capital contribution or asset is recorded in books otherwise by a partner or of the Firm/AOP/BOI. member to Firm/AOP/ BOI Distribution of capital Fair market value as on asset on dissolution or the date of transfer [Note otherwise of Firm/AOP/ 3] Body of Individuals Transaction Year of Chargeability Previous year in which transfer took place. Previous year in which money or other asset is received from the insurance company. Previous year in which stock in trade is sold. Previous year in which transfer took place Previous year in which transfer took place.

(1A)

(2)

(2A) (3)

(4)

Previous year in which transfer took place.

Capital Gains

13

Mensa Commerce Classes

(5) Compulsory acquisition under any law; or any transfer, whose consideration is deemed or approved by Central Govt. or RBI. Compensation awarded; or amount of compensation as determined or approved by Central Government/RBI

CA-Final (Income Tax)

The year in which such compensation or part thereof is first received. [Note 4]

Notes: (1) Section 45(1A) applies only when the damage/destruction is due to (a) Flood, typhoon, hurricane, cyclone, earthquake or other convulsion of nature; or (b) Riot or civil disturbance; or (c) Accidental fire or explosion; or (d) Action by enemy or action taken in combating an enemy (whether with or without declaration of war). However, where damage/destruction is not attributable to any of the reasons aforesaid, there will be no charge of capital gains, as there can be no transfer without existence of capital asset at the time of transfer. Vania Silk Mills P. Ltd. v. CIT [1991] 191 ITR 647 (SC). Computation of capital gains in respect of such assets: As per the CBDTs circular issued in this behalf, capital gains would be worked out in respect of assets which get destroyed, etc. as per the provisions of Sections 48 and 50, as the case may be, by taking the insurance money or the market value of the asset received from the insurer as the full value of consideration. Further, adjustment for cost inflation index will be made for non-depreciable assets and for depreciable assets, the written down value of such assets will be reduced from the block of assets as provided for in Section 43(6). (2) In this case, transfer takes place in the year of conversion. So, CII of the year of conversion is used for computation of capital gains. Further, such fair market value will be taken as cost of converted stock. (3) When the partners or members transfer the capital assets, the agreed consideration will be taken as their cost of acquisition. (4) (a) In case of enhanced compensation : In case the compensation is enhanced or further enhanced by the Court, Tribunal or other authority, the capital gains shall be chargeable to tax in the year when the enhanced compensation is received. The amount of enhanced compensation will be the full value of consideration and the cost of acquisition and cost of improvement in that case shall be nil. If the enhanced compensation is received by any other person due to the death of the transferor or due to any other reason, the amount will be deemed to be capital gain of the recipient. (b) Reduction in compensation : In case the initial compensation or the enhanced or further enhanced compensation is reduced by the court or Tribunal or any other authority, such assessed capital gain for that year shall be recomputed by taking the compensation or consideration as so reduced by the court, tribunal or other authority to be the full value of consideration.

Capital Gains

14

Mensa Commerce Classes

CA-Final (Income Tax)

Some Issues: (1) Payment, by way of cash or otherwise, to retiring partner over and above balance in his capital account : So far as retiring partner is concerned, the amount received by such partner from the firm in excess of capital and profits standing to his credit cannot be considered as capital gains, as there is no transfer. The amount received by him is not consideration for transfer of his interest to the continuing partners; he only receives his share in partnership. CIT v. R. Lingmallu Raghukumar [2001] 247 ITR 801 (SC). However, so far as the firm is concerned, it has been held in CIT v. A.N. Naik Associates [2004] 265 ITR 346 (Bom), that distribution of asset by the firm to a partner on his retirement shall come within the expression otherwise (as appearing in Section 45(4) and amounts to transfer of capital assets within the meaning of Section 45(4) and therefore, is liable to capital gains tax in the hands of the firm. (2) Distribution to partner on dissolution v. Gift of land to Partner: So far as registration is concerned, gift of land to partner is required to be registered under Registration Act, 1908, but the distribution of land to partner on dissolution of the firm, doesnt require registration, as decided in N. Khadervali Saheb v. N. Gudu Sahib [2003] 261 ITR 1 (SC). So far as taxability is concerned, gift of capital asset being a land, is exempt u/s 47(iii), but distribution of land on dissolution is taxable u/s 45(4). Thus, decision as to gift or distribution on dissolution is to be taken after taking this into consideration. (3) Interest on enhanced compensation: Interest received on enhanced compensation in case of compulsory acquisition or the transfer referred to in Section 45(5), will be taxable as income from other sources as per the method of accounting followed by assessee. If assessee follows cash system, it will be taxable in the year of receipt. However, if assessee follows mercantile system, such interest shall be spread on an annual basis over the period right from the date on which asset was acquired to the date on which the order for enhancement is made by the Court. [Rama Bai v. CIT [1990] 181 ITR 480 (SC)]. CAPITAL GAINS ON DISTRIDUTION OF ASSETS BY COMPANY IN LIQUIDATION [SEC.46] (1) In hands of company: distribution of assets by a company on its liquidation is not regarded as transfer. (2 in the hands of shareholder: Receipts of any money or other assets by the shareholder from the company on its liquidation shall be chargeable to tax as FollowsCash received or market value of the assets received on X liquidation Less: deemed dividend u/s 2(22) (c) to the extent of accumulated X profit as on the date of liquidation. ---Full value of consideration for the purposes of section 48. Less: indexed cost of acquisition (or cost of acquisition) of the X shares held in that company X Capital Gains 15

Mensa Commerce Classes Long-term capital gains or short-term capital gains

CA-Final (Income Tax) X

(3) Cost of Acquisition of assets received on liquidation in hands of shareholders [Sec.55 (2)]: Where any capital received by assessee on liquidation of a company, which had been assessed u/s 46, is transferred by him, the cost of acquisition in of such asset will be the fair market value as on the date of distribution.

7.8 CAPITAL GAINS ON BUY-BACK SECURITIES [Section 46A]

OF

SHARES

OR

OTHER

SPECIFIED

Any consideration received by a holder of shares or other specified securities from any company under a scheme of buy back shall constitute transfer and the difference between such consideration and the cost (or indexed cost) of acquisition shall be chargeable to tax as capital gains in the previous year in which such buyback takes place. Payment made by a company on buy-back doesnt constitute dividend u/s 2(22) (d).
7.9 CAPITAL GAINS IN CASE OF DEPRECIABLE ASSETS [Section 50 & 50A]

(1)

Capital gains in case of transfer of asset on which depreciation has been allowed under Section 32(1)(ii) in respect of block of assets [Section 50] : The capital gains shall be computed as follows : (a) Block of assets does not cease to exist but WDV of block is reduced to zero [Section 50(1)]: XXX Full value of consideration XXX Less : (1) Expenses on transfer XXX (2) WDV of asset on 1st day of the previous year (3) Cost of assets acquired during the previous year and falling within that block XXX Short Term Capital Gains XXX (b) Block of assets ceases to exist due to the sale of all assets falling within that block [Section 50(2)]: Full value of consideration XXX Less : (1) Expenses on transfer XXX XXX (2) WDV of asset on 1st day of the previous year (3) Cost of assets acquired during the previous year and falling within that block XXX Short Term Capital Gains/Loss XXX Transfer of capital assets of Power sector units on which depreciation allowed u/s 32(1) (i) [Section 50A]: (a) If WDV of the asset exceeds Moneys Payable on transfer of such assets: Terminal depreciation under Section 32(1) (iii) = WDV of such asset Moneys Payable 2

(2)

Capital Gains

Mensa Commerce Classes (b)

CA-Final (Income Tax)

If Moneys Payable exceeds WDV of the asset: Then, if Moneys payable doesnt exceed actual cost : Balancing charge u/s 41(2) = Money Payable WDV Moneys payable exceeds Actual Cost : Balancing Charge u/s 41(2) = Actual Cost WDV; and Short-term/Long-term Capital Gains = Moneys Payable Actual Cost

7.10 SLUMP SALE MEANING AND COMPUTATION OF CAPITAL GAINS [Section 50B]

Slump Sale [Sec. 2(42C)] : It means transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to the individual assets and liabilities in such sales. Charge and Nature of Capital Gains: Profits or gains arising from slump sale shall be taxable as Capital Gains in previous year in which slump sale is effected. If the capital asset, being one or more undertakings, was owned and held by the assessee for not more than 36 months, the capital gains will be short term capital gains. In any other case, it shall result into long-term capital gains. Mode of computation of capital gains: The capital gains shall be computed in the following manner Full value of consideration XXX Less : Expenses wholly and exclusively in connection with such transfer XXX Less : Cost of acquisition and cost of improvement being net worth** of the undertaking (no indexation benefit even in case of long-term capital asset) XXX Short Term/Long Term Capital Gains XXX ** The net worth of the undertaking shall be computed in the following manner
Aggregate value of total assets of the undertaking or division (ignoring any change in the value of assets on account of revaluation of assets) In case of depreciable assets, the WDV of the block as per Sec. 43(6) XXX In case of other assets, the book value XXX Less : Value of liabilities of such undertaking or division as appearing in its books Net Worth of the undertaking or division XXX XXX XXX XXX

Certificate of a Chartered Accountant: In case of slump sale, every assessee shall furnish along with the return of income a report of an accountant in prescribed form indicating the computation of net worth and certifying that the net worth of the undertaking or division has been correctly arrived at.

Illustration 1: Computation of Capital gains in case of slump sale Balance Sheet of X Ltd. as on December 31, 2006 reads as under Paid up capital: Rs.552 lakhs. (All amounts in Rs. lakhs) Unit A Unit B Capital Gains 2

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CA-Final (Income Tax)

Land 200 170 Fixed Assets (other than land) 100 150 Debtors 100 75 Liabilities 28 50 Stock-in-trade 50 25 Reserves 148 Share Premium 22 Revaluation Reserve on account of Revaluation of land 70 The company acquired Unit B on December 31, 2003. It made certain capital additions in the form of generator set and additional building, etc. of Rs.25 lakhs during the year 2004-05. The members of the company have authorized the Board in their meeting held on October 28, 2006 to dispose off the Unit B. The company decides to sell the Unit B by way of slump sale for Rs.325 lakhs as consideration. The buyer has agreed with the vendor company to give time for putting through the sale but not later than March 31, 2007 subject to discount of 1% on agreed sale consideration. However, this discount is not applicable if the sale is completed after December 31, 2006. The company now approaches you to advise them as a measure of tax planning to determine the date of sale keeping in view of the capital gains tax. The WDV of the Fixed Assets under Section 43(6) is Rs.120 lakhs. Solution: The computation of capital gains shall be in accordance with Section 50B of the Income Tax Act, 1961. Computation of net worth of Unit B: Rs. (in lakhs) WDV of Fixed Assets under Section 43(6) being depreciable assets 120 Land (170 70 i.e. book value after ignoring revaluation) 100 Debtors and Stock (75 + 25 i.e. at book value) 100 320 Less : Liabilities at Book Value 50 Net Worth (being cost of acquisition and improvement) 270 Case I: Where the slump sale takes place on or before December 31, 2006 In this case, the period of holding of Unit B will be not more than 36 months. Therefore, Unit B will be a short-term capital asset. (Rs. in lakh) Sale Consideration 325.00 Less : Discount @ 1% 3.25 270.00 Less : Net Worth Short Term Capital Gains 51.75 Tax payable (30% + Surcharge 10% + EC @ 2% on Tax and Surcharge) 17.42 Case II : Where Unit B is sold after December 31, 2006 : In this case, period of holding is for more than 36 months and therefore, it is a long-term capital asset. Sale Consideration 325 270 Less : Net Worth Long Term Capital Gains 55 Tax payable = 20% + Surcharge 10% + EC @ 2% on Tax and Surcharge 12.34 Capital Gains 3

Mensa Commerce Classes

CA-Final (Income Tax)

Conclusion: Since the tax payable is less in Case II, X Ltd. is advised to sell Unit B by way of slump sale after December 31, 2006 so as to minimize the tax liability.
7.11 FULL VALUE OF CONSIDERATION WHEN STAMP VALUE EXCEEDS SALE PRICE [Section 50C]

Full Value of Consideration : Where the consideration for transfer of land or building or both, is less than the value adopted by Stamp Valuation Authority for payment of stamp duty, the value so adopted by stamp valuation authority shall be deemed to be full value of consideration for the purpose of Section 48. Reference to Valuation Officer: The Assessing Officer may refer valuation thereof to Valuation Officer if (a) The assessee claims before the Assessing Officer that the value adopted or assessed by the Stamp Valuation Authority exceeds the fair market value of the property as on the date of transfer, and (b) The value adopted or assessed by the Stamp Valuation Authority has not been disputed in any appeal or revision or no reference has been made before any other authority, court or the High Court. In case reference is made to Valuation Officer, the full value of consideration shall be lower of (a) Value as determined by the Valuation Officer; or (b) Value assessed or adopted by the Stamp Valuation Authority.
7.12 CAPITAL GAINS WHEN ADVANCE OR OTHER MONEY FORFEITED [Section 51]

Where any capital asset was on any previous occasion the subject of negotiations for its transfer, and advance or other money received and retained by the assessee in respect of such negotiation shall be deducted from the cost for which the asset was acquired, or the WDV of the asset or the FMV in computing the cost of acquisition of the capital asset. [Note: Only amount forfeited by assessee is deducted, amount forfeited by the previous owner shall not be considered. Further, indexation applies only after such reduction from cost.] It has been held in Travancore Rubber & Tea Co. Ltd. v. CIT [2000] 243 ITR 158 (SC) that the phrase other money would cover deposits made by purchaser for guaranteeing due performance of contracts. Therefore, forfeiture of earnest money and the compensation awarded to the assessee for breach by the prospective purchaser of contract for purchase of property would go to reduce the cost of acquisition as per Section 51. Illustration 2 Right to specific performance: R entered into an agreement with L for the purchase of a property for Rs.10 lakhs and paid Rs.10, 000 as earnest money. On L failing to execute a conveyance in respect of the property, a suit for specific performance was filed by R. The suit was compromised and R agreed to receive Rs.50, 000 by way of damages and gave up his right to specific performance. What will be the position of this amount? Solution: It was held in K.R. Srinath v. ACIT [2004] 268 ITR 436 (Mad.) that a right to acquire a property i.e. right to specific performance is itself a capital asset. In this case, Rs.50, 000 received by R is consideration for relinquishment of right to Capital Gains 4

Mensa Commerce Classes

CA-Final (Income Tax)

specific performance and Rs.10, 000 is its cost of acquisition. R is therefore, liable to capital gain tax on Rs.40, 000 subject to deduction of the legal expenses incurred for enforcing this right.
7.13 EXEMPTIONS IN RESPECT OF CAPITAL GAINS AVAILABLE ONLY TO INDIVIDUAL AND/OR HUF ASSESSEES [Section 54, 54B and 54F] Provisions 1. Assessee 2. Asset transferred Section 54 Individual/HUF Residential house property being buildings or lands appurtenant thereto. Section 54B Individual Agricultural land used by individual or his parent for agricultural purposes during 2 years preceding date of transfer. Section 54F Individual/HUF Any capital asset not being residential house property. [Note : Exemption is not available if assessee (a) owns more than 1 residential house (other than new) on date of transfer of original asset; or (b) purchases a residential house, other than new asset, within 1 year from date of transfer of original asset] Long Term

3. Nature of Asset 4. New asset to be purchased/ constructed 5. Time-limit for purchase/ construction

Long Term Residential house property i.e. buildings or lands appurtenant thereto Purchase : Within 1 year before or 2 years after the date of transfer Construction : Within 3 years from date of transfer Applicable

Short/Long Term Agricultural (urban or rural)

6. Deposit Scheme (discussed later) 7. Amount of Exemption

land Residential house property i.e. buildings or lands appurtenant thereto Purchase within 2 Purchase : Within 1 years from the date of year before or 2 years transfer after date of transfer; and Construction : Within 3 years from date of transfer Applicable Applicable

8. Withdrawal of exemption on

Lower of Capital Lower of Capital Cost of new house Gains or Investment in gains or cost of new Capital Gains Net new asset asset consideration being Full value of consideration less Expenses on transfer Transfer of the new Transfer of the new (a) assessee purchases asset within 3 years asset within 3 years within 2 years or from its purchase/ from its purchase constructs within 3 construction years from date of transfer of original

Capital Gains

Mensa Commerce Classes

CA-Final (Income Tax)

asset, a residential house other than new house; or (b) Transfers new asset within 3 years from date of its purchase/ construction. Exemption claimed Amount exempted earlier shall be earlier shall be taxable reduced from cost of as long-term capital acquisition of new gains in previous year asset in which (a) another residential house is purchased or constructed; or (b) the new asset is transferred.

9. Taxability on withdrawal

Amount of exemption claimed earlier shall be reduced from the cost of acquisition of new asset

Note: Important points on exemption under Section 54 and 54F (1) Purchase/Construction of a Portion: Purchase or consideration of a portion of the house is eligible for exemption CIT v. Chandanben Maganlal [2000] 245 ITR 182 (Guj.). E.g. If an assessee purchases 15% undivided share in a house property, exemption will be available. However, mere construction by way of extension of old existing house is not eligible for exemption. CIT v. Pradeep Kumar [2006] 153 Taxman 138 (Mad.) (2) Purchase of co-owners interest : In case of property owned by co-owners, the payment made by one co-owner to get the full ownership by release of the interest of other co-owners amounts to purchase by such co-owner and is eligible for exemption. CIT v. Aravinda Reddy [1979] 120 ITR 46 (SC). (3) Registration not pre-condition: If assessee has purchased house and acquired its possession and control, he will be eligible for exemption even if such purchase is not registered as per Registration Act, 1908. EXEMPTIONS IN RESPECT OF CAPITAL GAINS ASSESSEES [Section 54D, 54EC, 54G and 54GA]:
Provisions 1. Assessee 2. Asset transferred Section 54D Any person Compulsory acquisition of land or building which was used in the business of industrial undertaking during 2 years prior to date of transfer. Short term/ Long term New land or building for the

AVAILABLE

TO

ALL

Section 54EC Section 54G Any person Any person Any long term Transfer of capital asset. plant, machinery or land or building for shifting industrial undertaking from urban area to rural area. Long term Bonds, redeemable

3. Nature of Asset 4. New asset to be purchased/

Section 54GA Any person Transfer of plant, machinery or land or building for shifting industrial undertaking from urban area to Special Economic Zone. Short term/ Short term/ Long term Long term (a) Purchase/ (a) Purchase/ Constructio constructio

Capital Gains

Mensa Commerce Classes

constructed industrial undertaking

CA-Final (Income Tax)

n of plant, machinery, land or building in such SEZ, or (b) Shifting the original assets to SEZ, or (c) Incurring notified expenses Within 1 year before or 3 years after the date of transfer Applicable

5. Time-limit for purchase/ construction of new asset 6. Deposit Scheme 7. Amount of exemption

after 3 years n of plant, issued machinery, land or (a) by National building in Highway such rural Authority of area or, India; or (b) Shifting (b) By Rural original Electrificatio assets to n Corp. that area, or (Amendment by the Finance Act, (c) Incurring notified 2006) expenses Within 3 years Within 6 Within 1 year from date of months from before or 3 receipt of initial the date of years after the compensation transfer of date of transfer original asset Applicable -Applicable

Lower of Lower of Lower of Lower of capital gains or Capital gains or Capital gains or Capital gains or investment in investment in cost incurred for cost incurred for new asset new asset or (a) to (c) of point (a) to (c) of point Rs.50 lacs 4. 4. 8. Withdrawal of Transfer of new Transfer of new Transfer of new Transfer of new Exemption asset within a asset, or shifted asset or shifted asset period of 3 conversion within a period within a period years from the thereof in of 3 years from of 3 years from date of its money or taking the date of its the date of its acquisition or loan or advance acquisition or acquisition or construction on its security construction or construction or within 3 years shifting. shifting. from date of its acquisition. 9. Taxability on Amount of Exempted Amount of Amount of withdrawal of exemption capital gain will exemption exemption exemption claimed earlier be taxable as claimed earlier claimed earlier shall be reduced long-term shall be reduced shall be reduced from the cost of capital gains in from the cost of from the cost of acquisition of previous year in acquisition of acquisition of new asset. which such new or shifted new or shifted transfer/ asset. asset. conversion takes place. Note: If exemption has been claimed u/s 54EC in respect of investment in a new asset, no deduction shall be allowed u/s 80C with reference to the amount of investment for which exemption has been claimed.

Transfer of depreciable assets held for more than 36 months Exemption u/s 54EC available: Section 50 nowhere mentions that the depreciable assets are short term capital assets but only states that capital gains Capital Gains 7

Mensa Commerce Classes

CA-Final (Income Tax)

arising from transfer of depreciable asset shall be deemed to be arising out of transfer of short term capital asset. Section 54EC is independent section and exemption therein is available if there is a transfer of long term capital asset and consideration is invested in specified assets within time limit. Therefore, depreciable assets held for more than 36 months are long-term capital assets and capital gains arising therefrom will be eligible for the benefit envisaged u/s 54EC CIT v. Assam Petroleum Industries P. Ltd. [2003] 131 Taxman 699 (Gau.) Extension of time in case of compulsory acquisition [Section 54H] : Where transfer of original assets referred to in Sections 54, 54B, 54D, 54EC and 54F, is by way of compulsory acquisition under any law, the period for acquiring new asset referred to in those sections or the period available under those sections for depositing or investing the amount of capital gain in relation to such compensation, which is not received on the date of the transfer, shall be reckoned from the date of receipt of such compensation. Capital Gains Accounts Scheme, 1988: This scheme applies to all assessees who are eligible for exemption under Section 54, 54B, 54D, 54F and 54G. The tax implications of this scheme are as follows (1) Exemption available if amount deposited: Exemptions u/s 54, 54B, 54D, 54F and 54G are available if the investment in new asset is made within time allowed in those sections. If the amount of capital gains or net consideration could not be fully or partly reinvested for the purposes specified in said sections before the due date of furnishing return of income, then exemption will be available in respect of the amount deposited before the due date of furnishing return of income in the said deposit account as if the amount so deposited had been invested in new asset. (2) Withdrawal out of deposit account: The amount in deposit account can be withdrawn for purposes specified in respective Sections 54, 54B, 54D, 54F and 54G. However, if the said amount is not utilized wholly or partly for purchase of new asset within stipulated period specified under said sections, then (a) In case exemption was claimed u/s 54, 54B, 54D and 54G : Amount not so utilized shall be chargeable to tax as Capital Gains of previous year in which period specified under those section expires. (b) In case exemption was claimed under Section 54F : The following amount shall be taxable as capital gains of previous year in which the period under Section 54F expires Taxable Amount not so utilised Original Capital Gains (before claiming exemption) Capital = Net sale consideration in respect of transfer of original asset Gains (3) If the individual dies before expiry of stipulated period u/s 54, 54B, 54D, 54F and 54F, the unutilized amount cannot be taxed in the hands of the deceased, also not in hands of legal heirs, as the unutilized portion is not income but is only a part of the estate devolving upon them. (Circular 743 dt. 06.05.1996)

Illustration 3 Exemption u/s 54 and 54F: Mr. A owns a self-occupied residential house and a plot of land. (He has no other house). He sells the house on 31.1.2007 and the plot on 15.2.2007 for Rs.6, 50,000 and Rs.5, 00,000 respectively. The house was purchased on 31.1.2002 for Rs.4, 00,000 and the plot on 30.3.2002 for Rs.2, 00,000. A has purchased a new Capital Gains 8

Mensa Commerce Classes

CA-Final (Income Tax)

residential house on 25.4.2007 for Rs.5, 00,000 and claims exemption in respect of such house. On 31.1.2008, he transfers the said residential house for Rs.7, 50,000 and purchases a new house on 31.3.2008 for Rs.10, 00,000. Compute the capital gains for relevant years. Solution: Computation of Capital Gains for assessment year 2007-08 Sale of residential house Sale of Plot (Rs.) (Rs.) 5,00,000 Full value of consideration 6,50,000 Less : Indexed cost of acquisition 4,87,324 (4,00,000 519/426) 2,43,662 (2,00,000 519/426) Long term capital gains 1,62,676 2,56,338 Less : Exemption u/s 54 & 54F 1,62,676 1,72,938 (2,56,338 3,37,324 5,00,000) Taxable Capital Gains Nil 83,400 Computation of Capital Gains on sale of residential house (amount in Rs.)
Sale price of the residential house (acquired on 25.4.2007) Less : Cost of Acquisition (5,00,000 Exemption claimed u/s 54 i.e. 1,62,676) Short-term Capital Gains for assessment year 2008-09 Long-term Capital Gains (Exemption claimed u/s 54F shall be chargeable as long-term capital gains of the year in which the house is transferred i.e. assessment year 2007-08) 7,50,000 3,37,324 4,12,676 1,72,938

Note: No exemption will be available in respect of second new house acquired on 31.3.2008. Exemption u/s 54 or 54F cannot be claimed because the house transferred on 31.1.2008 is a short-term capital asset.
7.14 REFERENCE TO VALUATION OFFICER [Section 55A]

With a view to ascertaining the Fair Market Value of a capital asset, the Assessing Officer may refer the valuation of a capital asset to a Valuation Officer in following cases (1) In case the value of asset claimed by assessee accords with the estimate made by Registered Valuer: If the Assessing Officer is of the opinion that the value so claimed is less than it is Fair Market Value. (2) In any other case : If the Assessing Officer is of the opinion that (a) [Fair Market Value of the asset Value claimed by the assessee] exceeds (i) Rs.25,000; or (ii) 15% of the value claimed by the assessee; or (b) Having regard to the nature of the asset and relevant circumstances, it is necessary to make a reference to the Valuation Officer.
7.15 CAPITAL GAINS EXEMPT FROM TAX [Section 10]

Sec. Exempted Income 10(33) Capital gains on transfer of units of US 64 10(37) Any Capital Gains arising to individual or HUF from transfer of urban agricultural land by way of compulsory acquisition under any Capital Gains

Conditions/Remarks Exempt if transferred on or after 1.4.2002. Such land must have been used by individual or his parents or the HUF for agricultural purposes during two years preceding the 9

Mensa Commerce Classes law or transfer the consideration of which is determined or approved by Central Government/RBI.

CA-Final (Income Tax) date of transfer. Compensation or consideration for transfer (or enhanced or further enhanced compensation) is received by the assessee on or after 1.4.2004. However, the income by way of long-term capital gains of a company shall be taken into account in computing the book profits and income-tax payable under Section 115JB. (Amendment by Finance Act, 2006 w.e.f. 1.4.2007)

10(38) Long-term capital gains arising from transfer of Equity Shares in a company or a unit of equity oriented fund, if such transaction has been charged to securities transaction tax.

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

(1) Short-term Capital Gains (STCG) on transfer of an equity share of a company or a unit of an equity-oriented fund on which securities transaction tax has been charged[s.111A]: tax is computed on such capital gains at a flat rate of 15% (amendment by Finance act, 2008 w.e.f 1-4-2009). However, in case of resident individual or resident HUF, ifa) other income (i.e. total income-such STCG) is less than' basic exemption limit.' b) Then, such STCG shall be reduced by such shortfalls and c) Tax on balance of STCG shall be computed @15%. d) Accordingly, tax on such STCG = 15%*[Such STCG (basic exemption limitother income) Further, where gross total income of an assessee includes any such short-term capital gains, the deduction under chapter VIA shall be allowed from the gross total income as reduced by such gains. (2) Other short-term capital gains: they are taxed at the normal rates applicable to the assessee. (3) Long - term Capital gains [ sec. 112]: tax is computed thereon at a flat rate of 20%.However, in case of resident individual or resident HUF, ifa) Other income (i.e. Total income -such LTCG) is less than' basic exemption limit', b) then, such, LTCG shall be reduced by such shortfall and c) Tax on balance of LPCG shall be computed@20%. d) Accordingly, tax on such LTCG= 20% *[such LTCG-(basic exemption limit-other income)]. Other points are:a) Deduction under section 80C to 80U are not available in respect of long-term capital gains. b) Tax payable in case of listed securities, etc. not to exceed 10%: in case of long-term capital gains arising from transfer of listed securities, units of UTI or mutual funds specified in sec 10(23D) or zero coupon bonds, the tax payable of such capital gains shall be lower of the followingCapital Gains 10

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(i) 10% Grass Capital Gains (without indexation and without giving benefit of basic exemption limit); (ii) 20% of taxable LTCG as computed above.

Illustration 4 Capital Gains on transfer of listed securities: Mr. X bought 10,000 Equity Shares of TT Ltd. listed in stock exchange in India and abroad on 15th March, 2006 @ Rs.2,250 per share. He sold the shares at Rs.5, 000 per share on 31st December, 2008. The brokerage and securities transactions tax deducted were at 0.5% and 0.1% respectively. Examine the liability of Mr. X to income tax. Will your answer be different, if instead of selling the shares in the market, Mr. X privately transferred the shares to his son at the same price? Solution: Tax Liability of Mr. X for the assessment year 2009-10: (1) Sale transaction on which securities transaction tax has been charged: As per Section 10(38) any long-term capital gains arising out of transfer of Equity Shares in a company shall be exempt from income tax if such transaction is chargeable to securities transaction tax. Hence, in this case, LTCG will be exempt. (2) When shares are privately transferred to his son: Since the shares are not transferred through recognized stock exchange, it will not be exempt u/s 10(38). Capital gains will be computed as under : (Amounts in Rs.) 5,00,00,000 Full value of consideration [Rs.5,000 10,000] Less : Brokerage @ 0.5% (Assuming that brokerage is payable for effecting private transfer also) 2,50,000 Net consideration 4,97,50,000 2,52,21,382 Less : Indexed cost of acquisition [2,250 10,000 519 463] Long Term Capital Gains 2,45,28,618 Income Tax on LTCG : [Lower of (a) or (b)] (a) 20% of (2,45,28,618 1,50,000, basic exemption limit assuming that X has no other income) 48,75,724 (b) 10% of (4,97,50,000 2,25,00,000), benefit of basic exemption limit is not available 27,25,000 Therefore, amount of income tax on LTCG Add : Surcharge @ 10% Income tax plus surcharge Add : Education Cess @ 2% Tax Liability of Mr. X 27,25,000 2,72,500 29,97,500 59,950 30,57,450

Provisions to curb tax avoidance by certain transactions in securities or prevention of dividend Stripping and Bonus-Stripping Transaction [sec 94]. 1) Loss on sale of securities or units to be ignored in cases of dividend stripping [S.94 (7)]: If a person-

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a) buys/acquires any securities or units within a period of 3 months prior to record date, b) sales/transfers the same within 3 months (9 months in case of unit) after record date, and c) the dividend/income on such securities or unit received or receivable by him is exempt, Then, the loss, if any arising to him on account of such purchase and sale, to the extent of dividend or income from securities/unit, shall be ignored while computing his income chargeable to tax. 2) Loss arising in case of bonus stripping of units to be ignored [S. 94(8)]: in case a persona) buys/acquires any units (' original units'), within a period of 3 months prior to record date; b) He is allotted bonus units on the basis of holding of such units on such date; and c) he sells or transfers all or any of the original units referred to in (a) within a period of 9 months after such date, while continuing to hold all or any of the bonus units referred to in (b), Then(a)The loss, if any, arising to him on account of purchase and sale of original units shall be ignored in computing his total income, and (b) The loss so ignored shall be deemed to be the cost of purchase or acquisition of such bonus units referred to in (b) as are held by him on the date of such sale or transfer. Record date: record date means the date fixed by a company for entitlement of dividend, or by a mutual fund/administration/specified company for entitlement of dividend of bonus units.

7.17 TREATMENT OF INCOME FROM DEEP DISCOUNT BONDS (DDBs) [Circular No. 2 dated 18.02.2002]

DDBs are to be valued on 31st March of each financial year. If they are held as investments, the income therefrom shall be interest income or capital gains. However, if they are held as trading assets, income therefrom shall be business income. Tax treatment of income from deep discount bonds is as follows: 1. General Interest Income/Business Income = Difference between the market Treatment valuations as on two successive valuation dates. Where bond is acquired during the year by an intermediate Capital Gains 12

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2. Transfer of Bonds before maturity

3. Redemption on maturity

purchaser, Interest income/Business Income = Market Value as on valuation date Actual cost of acquisition Short-term Capital Gains/Business Income = Sale Price [Cost for which bond was acquired by the transferor + Income, if any, already offered to tax by such transferor upto the date of transfer, as per general treatment given above] Note: The capital gains arising to investors shall always be shortterm capital gains. Redeemed by Original Subscriber: Interest Income/Business Income = Redemption price Value as on last valuation date immediately preceding the maturity date. Redeemed by an Intermediate Purchaser : Interest Income/ Business Income = Redemption price [Cost at which bonds were acquired by him + Income, if any, already offered to tax by the person redeeming the bond]

TAXABILITY OF ZERO COUPON BONDS [ZCBs] (i) According to Sec. 2(48), Zero Coupon Bonds means a bond (a) issued by any infrastructure capital company or infrastructure capital fund or public sector company on or after the 1st day of June, 2005; (b) in respect of which, no payment and benefit is received or receivable before maturity or redemption from infrastructure capital company or infrastructure capital fund or public sector company; and (c) Which the Central Government may, by notification in the Official Gazette, specify in this behalf. (ii) Any maturity or redemptioin of ZCBs shall be treated as transfer as per Section 2(47) and accordingly subject to tax under the head Capital Gains. However, in case such bonds are held as stock-in-trade of the business, it shall be chargeable to tax under the head Profits and Gains of Business or Profession. (iii) Any long term capital gain arising from the transfer of ZCBs shall be entitled to a concessional tax rate of 10% without the benefit of indexation or at the rate of 20% after availing the benefit of indexation. (iv) In case ZCBs are held for less than 12 months, it shall be considered as short term capital asset u/s 2(42A). However, concessional rate of 10% tax provided for short-term capital gains on transfer of listed shares u/s 111A is not applicable to ZCBs. Therefore, short term capital gains on transfer of ZCBs shall be subject to tax as per normal rates of tax. SPECIAL PROVISIONS FOR NON-RESIDENTS: In the case of an assessee who is a non-resident, capital gains arising from transfer of capital assets being the shares or debentures of an Indian company shall be computed by converting cost of acquisition, expenses incurred for the transfer and sale consideration into the same foreign currency as was utilized for the purchase of shares or debentures as indicated below. The capital gains so computed in such foreign currency shall be reconverted into Indian currency for the purpose of further computation First proviso to Section 48 and Rule 115A. Capital Gains 13

Mensa Commerce Classes Items Converted/ Reconverted Cost of acquisition Expenses incurred transfer Sale consideration

CA-Final (Income Tax) Rate of Conversion/Reconversion The average of telegraphic transfer selling rate and buying rate as on the date of acquisition for The average of telegraphic transfer selling rate and buying rate as on the date of transfer The average of telegraphic transfer selling rate and buying rate as on the date of transfer The buying rate for telegraphic transfer as on the date of transfer

1. 2. 3. 4.

Capital Gains [Reconversion] The conversion and reconversion shall be made on the basis of the rate of exchange adopted by the State Bank of India. The aforesaid manner of computation of capital gains shall be applicable in respect of capital gains arising from every reinvestment thereafter in the shares or debentures of an Indian company on the sale of such assets. In these cases, indexation will not be available in the computation of capital gains.

Illustration: Mr. Fedrick, a non-resident Indian, acquired in January, 2002, shares in Indian companies for a consideration of Rs.20.50 lakhs by remitting equivalent US Dollars. In October, 2006, he sold the entire shares for a sum of Rs.33, 00,000 after incurring Rs.66, 000 towards expenses for transfer. You are informed the details of telegraphic transfer rates of State Bank of India herebelow: Particulars Buying rate Selling rate On the date of acquisition 40.50 41.50 On the date of transfer 43.50 44.50 Compute the taxable capital gains on the basis of the above information. Ans: Computation of Long Term Capital Gains for the assessment year 2007-08 Particulars Indian Rate of US $ Rupees Conversion Sale consideration 33,00,000 44.00 75,000 66,000 44.00 1,500 Less : Expenses for transfer Net consideration 73,500 20,50,000 41.00 50,000 Less : Cost of acquisition Capital Gain Assessable 10,22,250 43.50 23,500

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