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INCOME FROM CAPTIAL GAINS
Introduction
When we buy any kind of property for a lower price and then subsequently sell it at a higher price, we make a gain. The gain on sale of a capital asset is called capital gain. This gain is not a regular income like salary, or house rent. It is a one-time gain; in other words the capital gain is not recurring, i.e., not occur again and again periodically. Opposite of gain is called loss; therefore, there can be a loss under the head capital gain. We are not using the term capital loss, as it is incorrect. Capital Loss means the loss on account of destruction or damage of capital asset. Thus, whenever there is a loss on sale of any capital asset it will be termed as loss under the head capital gain. The provisions for computation of Income from capital gains are covered under sections 45 to 55. Section 2(14) defines the term capital gain and section 45, the charging section lays down basis of change for taxability of capital gain or loss arises on transfer of capital asset. Taxability of capital gain depends upon the nature of capital gain arises, i.e., short term capital gain or long term capital gain. The type of capital gain depends upon the period for which the capital asset is held. The taxability of capital gain shall satisfy the conditions like there should be capital asset, the asset is transferred by the assessee, such transfer takes place during the previous year, etc. To give relief to the assessee, the concept of exemption introduced under different sections. At the end of this unit, you will learn the conditions to be satisfied for income to be chargeable under this head, which assets are classified as capital asset, the year in which the capital gains are chargeable to tax, classification of capital gain into long-term and short-term, which are the transactions not regarded as transfer, what are the exemptions available in respect of capital gains and when the assessing officer can make a reference to the valuation officer
Capital Gains
Under the Income Tax Act, any profits or gains arising from the transfer of a capital asset effected in the previous year, shall be chargeable to income tax under the head ‘capital gains’ and shall deemed to be the income of the previous year in which the transfer took place unless such capital gain is exempted under the prescribed exemptions. ‘Capital gains’ means any profit or gains arising from transfer of a capital asset. If any Capital Asset is sold or transferred, the profits arising out of such sale are taxable as capital gains in the year in which the transfer takes place. Capital gains are the difference between the price at which the capital asset was acquired and the price at which the same asset was sold. In technical terms, capital gain is the difference between the cost of acquisition and the fair market value on the date of sale or transfer of asset.
Sections 45 to 55A of the Income-tax Act, 1961 Deal with Capital Gains
Section 45 of the Act, provides that any profits or gains arising from the transfer of a capital asset effected in the previous year shall, save as otherwise provided in Sections 54, 54B, 54D, 54EC, 54ED, 54F, 54G, 54GA and 54H be chargeable to income-tax under the head “Capital Gains” and shall be deemed to be the income of the previous year in which the transfer took place. Doubts may arise as to whether ‘Capital Gains’ being a capital receipt can be brought to tax as income. It may be noted that the ordinary accounting canons of distinctions between a capital receipt and a revenue receipt are not always followed under the Income-tax Act. Section 2(24)(vi) of the Income-tax Act specifically provides that “Income” includes “any capital gains chargeable under Section 45(1)”. It may not be out of place to mention here that in the absence of a specific provision in Section 2(24) capital gains has no logic to be taxed as income. However , all capital profits do not necessarily constitute capital gains. For instance, profits on re-issue of forfeited shares, profits on redemption of debentures, premium on issue of shares, ‘pagri’ from tenants etc. are capital profits and not capital gains, hence, not liable to tax. The requisites of a charge to income-tax, of capital gains under Section 45(1) are:
1. There must be a capital asset.
2. The capital asset must have been transferred.
3. The transfer must have been affected in the previous year.
4. There must be a gain arising on such transfer of a capital asset. These requisites are briefly analyzed
below.
5. Such capital gain should not be exempt under Sections 54, 54B, 54D, 54EC, 54ED, 54F, 54G, or 54GA.
T he capital gain is chargeable to income tax if the following conditions are satisfied:
- There is a capital asset.
- Assessee should transfer the capital asset.
- Transfer of capital assets should take place during the previous year.
- There should be gain or loss on account of such transfer of capital asset Capital Asset Unless the gain is relatable to a capital asset there can be no charge to capital gains tax. Section 2(14) of the Income-tax Act defines the term “capital asset” to mean: Property of any kind held by an assessee whether or not connected with his business or profession but does not include:
- Any stock-in-trade, consumable stores or raw-materials held for the purposes of his business or profession
- Personal effects that is to say, movable property (including wearing apparel and furniture but excluding jewellery) held for personal use by the assessee or any member of his family dependent on
There are two types of Capital Assets:
1. Short-term Capital Assets (STCA): An asset, which is held by an assessee for less than 36 months, immediately before its transfer, is called Short Term Capital Assets. In other words, an asset, which is transferred within 36 months of its acquisition by assessee, is called Short Term Capital Assets. 2. Long-term Capital Assets (LTCA): An asset, which is held by an assessee for 36 months or more, immediately before its transfer, is called Long Term Capital Assets. In other words, an asset, which h is transferred on or after 36 months of its acquisition by assessee, is called Long Term Capital Assets. The period of 36 months is taken as 12 months under following cases: Equity or Preference shares, Securities like debentures, government securities, which are listed in recognised stock exchange, Units of UTI Units of Mutual Funds
Zero Coupon Bonds
Concept of Transfer Capital gain arises on transfer of capital asset; so it becomes important to understand what the meaning of word transfer is. The word transfer occupy a very important place in capital gain, because if the transaction involving movement of capital asset from one person to another person is not covered under the definition of transfer there will be no capital gain chargeable to income tax. Even if there is a capital asset and there is a capital gain. The word transfer under income tax act is defined under section 2(47) As per section 2 (47) Transfer, in relation to a capital asset, includes sale, exchange or relinquishment of the asset or extinguishments of any right therein or the compulsory acquisition thereof under any law. In simple words Transfer includes: Sale of asset Exchange of asset Relinquishment of asset (means surrender of asset) Extinguishments of any right on asset (means reducing any right on asset) Compulsory acquisition of asset. The definition of transfer is inclusive, thus transfer includes only above said five ways. In other words, transfer can take place only on these five ways. If there is any other way where an an asset is given to other such as by way of gift, inheritance etc. it will not be termed as transfer.
Transactions which do not Constitute Transfer [Sections 46 and 47]
The following transactions are not considered as transfer:
- Any distribution of capital assets on the total or partial partition of a Hindu Undivided Family.
- Any transfer of a capital asset under a gift or will or an irrevocable trust; Provided that this clause shall not apply to transfer under a gift or an irrevocable trust of a capital asset being shares, debentures or warrants allotted by a company directly or indirectly to its employees under the Employees’ Stock Option Plan or Scheme of the company offered to such employees in accordance with the guidelines issued by the Central Government in this behalf.
- Any transfer of a capital asset by a company to its subsidiary company, if: (a) the parent company or its nominees hold the whole of the share capital of the subsidiary company, and (b) the subsidiary company is an Indian company.
- Any transfer of a capital asset by a subsidiary company to the holding company, if: (a) the whole of the share capital of the subsidiary company is held by the holding company, and (b) the holding company is an Indian company.
- Any transfer, in a scheme of amalgamation, of a capital asset by the amalgamating company to the amalgamated company if the amalgamated company is an Indian company.
- Any transfer in a scheme of amalgamation of a capital asset being share or shares held in an Indian Company, by the amalgamating foreign company to the amalgamated foreign company, if: (a) at least twenty-five per cent of the shareholders of the amalgamating foreign company continue to remain shareholders of the amalgamated foreign company; and (b) such transfer does not attract tax on capital gains in the country, in which the amalgamating company is incorporated (applicable from the assessment year 1993–94).
- Any transfer by a shareholder, in a scheme of amalgamation, of a capital asset being a share or shares held by him in the amalgamating company, if: (a) the transfer is made in consideration of the allotment to him of any share or shares in the amalgamated company except where the shareholders itself is the amalgamated company, and the amalgamated company is an Indian company.
- Any transfer of agricultural land in India effected before the first day of March, 1970.
- Any transfer of a capital asset being any work of art, archaeological, scientific or art collection, book, manuscript, drawing, painting, photograph or print to the Government or a University or the
Thus, transfer of capital assets falling in any of the categories discussed above would not attract liability to capital gains tax.
Short-term and Long-term Capital Gains
Let us discuss the concept of capital gains and capital assets in detail : Any capital gain arising as a result of transfer of a short-term capital asset is known as short-term capital gain. According to Section 2(42A) of the Income-tax Act: “Short term” capital asset means a capital asset held by an assessee for not more than thirty-six months immediately preceding the date of its transfer. In the case of capital assets (being equity or preference share in a company) held by an assessee for not more than 12 months immediately prior to its transfer. In determining the period for which a capital asset is held by an assessee, the following must be noted:
- In the case of shares held in a company in liquidation, the period subsequent to the date on which the company goes into liquidation shall be excluded.
- In case the asset becomes the property of the assessee under the circumstances the period for which the asset was held by the previous owner shall be included.
- In the case of the shares in an Indian Company which become the property of the assessee in a scheme of amalgamation, the period for which the shares in the amalgamating company were held by the assessee shall be included
- In the case of a capital asset, being a share or any other security subscribed to by the assessee on the basis of his right to subscribe to such financial asset or subscribed to by the person in whose favour the assessee has renounced his right to subscribe to such financial asset, the period shall be reckoned from the date of allotment of such financial asset.
- In the case of capital assets, being the right to subscribe to any financial asset, which is renounced in favour of any other person, the period shall be reckoned from the date of the offer of such right by the company or institution, as the case may be, making such offer.
- In the case of a capital asset, being a financial asset, allotted without any payment and on the basis of holding of any other financial asset, the period shall be reckoned from the date of the allotment of such financial asset.
- In the case of a capital asset, being a share or shares in an Indian company, which becomes the property of the assessee in consideration of a demerger, there shall be included the period for which the share or shares held in the demerged company were held by the assessee.
- In the case of a capital asset, being trading or clearing rights of a recognized stock exchange in India acquired by a person pursuant to demutualisation or corporatisation of the recognized stock exchange in India as referred to in Clause (xiii) of Section 47, there shall be included the period for which the person was a member of the recognized stock exchange in India immediately prior to such demutualisation or corporatisation.
- In the case of a capital asset, being equity share or shares in a company allotted pursuant to demutualisation or corporatisation of a recognised stock exchange in India as referred to in Clause (xiii) of Section 47, there shall be included the period for which the person was a member of the recognized stock exchange in India immediately prior to such demutualisation or corporatisation. Assets other than short-term capital assets are known as ‘long-term capital assets’ and the gains arising therefrom are known as ‘long-term capital gains’. Note that with effect from assessment year 1988–89, a share, equity or preference held by an assessee would be regarded as a long-term capital asset if the ownership is for more than 12 months with him. In the case of other longterm capital assets, the period of holding is determinable subject to any rules made by CBDT. Zero Coupon Bonds The Finance Act, 2005 has introduced the procedure regarding the taxation of the income on the Zero Coupon Bonds being issued on or after 1.6.2005. “Zero Coupon Bond” as defined under Section 2(48) 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 or benefit is received or receivable before maturity or Notes 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. For the purpose of this clause, the expressions “infrastructure capital company” and “infrastructure capital fund” shall have the same meanings respectively assigned to them under clauses (a) and (b) of Explanation 1 to clause (23G) of Section 10. As per Clause (b) above, the payment of and benefit from zero coupon bond shall be received or receivable from the issuing company or fund only at the time of maturity or redemption. Consequently, Clause (via) has been inserted in Section 2(47) to provide that the maturity or redemption of a zero coupon bond shall be regarded as a transfer. The profits arising on the transfer of such zero coupon bond shall be chargeable under the head “capital gains”. Further, Section 2(42A) has been amended to provide that if such zero coupon bonds are held for not more than 12 months, such capital asset shall be treated as short-term capital asset and hence shall be subject to short-term capital gain. On the other hand, where these bonds are held for more than 12 months, such capital gain shall be treated as long-term capital gain.
The Finance Act, 1997 has with effect from 1.4.1998 denied the benefit of indexation of cost of bonds and debentures other than indexed bonds issued by the government. Provided also that where shares, debentures or warrants referred to in the proviso to Clause (iii) of Section 47 are transferred under a gift or an irrevocable trust, the market value on the date of such transfer shall be deemed to be the full value of consideration received or accruing as a result of transfer for the purposes of this section. Caution For this purpose:
- “Foreign currency” and “Indian currency” have the meanings respectively assigned thereto in Section 2 of the Foreign Exchange Management Act, 1999, and
- The conversion of Indian currency into foreign currency and the re-conversion of Notes foreign currency into Indian currency shall be at the rate of exchange prescribed in that behalf;
- ‘Indexed cost of acquisition’ means an amount which bears to the cost of acquisition the same proportion as Cost Inflation Index for the year in which the asset is transferred bears to the Cost Inflation Index for the first year in which the asset was held by the assessee or for the year beginning on the 1st day of April 1981 whichever is later;
- ‘Indexed cost of any improvement’ means an amount which bears to the cost of improvement the same proportion as Cost Inflation Index for the year in which the asset is transferred bears to the Cost Inflation Index for the year in which the improvement to the asset took place; and
- ‘Cost inflation index’, in relation to a previous year, means such Index as the Central Government may, having regard to seventy-five per cent of average rise in the Consumer Price Index for urban non- manual employees for the immediately preceding previous year to such previous year, by notification in the Official Gazette, specify in this behalf. Commission paid to a broker for effecting sale of the asset falls under (1) above. Similarly expenditure incurred on litigation for getting enhanced compensation is expenditure wholly and exclusively incurred in connection with transfer of the capital asset and is deductible. However, litigation expenses incurred for having the shares registered in his name are part of the cost of acquisition and that incurred for gaining better voting rights is cost of improvement. Section 48 of the Act does not an Assessing Officer from taking into amount sale consideration stated in the deed or actual consideration received by the assessee whichever is higher.
Cost of Acquisition
Cost of Acquisition (COA) means any capital expense at the time of acquiring capital asset under transfer, i.e., to include the purchase price, expenses incurred up to acquiring date in the form of registration, storage etc. expenses incurred on completing transfer. In other words, Cost of acquisition of an asset is the 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:
- on any distribution of assets on the total or partial partition of a Hindu undivided family
- under a gift or will: (a) by succession, inheritance or devolution; (b) 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; (c) on any distribution of assets on the liquidation of a company; (d) under a transfer to a revocable or an irrevocable trust; (e) by transfer in a scheme of amalgamation; (f) by an individual member of a Hindu Undivided Family living his separate property to the assessee HUF any time 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
Capital Gains Exempt from Tax Under different Sections of the Act, capital gains arising from the transfer of certain capital assets are exempt from tax under certain circumstances. These provisions are dealt with section wise below: 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: If cost of new asset is greater than the net consideration received, the entire capital gain is exempt. 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. 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. 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’.
