Capital Gains

Under Section 2(47), transfer includes sale, exchange, relinquishment of the asset, extinguishment of any rights therein, compulsory acquisition thereof under any law, conversion of asset into stock-in-trade, and any transaction allowing possession of immovable property in part performance of a contract.

Section 2(47) of the Income Tax Act, 1961, defines 'transfer' broadly for the purpose of capital gains. It includes:

1. Sale, exchange, or relinquishment of the asset: This is the most common form of transfer.
2. Extinguishment of any rights therein: This includes situations where a right associated with an asset ceases to exist, e.g., redemption of preference shares or debentures.
3. Compulsory acquisition thereof under any law.
4. Conversion of the asset by the owner into, or its treatment by him as, stock-in-trade of a business carried on by him. In such cases, the fair market value (FMV) on the date of conversion is deemed to be the full value of consideration, and capital gains arise in the year of conversion (though tax is paid when stock-in-trade is sold).
5. Any transaction involving the allowing of possession of any immovable property to be taken or retained in part performance of a contract of the nature referred to in Section 53A of the Transfer of Property Act, 1882.
6. Any transaction (whether by way of becoming a member of, or acquiring shares in, a co-operative society, company or other association of persons or by way of any agreement or any arrangement or in any other manner whatsoever) which has the effect of transferring, or enabling the enjoyment of, any immovable property.
7. Maturity or redemption of a zero-coupon bond.

Exclusions from 'Transfer': Certain transactions are specifically not considered 'transfer' for capital gains purposes, such as:

• Transfer of a capital asset under a gift or will (though the recipient's cost basis is that of the previous owner).
• Transfer of assets between a holding company and its 100% subsidiary company (under certain conditions).
• Transfer of assets in a scheme of amalgamation or demerger (under certain conditions).

The treatment of bonus shares and right shares differs significantly for capital gains computation:

Bonus Shares: These are shares issued by a company to its existing shareholders without any consideration, out of its accumulated profits.

• Cost of Acquisition (CoA):
  • If allotted before 01.04.2001: The Fair Market Value (FMV) of the bonus share as on 01.04.2001 is considered as its CoA.
  • If allotted on or after 01.04.2001: The CoA is NIL.
• Period of Holding (PoH): The PoH starts from the date of allotment of the bonus shares.

Right Shares: These are shares offered by a company to its existing shareholders to subscribe to additional shares in proportion to their existing holdings, usually at a price lower than the market price.

• Cost of Acquisition (CoA): The actual amount paid by the shareholder for acquiring the right shares is their CoA.
• Period of Holding (PoH): The PoH starts from the date of allotment of the right shares.
• Renunciation of Right Entitlement: If a shareholder renounces their right to subscribe to the shares in favour of another person, the consideration received for such renunciation is taxable as Short-Term Capital Gain (STCG) in the hands of the renouncer, as the right itself is considered a capital asset with a NIL cost of acquisition. The period of holding for the right entitlement is from the date of offer to the date of renunciation.

The 'cost of acquisition' (CoA) is the value for which the capital asset was acquired by the assessee. The 'cost of improvement' (CoI) refers to capital expenditure incurred in making additions or alterations to the capital asset.

General Rules:

• Acquired after 01.04.2001: Actual cost incurred by the assessee.
• Acquired before 01.04.2001: Assessee has the option to take either the actual cost of acquisition or the Fair Market Value (FMV) of the asset as on 01.04.2001, whichever is higher. For CoI, only expenses incurred after 01.04.2001 are considered.

Special Cases:

• Inherited/Gifted Assets (Section 49(1)): The CoA for the assessee is deemed to be the cost for the previous owner who acquired the asset otherwise than by inheritance/gift. If the previous owner acquired it before 01.04.2001, the FMV as on 01.04.2001 can be taken as CoA. The period of holding includes the period for which the asset was held by the previous owner.
• Bonus Shares: If allotted before 01.04.2001, the FMV as on 01.04.2001 is the CoA. If allotted on or after 01.04.2001, the CoA is NIL.
• Right Shares: The actual amount paid for acquiring the right shares is the CoA.
• Goodwill of a business or profession, or a trademark, brand name, etc.: If acquired by purchase, the purchase price is the CoA. If self-generated, the CoA is NIL.

Indexation is a mechanism to adjust the cost of acquisition and cost of improvement of a capital asset for inflation over the period it was held. This reduces the taxable long-term capital gain, as the purchasing power of money diminishes over time. The objective is to tax only the real gain, not the inflationary gain.

Formula for Indexed Cost:

• Indexed Cost of Acquisition (ICOA) = Cost of Acquisition × (CII of the year of transfer / CII of the year of acquisition or 2001-02, whichever is later)
• Indexed Cost of Improvement (ICOI) = Cost of Improvement × (CII of the year of transfer / CII of the year of improvement)

Cost Inflation Index (CII): This index is notified by the Central Government annually. The base year for CII is 2001-02, with a CII value of 100.

Applicability:

• Indexation benefit is available only for Long-Term Capital Gains (LTCG).
• It is generally applicable to all long-term capital assets, including immovable property, unlisted shares, and other assets.

Non-Applicability:

• Short-Term Capital Gains (STCG).
• LTCG on listed equity shares or units of equity-oriented mutual funds covered under Section 112A (taxed at 10% on gains exceeding ₹1 lakh without indexation).
• LTCG on bonds or debentures (other than capital indexed bonds issued by the Government and sovereign gold bonds).

Under Section 2(14) of the Income Tax Act, 1961, a 'capital asset' generally includes property of any kind held by an assessee, whether connected with their business or profession or not. This broad definition covers movable and immovable property, tangible and intangible assets, such as land, building, shares, debentures, goodwill, and trademarks. However, certain items are specifically excluded:

1. Stock-in-trade, consumable stores, or raw materials held for the purpose of business or profession.
2. Personal effects (movable property, including wearing apparel and furniture held for personal use by the assessee or any member of their family dependent on them), but excluding jewellery, archaeological collections, drawings, paintings, sculptures, or any work of art.
3. Rural agricultural land in India (land not situated within specified municipal or cantonment areas with a population of 10,000 or more, or within 8 km from such areas depending on population).
4. 6½% Gold Bonds, 1977, 7% Gold Bonds, 1980, or National Defence Gold Bonds, 1980, issued by the Central Government.
5. Special Bearer Bonds, 1991.
6. Gold Deposit Bonds issued under the Gold Deposit Scheme, 1999, or Deposit Certificates issued under the Gold Monetisation Scheme, 2015.

For Long-Term Capital Gains, the cost of acquisition and cost of improvement are indexed to adjust for inflation using the Cost Inflation Index (CII) notified by the government for the year of sale and the year of acquisition. Note: Recent budgets have introduced an option to pay a lower tax rate without indexation for real estate.

Section 54 provides an exemption from Long-Term Capital Gains (LTCG) arising from the transfer of a residential house property, provided the capital gains are reinvested in another residential house property.

Conditions for Exemption:

1. Assessee: Individual or Hindu Undivided Family (HUF).
2. Asset Transferred: A Long-Term Capital Asset, being a residential house property (building or land appurtenant thereto).
3. New Asset Acquired: The assessee must purchase or construct a new residential house property in India.
4. Time Limit for Reinvestment:
   • Purchase: Within 1 year before or 2 years after the date of transfer.
   • Construction: Within 3 years after the date of transfer.
5. Number of New Houses: The exemption is generally available for investment in one residential house property in India. However, if the amount of capital gain does not exceed ₹2 crores, the assessee has the option to invest in two residential house properties in India. This option can be exercised only once in the lifetime of the assessee.
6. Restriction on Sale of New Asset: The new residential house property must not be transferred within 3 years from the date of its acquisition/completion of construction. If transferred, the exemption previously claimed will be withdrawn, and the capital gain (or a portion of it) will be taxable in the year of sale of the new asset.
7. Capital Gains Account Scheme (CGAS): If the new house is not purchased/constructed before the due date of filing the return of income, the unutilized capital gain must be deposited in a CGAS account. This amount, if not utilized within the specified time limits, becomes taxable in the year the time limit expires.

Amount of Exemption:

• If the cost of the new house is equal to or more than the LTCG, the entire LTCG is exempt.
• If the cost of the new house is less than the LTCG, the exemption is limited to the cost of the new house.

Generally, an asset held for more than 36 months is a long-term capital asset. For listed securities and equity-oriented mutual funds, it's >12 months. For unlisted shares and immovable property (land/building), it's >24 months.

The distinction between Short-Term Capital Gain (STCG) and Long-Term Capital Gain (LTCG) depends on the 'period of holding' of the capital asset before its transfer.

Short-Term Capital Asset (STCA): An asset held for a period not exceeding:

• 12 months: For equity or preference shares listed on a recognised stock exchange in India, units of equity-oriented mutual funds, zero-coupon bonds, and units of UTI.
• 24 months: For unlisted shares and immovable property (land or building or both).
• 36 months: For any other capital asset not covered above.

Long-Term Capital Asset (LTCA): An asset held for a period exceeding the above-specified limits.

Significance:

• Tax Rates: STCG is generally taxed at normal slab rates for individuals, though STCG on listed equity shares/equity-oriented mutual funds (covered by Section 111A) is taxed at a concessional rate of 15%. LTCG (other than those covered by Section 112A) is taxed at a flat rate of 20% after indexation. LTCG on listed equity shares/equity-oriented mutual funds (covered by Section 112A) is taxed at 10% on gains exceeding ₹1 lakh, without indexation.
• Indexation Benefit: The benefit of indexation (adjusting the cost of acquisition for inflation) is available only for LTCG (except for Section 112A assets and certain bonds/debentures).
• Exemptions: Specific exemptions (e.g., Section 54, 54F, 54EC) are primarily available for LTCG.

The Capital Gains Account Scheme (CGAS) is a facility provided by the Income Tax Act, 1961, to enable assessees to claim exemption under various sections (e.g., 54, 54F) even if they are unable to reinvest the capital gains or net consideration in the new asset within the stipulated time before the due date for filing their income tax return.

Purpose:
When an assessee sells a capital asset and intends to claim exemption under sections like 54, 54F, or 54B, they are required to reinvest the capital gains or net sale consideration into a new asset within a specified period (e.g., 2 or 3 years for purchase/construction of a house). If this investment is not made by the due date for filing the income tax return for the year of transfer, the unutilized amount must be deposited into a CGAS account with a specified bank.

Key Features:

1. Deposit Types: There are two types of accounts: Account A (savings account type, for short-term needs) and Account B (term deposit type, for longer-term needs).
2. Time Limit: The deposit must be made before the due date of filing the income tax return for the assessment year in which the capital gain arose.
3. Utilization: The amount deposited in CGAS must be utilized for the specified purpose (e.g., purchasing/constructing a new house) within the original time limits (e.g., 2 or 3 years from the date of transfer of the original asset).
4. Consequence of Non-Utilization: If the amount deposited in CGAS is not utilized for the specified purpose within the prescribed time limit, the unutilized amount will be treated as capital gain of the previous year in which the time limit expires, and it will be taxable in that year.

When is it beneficial?
CGAS is beneficial when an assessee has realized capital gains but has not yet identified or completed the purchase/construction of the new asset within the short period available until the tax return filing deadline. By depositing the amount in CGAS, the assessee can still claim the exemption for the current year and has the full statutory period to make the actual investment.

The Income Tax Act, 1961, specifies rules for setting off and carrying forward capital losses to ensure proper computation of taxable income.

1. Set-off of Capital Losses (within the same assessment year):

• Short-Term Capital Loss (STCL): Can be set off against any capital gain (Short-Term Capital Gain or Long-Term Capital Gain).
• Long-Term Capital Loss (LTCL): Can only be set off against Long-Term Capital Gain (LTCG). It cannot be set off against STCG.

Important Points:

• Capital losses cannot be set off against any other head of income (e.g., salary, house property, business/profession).
• Loss from the sale of assets covered under Section 112A (listed equity shares/equity-oriented mutual funds on which STT is paid) cannot be set off against any capital gain if the gain itself is exempt up to ₹1 lakh.

2. Carry Forward of Capital Losses:

• Any capital loss (STCL or LTCL) that cannot be fully set off in the current assessment year can be carried forward to subsequent assessment years.
• Maximum Carry Forward Period: Capital losses can be carried forward for a maximum of 8 assessment years immediately succeeding the assessment year in which the loss was incurred.
• Set-off in Future Years:
  • Carried forward STCL: Can be set off against any capital gain (STCG or LTCG) in the future years.
  • Carried forward LTCL: Can only be set off against LTCG in the future years.
• Filing of Return: It is mandatory to file the return of income by the due date specified under Section 139(1) for the year in which the loss was incurred, to be eligible to carry forward the loss.

The tax rates for capital gains for an individual assessee depend on whether the gain is short-term or long-term, and the nature of the asset:

1. Short-Term Capital Gain (STCG):

   • STCG covered by Section 111A: Arising from the transfer of equity shares or units of an equity-oriented mutual fund, where Securities Transaction Tax (STT) has been paid. Taxed at a concessional rate of 15% (plus surcharge and cess).
   • Other STCG: Taxed at the normal slab rates applicable to the individual's total income.

2. Long-Term Capital Gain (LTCG):

   • LTCG covered by Section 112A: Arising from the transfer of listed equity shares or units of an equity-oriented mutual fund, where STT has been paid. Taxed at 10% on the amount exceeding ₹1 lakh, without the benefit of indexation (plus surcharge and cess). Gains up to ₹1 lakh are exempt.
   • LTCG covered by Section 112: This includes most other LTCG, such as on sale of immovable property, unlisted shares, debt mutual funds, etc. Taxed at a flat rate of 20% after providing for indexation benefit (plus surcharge and cess). However, for non-resident Indians, LTCG on unlisted shares may be taxed at 10% without indexation.
   • LTCG on Zero Coupon Bonds: Taxed at 10% without indexation.

Note: The basic exemption limit (e.g., ₹2.5 lakhs for individuals below 60 years) can be adjusted against STCG (other than Section 111A) and LTCG (other than Section 112A) if the total income excluding capital gains is less than the basic exemption limit. Surcharge and Health & Education Cess are applicable on the tax amount.

Section 54F provides an exemption from Long-Term Capital Gains (LTCG) arising from the transfer of any long-term capital asset (other than a residential house property), provided the net sale consideration is reinvested in a new residential house property.

Conditions for Exemption:

1. Assessee: Individual or Hindu Undivided Family (HUF).
2. Asset Transferred: Any Long-Term Capital Asset, other than a residential house property.
3. New Asset Acquired: The assessee must purchase or construct a new residential house property in India.
4. Time Limit for Reinvestment:
   • Purchase: Within 1 year before or 2 years after the date of transfer.
   • Construction: Within 3 years after the date of transfer.
5. Ownership Restriction: The assessee should not own more than one residential house property (other than the new one) on the date of transfer of the original asset.
6. Restriction on Sale of New Asset: The new residential house property must not be transferred within 3 years from the date of its acquisition/completion of construction. If transferred, the exemption previously claimed will be withdrawn, and the capital gain (or a portion of it) will be taxable in the year of sale of the new asset.
7. Capital Gains Account Scheme (CGAS): Similar to Section 54, unutilized net consideration must be deposited in a CGAS account if the new house is not purchased/constructed before the due date of filing the return.

Amount of Exemption: The exemption is proportionate to the investment made in the new residential house.

• Exemption = Long-Term Capital Gain × (Cost of new residential house / Net Sale Consideration)

If the entire net sale consideration is invested in the new house, the entire LTCG is exempt. If only a part of the net sale consideration is invested, only a proportionate part of the LTCG is exempt.

Section 54EC provides an exemption from Long-Term Capital Gains (LTCG) arising from the transfer of any long-term capital asset, provided the capital gains are reinvested in specified bonds.

Conditions for Exemption:

1. Assessee: Any assessee (individual, HUF, company, etc.).
2. Asset Transferred: Any Long-Term Capital Asset.
3. New Asset Acquired: Investment must be made in 'long-term specified assets', which are bonds redeemable after 5 years, issued by the National Highways Authority of India (NHAI) or Rural Electrification Corporation Limited (REC), or any other bond notified by the Central Government.
4. Time Limit for Reinvestment: Investment must be made within 6 months from the date of transfer of the original asset.
5. Maximum Investment: The maximum amount of investment in such bonds, for claiming exemption under Section 54EC, is capped at ₹50 Lakhs during any financial year.
6. Lock-in Period: The specified bonds must be held for a minimum period of 5 years from the date of their acquisition. If transferred or converted into money before 5 years, the exemption previously claimed will be withdrawn, and the capital gain will be taxable in the year of such transfer or conversion.

Amount of Exemption:

• The exemption is limited to the amount of capital gain or the amount invested in specified bonds, whichever is lower.
• If the entire capital gain is invested (up to the ₹50 lakh limit), the entire LTCG is exempt.

This section is particularly useful for assessees who may not wish to invest in residential property or do not meet the conditions of Sections 54 or 54F.