Capital Gains | Income Tax | Study Notes | Bachelor of Commerce | 3rd Semester CBCS (Honours) | Dibrugarh University

INCOME UNDER THE HEAD “CAPITAL GAINS”

What is the basis of charge [Sec. 45]?

-> Section 45 of Income Tax Act, 1961 provides that any profits or gains arising from the transfer of a capital asset affected in the previous year will be chargeable to income-tax under the head ‘Capital Gains’. Such capital gains will be deemed to be the income of the previous year in which the transfer took place. In this charging section, two terms are important. One is “capital asset” and the other is “transfer”.

What is Included in and Excluded from Capital Asset?

-> “Capital asset” is defined by section 2(14):

CAPITAL ASSET INCLUDES:-

Capital asset means property of any kind, whether fixed or circulating, movable or immovable, tangible or intangible. Besides, it includes the following-

1. Any rights in or in relation to an Indian company, including rights of management or control or any other rights whatsoever.
2. Property of any kind held by an assessee (whether or not connected with his business or profession).
3. Any securities held by a Foreign Institutional Investor which has invested in such securities in accordance with the regulations made under the SEBI Act.

CAPITAL ASSET DOES NOT INCLUDES

(1) STOCK IN TRADE

Stock in trade (not being securities held a foreign institutional investor), consumable stores or raw materials held for the purpose of business or profession (B&P) is not a capital asset. 

However, any securities (other than stock in trade which is not held by a foreign institutional investor) held by a foreign Institutional Investor which has invested or deposited in such securities in accordance with the regulations made under the Securities and Exchange Board of India (SEBI) Act, 1992 shall not be treated as stock-in-trade.

TREATMENT OF PROFIT ON SALE OF STOCK

Any stock-in-trade transfer or sale of profit shall be taxable under the head “Profits & gains of business or profession / PGBP”.

(2) PERSONAL EFFECT

Personal effect means any movable property (Including article of clothing and furniture) held for personal use of the assessee or for any dependent member of his family but excludes the followings:

a. jewellery

b. archaeological collections c

c. drawings

d. paintings

e. sculptures; or

f. any work of art

TAXPOINT

• An immovable property and aforesaid assets held for personal use (example- wearing apparel and furniture) are not personal effect and hence are capital assets. Example- a house property although used for personal purpose cannot be treated as personal effect and shall fall within the definition of capital assets. 

• Securities aren’t personal effect.

• Personal effect includes article of clothing, furniture, car, cycle, scooter used by the assessee for personal purpose.

• intangible asset does not have personal effect.

Here, Jewellery includes –

• ornaments (jewellery) made from gold, silver, platinum, the other precious metal or precious stones or any alloy containing one or more of such precious metals. it is immaterial whether or not such ornaments (jewellery) contain any precious or semi-precious stones and whether or not such ornaments (jewellery) are worked or sewn into any article of clothing; 

• Ornaments (jewellery) also includes precious or semi precious stones whether or not set in any furniture utensils or other article or worked or sewn in any article of clothing. Example- loose diamond shall be treated as jewellery.

TREATMENT OF PROFIT ON SALE OF PERSONAL EFFECT

Any income on transfer or sale of personal effect shall not be treated as capital gain. Such income is within the nature of capital receipt and hence shall not be taxed under any head.

(3) AGRICULTURAL LAND IN RURAL AREA

Agricultural land or agricultural property in India is not a capital asset except-

Agricultural land or agricultural property in India which is situated within the jurisdiction of any Municipality (whether referred to as a  municipal corporation, municipality, notified area committee, city area committee, town area committee, town committee, or by any other name) or Cantonment Board having population (the population according to the last preceding census) of 10,000.

What is transfer of Capital Asset?

-> Transfer of a capital asset includes:
1. Sale, exchange, relinquishment (Surrender) of the asset;
2. Extinguishment of any rights in the asset (reducing any right on asset);
3.Compulsory acquisition of an asset;
4.Conversion or treatment of any capital asset into or as stock in trade of a business;
5.Maturity or redemption of zero coupon bonds;
6.Any other transaction which allows to take or retain the possession of an immovable property in part performance of the contract as per sec 53A of the transfer of Property Act;
7.Any other transaction which has the effect of transferring or enabling the enjoyment of an immovable property whether by way of becoming a member, or acquiring shares in a cooperative society , company or any other association by way of any agreement or arrangement;

If any capital asset is transferred by way of gift or will or inheritance, this shall not be treated as transfer;

If asset transferred is not a capital asset, provisions of capital gain shall not apply.

Capital Gains- How Computed [Sec 48]?

-> Capital gains are of two types: 

1. Short-term capital gain which arises on the transfer of a short-term capital asset; and 
2. Long-term capital gain which arises on the transfer of a long-term capital asset. 

Short-term capital gain is the excess of the full value of consideration over the aggregate of the following three: 

1. cost of improvement; 
2. expenses of transfer; 
3. cost of acquisition of the asset. 

Whereas in the case of long-term capital gain, the capital gain shall be the excess of the full value of consideration over the aggregate of the following three amounts: 

1. Expenses of transfer; 
2. Indexed cost of acquisition of the asset; 
3. Indexed cost of improvement. 

From capital gain, computed as above, certain exemptions are available under sections 54/54B/ 54D/54EC/54F/54G/ 54GA/54GB. The capital gain after claiming they said exemption(s) is known as taxable long-term or short-term capital gain. 

A format to compute the capital gain is given below:

Computation of Short-Term Capital Gain:

 Computation of Long-Term Capital Gain:

(A) Full Value of Consideration (Section 48) in lieu of Capital Asset for Calculating Capital Gain

Full value of consideration is the consideration received or receivable by the transferor in lieu of assets, which he has transferred. Such consideration may be received in cash or in kind. If it is received in kind, then fair market value of such assets is taken as full value of consideration. Full value of consideration does not mean market value of that asset which is transferred.

Adequacy of Consideration –

Adequacy or inadequacy of consideration is not a relevant factor for the purpose of determining full value consideration. However, in the case of transfer of land or building (or both), if stamp duty value is more than 105 per cent of sale consideration, the stamp duty value is taken as full value of consideration. 

Receipt of Consideration –

It makes no difference whether (or not) “full value of consideration” is received during the previous year. Even if consideration is not received, capital gain is chargeable to tax in the year of transfer. 

If consideration is not Determinable –

Where in the case of a transfer, consideration for the transfer of a capital asset(s) is not determinable, then for the purpose of computing capital gains, the fair market value of the asset shall be taken to be the full market value of consideration [sec. 50D]. 

(B) Expenditure on Transfer of Capital Asset for Calculating Capital Gain

Expenditure incurred wholly and exclusively in connection with transfer of capital asset is deductible from full value of consideration. The expression “expenditure incurred wholly and exclusively in connection with such transfer” means expenditure incurred which is necessary to effect the transfer. 

Examples of such expenses are: 

• brokerage or commission paid for securing a purchaser, 
• cost of stamp, 
• registration fees borne by the vendor, 
• travelling expenses incurred in connection with transfer, 
• litigation expenditure for claiming enhancement of compensation awarded in the case of compulsory acquisition of assets. 

(C) Cost of Acquistion of an Asset for Calculating Capital Gain

Cost of acquisition of an asset is the value for which it was acquired by the assessee. 

• Expenses of capital nature for completing or acquiring the title to the property are includible in the cost of acquisition. 
• Interest on money borrowed to purchase asset is part of actual cost of asset. 
• The amount paid for discharge of a mortgage is part of “cost of acquisition”, if the mortgage was not created by the transferor. 

(D) Cost of Improvement to the Capital Asset for Calculating Capital Gain

Cost of improvement is capital expenditure incurred by an assessee in making any additions / improvement to the capital asset. It also includes any expenditure incurred to protect or complete the title to the capital assets or to cure such title. Any expenditure incurred to increase the value of the capital asset is treated as cost of improvement. 

Improvement cost incurred before April 1, 2001 –

Cost of improvement incurred before April 1, 2001 is never taken into consideration. This rule does not have any exception. 

What is Full Value of Consideration [Sec. 48]?

-> Full value of consideration is the consideration received or receivable by the transferor in lieu of assets, which he has transferred. Such consideration may be received in cash or in kind. If it is received in kind, then fair market value of such assets is taken as full value of consideration. Full value of consideration does not mean market value of that asset which is transferred.

Adequacy of consideration – Adequacy or inadequacy of consideration is not a relevant factor for the purpose of determining full value consideration. However, in the case of transfer of land or building (or both), if stamp duty value is more than 105 per cent of sale consideration, the stamp duty value is taken as full value of consideration.

Receipt of consideration-It makes no difference whether (or not) “full value of consideration” is received during the previous year. Even if consideration is not received, capital gain is chargeable to tax in the year of transfer.

If consideration is not determinable – Where in the case of a transfer, consideration for the transfer of a capital asset(s) is not determinable, then for the purpose of computing capital gains, the fair market value of the asset shall be taken to be the full market value of consideration [sec. 50D].

How to Find Out Expenditure on Transfer? 

-> Expenditure incurred wholly and exclusively in connection with transfer of capital asset is deductible from full value of consideration. The expression “expenditure incurred wholly and exclusively in connection with such transfer” means expenditure incurred which is necessary to effect the transfer.

Examples of such expenses are: brokerage or commission paid for securing a purchaser, cost of stamp, registration fees borne by the vendor, travelling expenses incurred in connection with transfer, litigation expenditure for claiming enhancement of compensation awarded in the case of compulsory acquisition of assets.

What is Cost of Acquisition?

-> The cost of acquisition is the total expense incurred by a business in acquiring a new client or purchasing an asset. An accountant will list a company’s cost of acquisition as the total after any discounts are added and any closing costs are deducted. However, any sales tax paid is not included in this line item. The term cost of acquisition is used for accounting purposes and in business sales.

What is Cost of Improvement?

-> Cost of improvement is capital expenditure incurred by an assessee in making any additions/improvement to the capital asset. It also includes any expenditure incurred to protect or complete the title to the capital assets or to cure such title. Any expenditure incurred to increase the value of the capital asset is treated as cost of improvement.

How to Convert Cost of Acquisition/Improvement into Indexed Cost of Acquisition/Improvement?

-> Indexed Cost of acquisition is calculated as follow-

Cost of acquisition/Cost inflation index (CII) for the year in which asset was first held by the assessee or 2001-02, whichever is later * Cost inflation index for the year in which the asset is transferred. 

Indexed Cost of improvement is calculated as follow-

Cost of improvement/Cost inflation index (CII) for the year which improvement took place * Cost inflation index for the year in which the asset is transferred. 

Cost inflation index for different previous year-

Capital Gain in Special Cases- How to find out

-> 1. Cost to the previous owner [Sec. 49(1)] – If a person has acquired a capital asset in the circumstances specified under section 49(1), then to calculate capital gain at the time of transfer of such asset cost to the previous owner is taken as cost of acquisition. This rule is always applicable and does not have any exception. Circumstances specified by section 49(1) are as follows-

a. acquisition of property on any distribution of assets on the total or partial partition of a Hindu undivided family,

b. acquisition of property under a gift or will;

c. acquisition of property –

i. by succession, inheritance or devolution, or

ii. on any distribution of assets on the dissolution of a firm, body of individuals or other association persons where such dissolution had taken place before April 1, 1987, or

iii. on any distribution of assets on the liquidation of a company, 

4. under a transfer to a revocable or an irrevocable trust, or 
5. by a wholly-owned Indian subsidiary company from its holding company, 
6. by an Indian holding company from its wholly-owned subsidiary company, or
7. under a scheme of amalgamation, or
8. under a scheme of demerger; or 
9. under a scheme of conversion of private company/unlisted company into LLP;
10. on any transfer in the case of conversion of firm/sole-proprietary concern into company; or 

d. acquisition of property, by a Hindu undivided family where one of its members has converted his self acquired property into joint family property after December 31, 1969.

2. Cost of acquisition being the fair market value as on April 1, 2001- In the following cases, the assessee may take, at his option, either actual cost or the fair market value of the asset as on April 1, 2001 as cost acquisition:

a. where the capital asset became the property of the assessee before April 1, 2001; or 

b. where the capital asset became the property of the assessee by any mode referred to in section 49(1) and capital asset became the property of the previous owner before April 1, 2001.

3. Capital gain in the case of transfer of depreciable assets [Sec. 501]- The following rules are applicable- 

• Capital gain arises only in two cases – If a depreciable asset is transferred, capital gain (or loss) will arise only in the following two cases –

1. When on the last day of the previous year written down value of the block of assets is zero [sec. 50(1)].

2 When the block of assets is empty on the last day of the previous year [sec. 50(2)]. In no other case capital gain is chargeable to tax, when a depreciable asset is transferred. This rule is equally applicable whether depreciation is allowed in the current year (or any of earlier years).

▸Cost of acquisition – In the above two cases, cost of acquisition shall be the aggregate of the following- 

 Step 1- Find out written down value of block of assets at the beginning of the previous year.

Step 2- Add: Actual cost off any asset(s) falling within that block of asset acquired by the assessee during the previous 

• Always short-term – On transfer of depreciable assets gain (or loss) is always short-term capital gain (or loss). It can never be treated as long-term capital gain (or loss).

4. When advance money was forfeited earlier [Sec. 51]- In the course of negotiations for transfer of a capital asset, the assessee (i.e., transferor) received advance money. Later on, the prospective purchaser could not pay the balance consideration and the advance money is retained or forfeited by the assessee or advance money is forfeited by the assessee because of some other reason. The tax treatment of advance money so forfeited or retained by the assessee is as follows –

1. If advance money is forfeited during the previous year 2013-14 (or any earlier previous year) – It is not taxable in the hands of recipient till the capital asset (in respect of which advance money was received and forfeited) is transferred. If capital asset is not transferred during his lifetime, advance money forfeited by him will not be chargeable to tax. Conversely, if the capital asset is transferred during his lifetime, the advance money will be deducted from the cost for which the asset was acquired or the written down value or the fair market value, as the case may be, in computing the cost of acquisition. 

2. If advance money is forfeited during the previous year 2014-15 (or any subsequent previous year) – It is taxable in the hands of recipient under section 56(2)(ix) under the head “Income from other sources” in the year in which advance money is forfeited. Consequently, it will not be deducted from cost of acquisition when the capital asset is ultimately transferred.

5. Conversion of capital asset into stock-in-trade- If capital asset is converted into stock-in-trade during a previous year relevant to the assessment year 1985-86 (or any subsequent year), the following special rules are applicable-

1. It will be assumed that capital asset is transferred in the year in which conversion takes place. 

2. Fair market value of the asset on the date of conversion will be taken as full value of consideration. 

3. However, capital gain will not be taxable in the year of conversion. It will be taxable in the year in which stock in-trade is transferred.\

6. Transfer of capital asset by a partner to a firm- A capital asset is transferred by a partner to his partnership firm by way of his capital contribution (or otherwise). It is treated a “transfer” and capital gain will be taxable in the hands of the partner. The amount recorded in the books of account is taken as full value of consideration. This rule is also applicable when a member transfers capital assets to his association of persons or body of individuals.

7. Distribution of capital assets by a firm to partners at the time of dissolution- It is treated as transfer. Capital gain is taxable in the hands of firm. The fair market value of the asset on the date of distribution is taken as full value of consideration. This rule is also applicable when an asset is transferred by an association of persons or body of individuals.

8. Compulsory acquisition of a capital asset- The special rules given below are applicable where the Government has acquired an asset of a person by way of compulsory acquisition. These rules are also applicable when consideration is approved or determined by the Central Government or RBI (even if there is no compulsory acquisition).

►Initial compensation – Initial compensation is taken as full value of consideration. Capital gain is chargeable to tax in the year in which the initial compensation (or part thereof) is first received. Indexation benefit is, however, available up to the year in which the asset is compulsorily acquired.

▶Additional compensation – If a Court/Tribunal/authority enhances compensation, it will be taxable in the year in which enhanced compensation or additional compensation is received. For this purpose cost of acquisition and cost of improvement are taken as nil. However, litigation expenses or incidental expenditure for obtaining additional compensation is deductible.

If the enhanced compensation is received by any other person (because of the death of the transferor or for any other reason), it is taxable as income of the recipient.

9. Capital gain on transfer of shares/debentures in the hands of non-residents- If a non-resident acquires shares in, or debentures of, an Indian company by utilizing foreign currency, the gain will be calculated in the same foreign currency, which was initially utilized in acquiring shares/debentures. After calculating capital gain in foreign currency, it will be converted into Indian currency.

The aforesaid rule is not optional but it is compulsory and applicable whether the asset is short-term or long-term. The benefit of indexation is not available, even if the asset is long-term.

Valuation of Capital Asset- When can be referred to Valuation Officer? 

-> With a view to ascertaining the fair market value of a capital asset, the concerned Assessing Officer may refer the valuation of the capital asset to the Valuation Officer appointed by the Income-tax Department in the following cases:

a. where the value of the assets as claimed by the assessee is in accordance with the estimate made by a registered valuer (who works in a private capacity under a license issued by the Central Board of Direct Taxes and his valuation is not binding on the Income-tax Department), but the Assessing Officer is of the opinion that the value so claimed is –

i. less than its fair market value; or 

ii. at variance with its fair market value [sec. 55A(a)];

b. where the Assessing Officer is of the opinion that the fair market value of the asset exceeds the value of the asset by more than Rs. 25,000 or 15 per cent of the value claimed by the assessee, whichever is less; or 

c. where the Assessing Officer is of the opinion that having regard to nature of an asset and relevant circumstances, it is necessary to do so.

How to find out tax on short-term/long term capital gain? 

-> Tax on short-term and long-term capital gains is computed as follows –