Capital Gains

For an unlisted company, the buyback of shares is subject to a specific tax regime. The company undertaking the buyback is liable to pay an additional income tax (distributed income tax) under Section 115QA on the distributed income, which is the difference between the consideration paid by the company on buyback and the amount received by the company for issuing such shares. This tax is levied at a rate of 20% (plus surcharge and cess), making the effective rate 23.296%. This tax is final, and no deduction is allowed to the company. Consequently, the income arising to the shareholder from such a buyback is exempt from tax under Section 10(34A) in their hands, to avoid double taxation. For listed shares, or buyback by a listed company, the general capital gains provisions (Section 46A) apply to the shareholder, and the company is not liable for tax under Section 115QA.

Unlisted shares are considered short-term capital assets if held for <= 24 months, and long-term if held for > 24 months. STCG is taxed at applicable slab rates. LTCG is generally taxed at 20% with indexation benefit, or 10% without indexation for non-residents (subject to certain conditions). Note: Recent budgets have altered LTCG rates to 12.5% for certain assets, so always check the latest Finance Act.

Under Section 111A, STCG arising from the transfer of listed equity shares or equity-oriented mutual funds on which Securities Transaction Tax (STT) is paid is taxed at a flat rate of 15% (plus surcharge and cess). Note: The Finance Act 2024 increased this rate to 20%.

For a charitable trust registered under Section 12AA or 12AB of the Income Tax Act, 1961, capital gains arising from the transfer of a capital asset are generally considered part of its income. To claim exemption, such gains must be applied for charitable or religious purposes.

Section 11(1A) specifically deals with the treatment of capital gains for trusts. It provides that where a capital asset held under trust wholly or partly for charitable or religious purposes is transferred, and the whole or any part of the net consideration is utilized for acquiring another capital asset to be so held, then the capital gain arising from the transfer shall be deemed to have been applied to charitable or religious purposes to the extent specified.

Conditions for Exemption under Section 11(1A):

1. Reinvestment of Net Consideration: The whole or part of the 'net consideration' (full value of consideration less expenses on transfer) received from the sale of the original capital asset must be utilized for acquiring a new capital asset.
2. Purpose of New Asset: The newly acquired capital asset must also be held under trust wholly for charitable or religious purposes.
3. Extent of Deemed Application:
   • If the whole of the net consideration is utilized in acquiring the new capital asset, the whole of such capital gain is deemed to have been applied for charitable or religious purposes.
   • If only a part of the net consideration is utilized, then so much of the capital gain as is equal to the amount by which the amount so utilized exceeds the cost of the transferred asset is deemed to have been applied.

This provision ensures that the corpus of the trust remains intact or is enhanced, as the sale proceeds are reinvested in assets for the trust's objectives. If the capital gains are not reinvested as per Section 11(1A), the trust must apply at least 85% of such income for charitable purposes in the same previous year to claim exemption under Section 11(1)(a).

For shareholders of an unlisted company in India, the income received from the buyback of shares is exempt from capital gains tax under Section 10(34A) of the Income Tax Act, 1961.

However, the company undertaking the buyback is liable to pay an 'additional income tax' (often referred to as buyback tax or distribution tax) under Section 115QA of the Income Tax Act.

Key Provisions:

• Tax on Distributed Income (Section 115QA): The unlisted company is required to pay tax at the rate of 20% (plus surcharge and cess, making the effective rate around 23.296%) on the 'distributed income'.
• Distributed Income: This is defined as the consideration paid by the company on the buyback of shares as reduced by the amount that was received by the company for the issue of such shares.
• Tax Payment by Company: The company must pay this tax within 14 days from the date of payment of any consideration to the shareholder on buyback.
• Final Tax Payment: The tax paid by the company under Section 115QA is considered the final payment of tax, and no further credit or deduction is allowed to the company or the shareholder in respect of this income.
• Shareholder Exemption (Section 10(34A)): Because the company pays this distribution tax, the income arising to the shareholder from such buyback of unlisted shares is completely exempt from tax in their hands.

This mechanism was introduced to prevent tax avoidance, as earlier, capital gains on buyback were taxable in the hands of shareholders, which could be structured to minimize tax.

A slump sale, as defined in Section 2(42C) of the Income Tax Act, 1961, refers to the transfer of one or more undertakings as a result of a sale for a lump sum consideration without values being assigned to the individual assets and liabilities in such sale.

Computation of Capital Gains (Section 50B):
Capital gains arising from a slump sale are computed as the difference between the 'full value of consideration' received and the 'net worth' of the undertaking.

• Full Value of Consideration (FVC): The FVC is the lump sum consideration received from the slump sale. As per amendments, the Fair Market Value (FMV) of the capital assets transferred, calculated in the prescribed manner, is deemed to be the full value of consideration. This FMV is generally the higher of FMV1 (based on book value of assets) or FMV2 (based on consideration received).
• Net Worth (Cost of Acquisition): The 'net worth' of the undertaking is deemed to be its cost of acquisition and cost of improvement. It is calculated as:
  • Aggregate value of total assets of the undertaking or division, determined as follows:
    • Depreciable assets: Written Down Value (WDV) as per Section 43(6)(c)(i)(C).
    • Goodwill of a business or profession (not acquired by purchase): Nil.
    • Assets for which 100% deduction under Section 35AD was allowed: Nil.
    • Other assets: Book value.
  • Reduced by the value of liabilities of such undertaking or division as appearing in its books of account.
  • Any change in the value of assets on account of revaluation is ignored for computing net worth.

Key Points:

• No indexation benefit is available for the cost of acquisition (net worth).
• The capital gain is treated as long-term if the undertaking is held for more than 36 months; otherwise, it's short-term.
• A report from an accountant certifying the computation of net worth is mandatory.

Section 50 of the Income Tax Act, 1961, provides special provisions for computing capital gains in the case of depreciable assets. When a depreciable asset forming part of a block of assets is transferred, any gain arising is always treated as a short-term capital gain, irrespective of the period for which the asset was held. The computation is done by deducting the actual cost of the asset (or written down value, as applicable) from the sale consideration received. If the entire block of assets ceases to exist during the previous year due to transfer, and the consideration received exceeds the written down value of the block at the beginning of the year plus any actual cost of assets falling in that block acquired during the year, the excess is treated as short-term capital gain. Conversely, if the block of assets ceases to exist and the written down value exceeds the consideration, the difference is treated as a short-term capital loss. This provision overrides the general provisions of Sections 48 and 49.

According to Section 49(1) of the Income Tax Act, 1961, when a capital asset becomes the property of the assessee by way of gift, will, inheritance, or certain other modes specified, the cost of acquisition of the asset for the assessee is deemed to be the cost for which the previous owner who acquired the asset otherwise than by these modes, acquired it. If the previous owner's cost cannot be ascertained, the fair market value as on April 1, 2001, can be considered if the asset was held by the previous owner before that date. For determining the period of holding, the period for which the asset was held by the previous owner is also included. This is crucial for classifying the capital gain as short-term or long-term and for availing indexation benefits, if applicable.

Section 50C states that where the consideration received or accruing as a result of the transfer of land or building is less than the value adopted by the Stamp Valuation Authority (stamp duty value), the stamp duty value shall be deemed to be the full value of consideration for computing capital gains.

When a partnership firm converts into a company, the transfer of capital assets from the firm to the company is generally considered a 'transfer' for capital gains purposes. However, Section 47(xiii) of the Income Tax Act, 1961, provides an exemption from capital gains tax if certain conditions are met.

Conditions for Exemption under Section 47(xiii):

1. All assets and liabilities of the firm relating to the business immediately before the succession become the assets and liabilities of the company.
2. All the partners of the firm immediately before the succession become shareholders of the company in the same proportion as their capital accounts in the firm.
3. The partners receive consideration for the transfer only by way of allotment of shares in the company. No other benefit or consideration, direct or indirect, should be received by the partners.
4. The aggregate shareholding of the partners in the company should not be less than 50% of the total voting power in the company, and this shareholding must be maintained for a period of 5 years from the date of succession.

If all these conditions are satisfied, the transfer of capital assets from the firm to the company will not be treated as a 'transfer' for capital gains purposes, and thus, no capital gains tax will be levied at the time of conversion. If any of these conditions are violated subsequently, the exemption may be withdrawn, and capital gains may become taxable in the year of violation.

For individuals and Hindu Undivided Families (HUFs) entering into a Joint Development Agreement (JDA) for the development of immovable property, Section 45(5A) of the Income Tax Act, 1961, provides a specific framework for capital gains taxation, primarily addressing the timing of taxability.

Timing of Taxability:
Prior to Section 45(5A), capital gains were taxable in the year the JDA was signed, which often created hardship for landowners who had not yet received their share of the developed property or monetary consideration. Section 45(5A) defers the capital gains tax liability for the landowner to the previous year in which the certificate of completion for the whole or part of the project is issued by the competent authority.

Computation of Capital Gains:

1. Full Value of Consideration (FVC): The FVC for computing capital gains is deemed to be the sum of:
   • The stamp duty value of the landowner's share in the project as on the date of the issuance of the completion certificate.
   • Any monetary consideration (cash) received under the JDA.
2. Cost of Acquisition: The cost of acquisition of the original land or building is deducted from the FVC, with indexation benefit available up to the year of transfer (which is the year the completion certificate is issued for taxability purposes).

Applicability: This provision applies only to individuals and HUFs. It does not apply to cases where the developer pays the full consideration in monetary terms.

Reporting: The CBDT has also issued Standard Operating Procedures (SOPs) for tax authorities to track capital gains from JDAs using RERA data and cross-checking with Income Tax Returns to ensure compliance.

A slump sale involves the transfer of an undertaking as a whole for a lump sum consideration without values being assigned to individual assets and liabilities. Capital gains arising from a slump sale are always treated as long-term capital gains if the undertaking has been held for more than 36 months, otherwise short-term. The gain is computed under Section 50B of the Income Tax Act, 1961. The cost of acquisition for a slump sale is considered to be the 'net worth' of the undertaking. Net worth is calculated as the aggregate book value of assets (excluding revaluation reserves and assets whose depreciation has been allowed under Section 32) less the aggregate book value of liabilities appearing in the books of accounts. No indexation benefit is available for computing capital gains on a slump sale.

For an Association of Persons (AOP) or Body of Individuals (BOI), capital gains are generally computed in the same manner as for any other assessee, applying the relevant sections (e.g., Sections 45 to 55A). However, the tax rates applicable can vary depending on the circumstances. If the shares of the members in the AOP/BOI are indeterminate or unknown, or if any member's total income exceeds the maximum amount not chargeable to tax, the entire income of the AOP/BOI (including capital gains) is taxable at the maximum marginal rate (MMR). If the shares of members are determinate and no member has income exceeding the basic exemption limit, then the AOP/BOI is taxed at normal slab rates. Long-term capital gains (LTCG) on listed equity shares/units (Section 112A) or other LTCG (Section 112) and short-term capital gains (STCG) on listed equity shares/units (Section 111A) are taxed at special rates, irrespective of whether the AOP/BOI is taxed at slab rates or MMR, unless specifically provided otherwise.

Section 54EC offers an exemption from long-term capital gains (LTCG) if the net consideration or a part thereof is invested in specified long-term assets (bonds) within six months from the date of transfer of the original asset. The specified bonds are issued by NHAI, REC, PFC, IRFC, or any other bond notified by the Central Government. The maximum amount that can be invested in these bonds in a financial year is ₹50 lakhs. These bonds have a lock-in period of five years. If the bonds are transferred or converted into money within this lock-in period, the exemption originally claimed will be withdrawn, and the capital gains will become taxable in the year of such transfer or conversion. It's crucial for CA students to note the strict time limit for investment and the maximum investment cap per financial year.

The conversion of a partnership firm into a company or an LLP generally attracts capital gains tax on the transfer of assets from the firm to the new entity. However, Section 47(xiii) provides an exemption from capital gains tax if a partnership firm converts into a company, provided certain conditions are met. These conditions include: all assets and liabilities of the firm becoming assets and liabilities of the company, all partners becoming shareholders in the same proportion as their capital accounts, and the total shareholding of the partners in the company not being less than 50% for 5 years from conversion. Similarly, Section 47(xiiib) provides exemption for conversion of a private company or unlisted public company into an LLP, subject to conditions like all shareholders becoming partners, no consideration other than share of profit and capital contribution, and total turnover not exceeding ₹60 lakhs in any of the three preceding years. If any of these conditions are violated subsequently, the exemption is withdrawn, and capital gains become taxable in the year of violation.