CHAPTER 5 COMPLICATIONS RELATING TO INCOME FROM CAPITAL GAINS AND SUGGESTIONS TO OVERCOME THEM 5.1 ACCRUAL OF INCOME FROM CAPITAL GAINS As per section 45(1) of the Act, 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, 54F, 54G and 54GA, 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. Thus, when as assessee transfers a capital asset during the previous year, the amount of profit or gain arising as a result of transfer is chargeable as income from capital gains if it is not exempted under the specified sections. 5.1.1 Which assets are treated as capital assets "Capital asset" as per section 2(14) of the Act means property of any kind held by an assessee, whether or not connected with his business or profession except the following six assets : (i) (ii) Any stock-in-trade, consumable stores or raw materials held for the purposes of business or profession by the assessee. Any surplus arising on transfer of stock-intrade, consumable stores or raw material is chargeable to tax as income from business. Personal effects, that is to say, movable property held for personal use by the assessee or any member of his family dependent on him which include wearing apparel and furniture but does not include : (a) jewellery; (b) archaeological collections; (c) drawings;
(d) paintings; (e) sculptures; or (f) any work of art This means that income from transfer of the assets stated under (a) to (f) above is chargeable to tax as income from Capital gains and are, thus, not excluded from the expression "Capital Assets". As per the Explanation to section 2(14), "Jewellery" includes (a) (b) 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 stone, and whether or not worked or sewn into any wearing apparel; and precious or semi-precious stones, whether or not set in any furniture, utensil or other article or worked or sewn into any wearing apparel. A property intended for personal or household use is always a "personal effects" may it be only for ceremonial occasions. Clothes meant for use at weddings or formal occasions are not used daily but are stitched for personal use of the wearer. Therefore, they would form a part of his personal effects 1. Similarly, the Supreme Court has held that gold and silver coins and bars used for pooja of deities as a matter of pride or ornamentation and normally not intended for personal or household use are not "Personal effects" and are treated as capital assets 2. The Supreme Court observed that the legislature intended only those articles to be included in "personal effects" which are intimately and commonly used by the assessee. In view of this observation personal effects may be taken to include a conveyance be it a scooter, car or aeroplane. Therefore, surplus arising on transfer of a conveyance used for personal purposes is not taxable as income from capital gains. Personal effects include Car, Cycle, Scooter, Motor-cycle owned and used by the taxpayer. Furniture can be said to be movables held for personal use. But, a foreign stamp collection, securities, loose diamonds held by an assessee and holding
of goats by an assessee for procuring their wastes as natural manure to increase the agricultural production are not "personal effects". (iii) (a) (b) Agricultural land situated in a rural area, that is, which is not situated in any area within the territorial jurisdiction of a municipality or a cantonment board having a population of 10,000 or more according to the last preceding census; or in any notified area, that is, an area within such distance, not being more than eight kilometres, from the local limits of any municipality, or cantonment board as stated above, as the Central Govt. may, having regard to the extent of, and scope for, urbanisation of that area and other relevant considerations, specify in this behalf. If agricultural land is situated in a village which comes within a municipality then population of the municipality shall be considered and not that of the village. If population of the municipality exceeds 10,000, then agricultural land is a capital asset, even if population of the village is less than 10,000 1. (iv) Gold bonds issued by the Central Govt. which are 6.5% Gold Bonds, 1977; 7% Gold Bonds, 1980; National Defence Gold Bonds, 1980. It is not necessary that the assessee should be the initial subscriber to the Gold Bonds. (v) (vi) Special Bearer Bonds, 1991 issued by the Central Govt. It is not necessary that the assessee should be the initial subscriber of these bonds. Gold Deposit Bonds which are issued under the Gold Deposit Scheme, 1999 notified by the Central Govt. Thus, except the above six assets, capital asset means property of every descriptiontangible or intangible, movable or immovable, incorporeal rights and chooses in action. The Supreme Court has, in this context, held that the term "property" is a term of the widest import and subject to any limitation which the context may require, it
signifies every possible interest which a person can closely hold and enjoy 1. 5.1.2 What does "transfer" of a capital asset mean The definition of "transfer" in relation to a capital asset, contained in section 2(47) of the Act is only inclusive and is thus not exhaustive. According to section 2(47), "transfer" includes (i) (ii) (iii) (iv) (v) (vi) (vii) the sale, exchange or relinquishment of the asset; or the extinguishment of any rights therein; or the compulsory acquisition thereof under any law; or in a case where the asset is converted by the owner thereof into, or is treated by him as, stock-in-trade of a business carried on by him, such conversion or treatment; or the maturity or redemption of a zero coupon bond; or any transaction involving the allowing of the 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; or 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. The Supreme Court has held that this definition of "transfer" which contains the above noted seven modes of transfer. Thus, transfer of tenancy right is a "transfer" does not exhaust other kinds of transfer 1. 5.1.2.1 Sale, exchange and relinquishment of an asset 'Sale' is a mode of transfer of the absolute or general property by a seller to a buyer for money consideration by way of mutual agreement. 'Exchange' is a mutual transfer of ownership of one thing for the ownership of another. Thus, conversion of preference shares into ordinary shares is a transaction of 'exchange'. However, as per circular No. 751, dated Feb. 10, 1997, the
transaction of lending shares of same distinctive numbers and receiving back of some other numbers is not 'exchange'. 'Relinquishment' of property takes place when the owner withdraws himself from the property and abandons his rights thereto; the property continues to exist and it continues to be owned by some person or persons. 5.1.2.2. 'Extinguishment' of rights in property 'Extinguishment' means to put a total end to or to blot out of existence. Thus, 'extinguishment', refers to putting an end to the rights of a holder of an asset. When there is a reduction of share capital by a company by paying a part of capital to its shareholders, it would result in 'extinguishment' of proportionate right in shares held by shareholders and it would be chargeable to capital gains tax in the hands of shareholders 2. Similarly, redemption of preference shares by a company comes within the phrase 'sale, exchange or relinquishment of the asset and consequently, it is treated as transfer 3. 5.1.2.3 'Compulsory acquisition' of an asset The Govt. is empowered under the constitution of India to acquire property being land or land and building of any person keeping in view the development of a particular area in the national interest; right to property is no longer a fundamental right. The Govt. has to make payment by way of compensation to the person whose property is acquired by it which is computed on the basis of market price prevailing in the area on the date of acquisition. Thus, acquisition of property is one of the modes of transfer of capital asset. The income accruing to the person whose property is acquired by the Govt. is chargeable to capital gains tax. 5.1.2.4 Conversion of capital asset into stock-in-trade Conversion of investment into stock-in-trade of a new business or an existing business carried on by a taxpayer is treated as transfer under section 2(47) with effect from the assessment year 1985-86. The notional profit arising from transfer by way of conversion of capital asset into stock-in-trade is chargeable to tax in the year in which stock-in-trade is sold. For the purposes of computing the capital gain in such cases, the fair market value of the capital asset on the date on which it was converted or treated as stock-in-trade shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of the capital asset. If stock-in-
trade is sold in parts in different years, tax on capital gain on conversion of capital asset into stock-in-trade as per section 45(2), can be said to arise in parts in different years and not in one year in which last of stock-in-trade is sold 1. 5.1.2.5 Maturity or redemption of a zero coupon bond "Zero coupon bond" according to section 2(48), means a bond (a) (b) (c) issued by any infrastructure capital company or infrastructure capital fund or public sector company or scheduled bank on or after June 1, 2005; in respect of which no payment and benefit is received or receivable before maturity or redemption from infrastructure capital company, or fund, public sector company or scheduled bank; and which the Central Govt. may, by notification in the official Gazette, specify in this behalf. Since no payment or benefit is received or receivable before maturity or redemption of these bonds, these bonds are known as zero coupon bonds. The life of zero coupon bond should not be less than 10 years and should not be more than 20 years. Maturity or redemption of these bonds will amount to "transfer" under section 2(47) (iva) with effect from the assessment year 2006-07. 5.1.2.6 Possession of immovable property in part performance of a contract u/s 53A of Transfer of Property Act With effect from the assessment year 1988-89, any transaction involving the allowing of the possession of any immovable property to be taken or retained in part performance of a contract referred to in section 53A of the Transfer of Property Act, 1882 is treated as 'transfer'. Under section 53A of the Transfer of Property Act, following three conditions require to be fulfilled (a) (b) (c) There should be an agreement in writing between the purchaser and seller. The purchaser has paid the consideration or he is ready to pay the consideration. The purchaser has taken the possession of the property.
The purchaser becomes the deemed owner of the property by fulfilling these conditions even if he is not the registered owner of the property. Thus, if Mr. X enters into a written agreement to purchase a property from Mr. Y for Rs. 10 lac.he has taken the possession but has not paid the amount. The sale deed is yet to be registered. For the purpose of paying tax on rental income from the property Mr. X becomes deemed "owner" of the property though he is not the registered owner of the property. 5.1.2.7 Transaction which has the effect of transferring an immovable property when a member of a co-operative society, company or association of persons is allotted an immovable property or he will be allotted an immovable property by virtue of his membership and he transfers the membership right. As a result of this act of the transfer or the immovable property will be deemed to have been transferred to the person to whom the membership right is transferred. 5.2 CATEGORIES OF CAPITAL GAINS : Income from capital gains may be divided into two categories short term capital gains and long term capital gains. Income accruing to an assessee from the transfer of 'short term capital asset' is known as short term capital gains while income accruing from transfer of 'long term capital asset' is known as long term capital gains. 'Short term capital asset' means a capital asset held by an assessee for not more than 36 months, immediately prior to its date of transfer. 'Long term capital asset' means a capital asset held by an assessee for more than 36 months, immediately prior to its date of transfer. However, in the case of the following five capital assets the period of '12 months' is substituted in place of the period of '36 months' for determining whether the gain from transfer of a capital asset is 'short term' or 'long term' (i) (ii) (iii) Shares in a company equity and preference both, whether listed at a recognized stock exchange in India or not. Securities which are listed at a recognized stock exchange in India. Units of Unit Trust of India whether listed at a recognized stock exchange in India or
not. (iv) (v) Units of a mutual fund registered under the SEBI Act 1992 and other mutual fund set up by a public sector bank or a public financial institution authorised by the RBI and notified by the Central Govt. in the Official Gazette whether listed at a recognized stock exchange in India or not. Zero coupon bonds issued by any infrastructure capital company, infrastructure capital fund, public sector company or scheduled bank whether listed at a recognized stock exchange in India or not. In the case of above stated five capital assets, if any asset is held for more than 12 months immediately prior to its transfer, the amount of capital gains thus accruing is known as long term capital asset. On the other hand if transfer of a capital asset in these five cases is effected within 12 months of its holding, the amount of capital gains thus accruing from the capital asset is known as short term capital gains. Short term capital gains is taxed like any other income and so the rate of tax may go upto 30% in its case. On the other hand long term capital asset is taxed at a lower rate. Also, the number of exemptions from capital gains tax is more in the case of long term capital gains than the exemptions available in the case of short term capital gains. 5.3 'PERIOD OF HOLDING' OF A CAPITAL ASSET Period for which a capital asset is held by an assessee before its transfer helps in the determination of whether the amount of capital gain accruing from the transfer is short term or long term. The period of holding is reckoned from the date of acquisition of the asset by the assessee and upto the date of its transfer by him. However, when the assessee did not himself acquire the asset but the asset devolved on him under any of the circumstances mentioned u/s 49(1) of the Act from the previous owner, the date of acquisition by the previous owner will be taken to be the date of acquisition by the assessee. Under section 49(1) the asset may devolve on the assessee under any of the following modes : 1. On distribution of assets by an HUF among its members on its total or partial
partition. 2. Under gift or will. 3. By succession, inheritance or devolution. 4. On distribution of assets on the dissolution of a firm, body of individuals or association of persons where such dissolution had taken place at any time before April 1, 1987. 5. On distribution of assets on the liquidation of a company. 6. Under a transfer to a trust whether revocable or irrevocable. 7. On transfer by a wholly-owned Indian subsidiary company from its holding company. 8. On transfer by an Indian holding company from its wholly owned subsidiary company. 9. On transfer, in a scheme of amalgamation, by the amalgamated company from the amalgamating company under any of the following three conditions (a) 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; (b) any transfer in a scheme of amalgamation, of a capital asset being a share or shares held in an Indian company, by the amalgamating foreign company to the amalgamated foreign company, if (i) at least 25% of the shareholders of the amalgamating foreign company continue to remain shareholders of the amalgamated foreign company and (ii) such transfer does not attract tax on capital gains in the country in which the amalgamating company is incorporated; and (c) any transfer, in a scheme of amalgamation of a banking company with a banking institution sanctioned by the Central Govt., of a capital asset by the banking
company to the banking institution. 10. Acquisition of property by a HUF where one of its members has converted his selfacquired property into joint family property after Dec.31, 1969. The provisions of section 49(1) have a two-fold effect : 1. The provisions have a decisive impact on the question of determination of whether the amount of capital gains accruing on transfer of a capital asset is 'short term' or 'long term'. When the person on whom a capital asset devolved in any of the circumstances u/s 49(1) which are stated above transfers the asset, the date of acquisition of the asset to the previous owner is deemed to be the date of acquisition for the transferor. This provision is beneficial to the transferor because the period for which the asset was held by the previous owner is considered as being the period of holding by the transferor on whom the asset devolved from the previous owner. It will help is making the amount of capital gains accruing on its transfer to be 'long term' capital gain; the incidence of tax will be lower. 2. While computing amount of capital gains in the hands of the transferor, cost of acquisition of the capital asset to the previous owner is deemed to be the cost of acquisition to the transferor; this is again beneficial to the transferor in view of the fact that he did not pay anything to the previous owner at the time the asset devolved on him u/s 49(1). Of course, where the previous owner has acquired the asset in any of the above cited instances u/s 49(1), the 'previous owner' of the asset means the last previous owner who acquired the property by means other than those stated above. Cost of any improvement of the asset borne by the previous owner will be added to such cost. By virtue of section 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.
When the property devolves on an assessee under any of the instances stated u/s 49(1), the transaction is not treated as 'transfer' and no capital gain is said to accrue at that time. When the assessee transfers such asset, then he is liable to pay tax on entire amount of capital gains accruing on the date of transfer; it includes the share of capital gains upto the date of devolvement of the asset on the assessee which represents the share of capital gains to the previous owner and also the share of capital gains to the assessee from the date of devolvement of the asset on him and upto the date of transfer by him. However, in the case of transfer of a depreciable asset, capital gain is taken as short term capital gain irrespective of the period of its holding by the assessee. This rule does not apply in the case of assets used by a power generating unit which are eligible for depreciation on straight line basis. Assets used in business of an assessee on which depreciation is provided on diminishing balance method are covered under 'depreciable assets'. 5.4 PROCEDURE OF COMPUTING INCOME FROM CAPITAL GAINS 5.4.1 Computation of short term capital gains Income by way of short term capital gains is arrived at by subtracting the sum of the following three amounts from the full amount of sales consideration received or receivable by the transferor in respect of the asset transferred by him (i) (ii) (iii) Expenditure which is incurred wholly and exclusively in connection with the transfer; Cost of acquisition of the Capital asset; and Cost of improvement; if any. 5.4.1.1 Full value of consideration As per section 48 of the Act, the expression "full value" means the entire price agreed as the sales consideration by the transferor and the transferee without any deduction whatsoever. Sales consideration may be received in cash or in kind or partly in cash and partly in kind. When it is received in kind, then fair market value of such assets is taken as full value of consideration. Section 48 does not show that only consideration shown in sale deed is to be regarded as full value of consideration
received; there is nothing in the section, which precludes Assessing Officer from substituting actual sale consideration for sale consideration shown in the sale deeds, if there is evidence to show that assessee had indeed received higher amount 1. It is important to note that it makes no difference whether or not full value of consideration is received during the previous year. Even if the full value of consideration is received in instalments in different years, the entire value of consideration has to be taken into account for computing the amount of capital gains, which become chargeable in the year of transfer. The decision of the Karnataka High Court seems to be quite logical when it held the compensation received for injurious affection of unacquired portion of a larger plot to be a part of full value of consideration where a portion of a larger plot is acquired which injuriously affects the value of the unacquired portion 1. Cases when "full value of consideration" is determined on notional basis In the following cases "full value of consideration" is determined on notional basis according to different provisions given in the Act (1) Money or other asset received under any insurance from an insurer due to damage or destruction of a capital assets As per section 45(1A) of the Act when compensation is received from an insurer because of 'damage to' or 'destruction of' any capital asset which is a result of (i) flood, typhoon, hurricane, cyclone, earthquake or other convulsion of nature; or (ii) riot or civil disturbance or (iii) accidental fire explosion; or (iv) action by an enemy or action taken in combating an enemy, then the value of any money or the fair market value of the asset on the date of its receipt shall be deemed to be full value of the consideration received or accruing as a result of transfer of such asset. Any profits or gains arising from receipt of such money or other assets shall be chargeable to capital gains tax. Also, it shall be deemed to be the income of such person for the previous year in which such money or other asset is received.
(2) Conversion of capital asset into stock-in-trade The fair market value of the capital asset on the date on which it was converted or treated as stock-in-trade of the business of the assessee shall be deemed to be the amount of full value of the consideration received or accruing as a result of the transfer of the capital asset. As per section 45(2), the notional profit arising from transfer by way of conversion of capital asset into stock-in-trade is chargeable to tax in the year in which stock-in-trade is sold though it accrues in the year in which the capital asset is converted into stock-intrade. This is clear with the help of the following example. Example 5.1 Mr. X converts his capital asset into stock-in-trade on April 1, 1984 when its fair market value is Rs. 10 lac. He acquired the asset on June 1,1977 for Rs. 1 lac and its fair market value on April 1, 1981 was Rs. 2 lac. He sells the stock-in-trade so converted for Rs. 18 lac on July 1, 2008. The cost inflation indices for the year 1981-82, 1984-85 and 2008-09 were 100, 125 and 582 respectively. What shall be the amount of taxable income? Solution : Computation of Total Income of Mr. X for the assessment year 2009-10 Particulars Amount (Rs.) Computation of business income : Sales consideration 18,00,000 Less : Fair market value of the stock-in-trade on its date of conversation 10,00,00 Income from Business 8,00,000 Computation of long term Capital gains : Full value of consideration (i.e., fair market value on the date of conversion) 10,00,000
Less : Cost of acquisition (i.e., fair market value on April 1,1981) (2,00,000x125/100) 2,50,000 Long Term Capital gains 7,50,000 Total Income (Rs. 8,00,000 + 7,50,000) 15,50,000 Note : Long term Capital gains will be taxable for the assessment year 2009-10 i.e., relevant to the previous year in which stock-in-trade is transferred though it accrued during the assessment year 1985-86 when the capital asset was converted into stock-in-trade. (3) Transfer of capital asset by a partner or member to a firm or AOP or BOI as his capital contribution As per section 45(3) when a person is or becomes a partner or member in a firm/aop/boi and transfers a capital asset by way of his capital contribution or otherwise, the amount recorded in the books of account of the firm/aop/boi as the value of the capital asset shall be taken as full value of consideration received as a result of the transfer. The capital asset so transferred may be short term/long term, depreciable/nondepreciable. Thus, if a personal car is transferred, section 45(3) will not apply because personal car is not a capital asset. The capital gain accruing as a result of the transfer is chargeable to tax in the previous year in which such transfer takes place. This rule is not applicable when a member transfers a capital asset to a company or a cooperative society. In such a case, the amount in books of account of the firm/aop/boi/as value of the capital asset is taken as sales consideration. For example, if A joins a firm of two partners X and Y by transferring a capital asset to the firm whose market value is Rs. 5 Lac but in the books of the firm it is recorded at Rs. 4 lac, then Rs. 4 lac is taken as sales consideration. (4) Distribution of capital asset by a firm/aop/boi to its partners or members on its dissolution As per section 45(4) when a firm/aop/boi transfers capital assets by way of distribution of capital assets on the dissolution of the firm/aop/boi, the fair market value of the capital asset on the date of transfer is treated as the full value of sales consideration. The Capital asset so transferred may be short term/long term,
depreciable/non-depreciable. Thus, if rural agricultural land is transferred, section 45(4) will not apply because rural agricultural land is not a 'capital asset'. The agreed consideration between the firm/aop/boi and partners/members and as also the amount recorded in the books will not be treated as full value of consideration at all. The fair market value of the asset on the date of transfer shall be taken as full value of consideration for the firm/aop/boi. If a firm/aop/boi distributes a depreciable asset, the capital gain/loss shall always be short term capital gain/loss. However, in the hands of the partners/members, cost of the capital asset shall be treated as the agreed amount of consideration. The capital gain accruing as a result of the transfer is chargeable to tax in the hands of the firm/aop/boi as income of the year in which the transfer takes place. This rule is not applicable when an asset is transferred by a company or a co-operative society. (5) Money or other assets received by shareholders at the time of liquidation of a company As per section 46(2), when a shareholder receives money or other assets at the time of liquidation of the company in which he is a shareholder, the difference between the amounts stated under (a) and (b) below is treated as full value of consideration received by the shareholder on transfer of shares (a) Money received and the market value of other "assets" on the date of distribution. As per the decision of the Supreme Court, the word "asset" means "Capital Asset" or any other asset 1. (b) Any distribution by a company at the time of liquidation made to the shareholders to the extent to which the distribution is attributable to the accumulated profits of the company immediately before its liquidation whether capitalised or not; as per section 2(22) (c) the amount is treated as dividend. From the amount of full value of consideration, the amount of transfer expenses and cost of acquisition/indexed cost of acquisition will be subtracted to find out the amount of capital gains.
When a distribution is made by the liquidator, the distribution is deemed to take place in same proportion in which share capital and accumulated profits stood in the accounts of the company immediately before the distribution; that part of the receipt which is attributable to the accumulated profit is treated as dividend 2. When money is received from liquidator in instalments, then the cost of acquisition has to be deducted from earlier payments and once the cost of acquisition is wiped off, any sum received thereafter will be capital gain. 6. Shares etc., allotted by an employer to an employee under notified ESOP/ESOS and such shares etc., are gifted by the concerned employee to any person As per the fourth provision to section 48 when an assessee who is an employee of a company is allotted, directly or indirectly, shares/debentures/warrants by the company under a notified Employee's Stock Option Plan/Scheme in accordance with the guidelines issued by the Central Govt. and the shares/debentures/warrants are gifted by the employee to any person, the gift will be treated as 'transfer' and market value of the shares, etc., at the time of the gift will be treated to be the full value of sales consideration. The provision acts as an exception to the rule prescribed u/s 47(iii) where transfer of a capital asset in Rind by way of gift, etc., is not treated as 'transfer'. This can be explained with the help of the following example. Example 5.2 Mr. A is an employee of P. Ltd. on July 5, 2008, P. Ltd., has given an option to each employee to get 1000 shares in the company at a price of Rs. 12 per share under a Notified Employees' Stock Option Plan. So, Mr. A was allotted 1000 shares @ Rs. 12 per share on July 15, 2008 on which date the market price per share is Rs. 100/- On October 1, 2008, Mr. A gifts ESOP shares to a friend when the market price per share is Rs. 220. What shall be the amount of capital gain chargeable to tax? Solution : The vesting of shares of Mr. A is a perquisite which is exempt in the hands of Mr. A and the company will pay fringe benefit tax on Rs. [100-12]x1000 or Rs. 88,000. Gift
of ESOP shares by Mr. A will be treated as 'transfer' and he will have to pay tax on short-term capital gain of Rs. [220-100]x1000 or Rs. 1,20,000/-. (7) Transfer of land or building whereby the sales consideration shown in the conveyance deed is less than the value adopted by stamp valuation authority As per section 50C, if there is a transfer of land, building or both which may be short term/long term, depreciable/non-depreciable and the sale consideration is less than the value adopted or assessed by any authority of a State Govt. for the purpose of payment of stamp duty in respect of such transfer, the value adopted by stamp duty authority shall be taken as full value of consideration for the purpose of computation of capital gains. If the assessee accepts the value adopted by the stamp duty authority, it is taken as full value of consideration. If the assessee has disputed the value adopted by the stamp duty authority, the stamp duty valuation as finally accepted for stamp duty purpose is treated as full value of consideration. If the assessee claims that value adopted by stamp duty authority is greater than the fair market value but he has not disputed such valuation in stamp duty proceedings and the fair market value determined by the valuation officer is less than the stamp duty valuation, such fair market value is taken as full value of consideration; if the fair market value determined by the valuation officer is more than the stamp duty valuation then stamp duty valuation is taken as full value of consideration. 5.4.1.2 Transfer expenses Such expenses as are necessarily to be met by the transferror of a capital asset at the time of its transfer are treated as expenses incurred wholly and exclusively in connection with the transfer. Such expenses include (i) (ii) (iii) (iv) brokerage or commission; registration fee if borne by the transferror; cost of stamps if borne by the vendor; travelling expenses including reasonable amount on refreshment incurred by the
transferror for himself and his witnesses; and (v) legal expenses incurred to effect enhancement in the amount of compensation in connection with the compulsory acquisition of asset by the Govt. 5.4.1.3 Cost of acquisition 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. Cost to the previous owner is deemed to be the cost of acquisition to the assessee in cases where capital asset became the property of the assessee under any mode of transfer specified u/s 49(1) which have been described above. Substitution of fair market value as on April 1, 1981 in place of actual cost of acquisition : In the case of non-depreciable asset, as per section 55 (2) (b), the assessee may take at his option either actual cost or the fair market value of the asset as on April 1, 1981 as cost of acquisition in the following two cases (i) (ii) where the assessee acquired the property before April 1, 1981; and Where the property devolved on the assessee under any of the modes specified u/s 49(1) from the previous owner and the previous owner acquired it before April 1, 1981. This provision is beneficial to an assessee because he can choose higher of (a) actual cost of acquisition and (b) market value on April 1, 1981 to be the cost of acquisition; the higher the cost of acquisition the lower will be the amount of income from capital gains and consequently the lower will be the amount of tax payable. The option of substituting market value as on April 1, 1981 is not available in respect of goodwill of business, trade mark or brand name associated with business, or right to manufacture, produce or process any article or thing or right to carry on a business, tenancy rights, stage carriage permits or loom hours whether such assets are self-generated or purchased by the assessee. This option is, however, available in the case of bonus shares
allotted to an assessee before April 1, 1981. The option of choosing fair market value as on April 1, 1981 to be the cost of acquisition is not available in the case of depreciable assets. Cost of acquisition in the case of advance money received As per section 51, where any capital asset was subject to negotiations for its transfer on any previous occasion, in computing cost of acquisition any advance or other money received and forfeited by the assessee is to be deducted from the cost for which the asset was acquired or from the written down value or fair market value, as the case may be. However, the amount forfeited by the previous owner shall not be considered. The Supreme Court has, in this connection, held that the money received on the previous occasions and retained by the vendor i.e., the assessee cannot, therefore, be treated as a revenue receipt 1. 5.4.1.4 Cost of improvement Cost of improvement, as per section 55 of the Act, is capital expenditure incurred by an assessee in making additions or improvement to the capital asset. It includes expenditure incurred to protect or complete the title to the capital assets or to cure such title. Thus, any expenditure incurred to increase the value of the capital asset is known as cost of improvement. Cost of improvement includes expenditure on improvement incurred by the assessee or the previous owner or by both which is incurred only on or after April 1, 1981. This provision has been incorporated in the Act due to the introduction of the concept of indexation with effect from the previous year 1981-82. Cost of improvement incurred before April 1, 1981 is treated as part of cost of acquisition of the asset. Cost of improvement does not include any expenditure which is deductible in computing the income chargeable under the heads "Interest on securities" This used to be one of the heads of income earlier which has now been merged with the head "Income from other sources" with effect from April 1, 1989. "Income from house property", "Profit's and gains of business or profession" and "Income from other sources". Cost of any improvement, as per section 55(1)(b) in relation to a capital asset being goodwill of a business or a right to manufacture, produce or process any article or thing or right to carry on any business shall be
taken to be nil. Cost of any improvement in relation to any other capital asset where it became the property of the previous owner or the assessee before April 1, 1981, means all expenditure of a capital nature incurred in making any additions or alterations to the capital asset on or after April 1, 1981 by the previous owner or the assessee; in any other case, means all expenditure of a capital nature incurred by the previous owner and the assessee both. It may be noted that there can be cost of improvement even in the case of an intangible asset 1. Likewise, the expenditure in the shape of betterment charges paid under the town planning scheme for acquiring an enduring benefit are in the nature of capital expenditure and go to improve the value of the land 2. The computation of income from short term capital gains can be understood with the help of the following examples : Example 5.3 Mr. X a member of an HUF is allotted a residential house by the HUF on its partition on December 15, 2006. The HUF acquired the house for Rs. 5 lac on May 1, 2006. Mr. X incurs Rs. 1 lac on constructing two rooms to the house in April 2007 and sells the house for Rs. 12 lac on Feb. 15, 2009. What shall be the taxable amount of capital gains in the hands of Mr. X if he paid Rs. 12,000 to the dealer by way of brokerage? Solution : Computation of Short Term Capital gains of Mr. X for the assessment year 2009-10 Particulars Amount (Rs.) Sales consideration 12,00,000 Less : Transfer expenses 12,000 Cost of acquisition (being cost to the previous owner) 5,00,000 Cost of improvement 1,00,000 6,12,000 Taxable amount of short term Capital Gains 5,88,000
Example 5.4 Mr. X gifts the debentures to his friend on July 15, 2006 which he purchased on Jan. 9, 2006 for Rs. 35,000. The debentures are transferred to Mr. Y on April 15, 2007 on the death of Mr. X; Mr. Y is the son of Mr. X who had written a will in this regard. Mr. Y sold these debenture on Aug. 20, 2008 for Rs. 65,000. The debentures are not listed at a recognized stock exchange in India. What shall be the taxable amount of capital gains for Mr. Y if the market value of the debentures on July 15, 2006 and April 15, 2007 was Rs. 45,000 and Rs. 55,000 respectively. Solution : Computation of short term Capital Gains of Mr. Y for the assessment year 2009-10 Particulars Amount (Rs.) Sales Consideration 65,000 Less : Cost of acquisition (being the cost to the previous owner) 35,000 Taxable amount of short term Capital Gains 30,000 Note : (1) When as asset devolves on the transferor in one of the circumstances mentioned u/s 49 (1), the market value before April 1, 1981 is irrelevant. (2) The debentures are unlisted. So, the capital gains would be short term because transfer is effected within 36 months of then holding. However, where the assessee had paid an amount to improve his title by compromising a suit filed by a disputant claiming title to the property, it was held that this was not cost of improvement to the asset and could not be deducted for computation of capital gains 1. In the case of depreciable assets, the amount of capital gains on their transfer is always treated as short term irrespective of the period of their holding by the assessee; amount of capital gain in respect of such assets is computed after writing off the amount of depreciation which is computed as per the procedure discussed in Chapter 4 under Section 4.4. The computation of amount of short term capital gains can be understood with the help of the following example.
Example 5.5 On April 1, 2008 X Ltd. owns three plants P, Q & R which belong to the block having 15% as rate of depreciation; the written down values of these assets on this date were Rs. 2 lac, Rs. 5 lac and Rs. 7 lac respectively. The company acquired plant S for Rs. 50,000 on Sep. 10, 2008; Plants also belonged to this block and was not eligible for additional depreciation. On March 20, 2009 the company sold plants P, Q, R and S for Rs. 1,60,000, Rs. 8,50,000, Rs. 5,50,000 and Rs. 45,000 respectively. The company incurred Rs. 20,000 in respect of the transfer of Plants P and S. What is the amount of Capital gains for the assessment year 2009-10? Solution : Computation of amount of depreciation Particulars Amount (Rs.) Written down value of the block on April 1, 2008 of Plants P, Q&R (Rs. 2 lac + Rs. 5 lac + Rs. 7 lac) 14,00,000 Add : Cost of Plant S acquired during the previous year 2008-09 50,000 14,50,000 Less : Sale consideration of plants P, Q, R & S but subject to a maximum of Rs. 14,50,000 14,50,000 Written down value of the block on March 31, 2009 Nil Depreciation for the previous year 2008-09 Nil Computation of amount of short term Capital gains of X Ltd. for the assessment year 2009-10 Particulars Amount (Rs.) Sales consideration of Plant P, Q, R & S (Rs. 1,60,000+Rs. 8,50,000+Rs. 5,50,000+Rs. 45,000) 16,05,000 Less : Cost of acquisition W.D.V. of the block on April 1, 2008 14,00,000 Cost of Plant S acquired during the year 50,000 14,50,000 1,55,000
Less : Expenses on Transfer 20,000 Taxable amount of short term Capital Gains 1,35,000 5.4.2 Computation of income from long term Capital gains Income by way of long term capital gains is arrived at by substracting the sum of the following three amounts from the full value of sales consideration received or receivable by the transferor in respect of the long term asset transferred by him (i) (ii) (iii) Expenditure which is incurred wholly and exclusively in connection with the transfer; indexed cost of acquisition of the capital asset; and indexed cost of improvement; if any. The expressions 'full value of sales consideration' and 'transfer expenses' have the same meaning as have been given above under 5.4.1.1 and 5.4.1.2 respectively. 5.4.2.1 Indexed cost of acquisition As per explanation (iii) of section 48 "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 April 1, 1981, whichever is later. As per Explanation (v) to section 48, "Cost Inflation Index", in relation to a previous year, means such Index as the Central Govt. may, having regard to 75% 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. The Central Govt. has notified the cost inflation index for different years with effect from the previous year 1981-82 and upto the current previous year 2008-09; it was, for example. 100 for the previous year 1981-82; 199 for the previous year 1991-92; 426 for the year 2001-02 and 582 for the year 2008-09. These provisions can be understood easily with the help of the following example. Example 5.6
Mr. A acquired a piece of land in Ghaziabad on Jan. 9,1985 at a cost of Rs. 20,000 but the Stamp Duty Authority adopted its value of Rs. 50,000. Mr. A sold this plot on March 9, 2009 at Rs. 5 lac. What shall be the taxable amount of capital gains in the following situations : (a) (b) (c) (d) The value adopted by Stamp Duty Authority is Rs. 7 lac and Mr. A does not dispute it. The value adopted by the Stamp Duty Authority is Rs. 7,50,000. Mr. A files an appeal under the Stamp Act and the High Court reduces the stamp duty valuation to Rs. 6,50,000. The value adopted by the Stamp Duty Authority is Rs. 7,25,000. Mr. A does not challenge it under the Stamp Act but he claims before the Assessing Officer that the value of Rs. 7,25,000 is more than the fair market value of the land. On reference by the Assessing Officer, the valuation officer-determines Rs. 7,10,000 as fair market value. In situation (c) above, suppose the value determined by the valuation officer is Rs. 7,50,000. Solution : The cost inflation index for the year 1984-85 is 125 and for the year 2008-09 is 582. Computation of income from Capital gains of Mr. A for the assessment year 2009-10 Particulars S i t u a t i o n s (a) (b) (c) (d) Rs. Rs. Rs. Rs. Full value of consideration 7,00,000 6,50,000 7,10,000 7,25,000 Less : Indexed cost of acquisition [20000x582/125] 93,120 93,120 93,120 93,120
Long term capital gains 6,06,880 5,56,880 6,16,880 6,31,880 Notes : (1) Value adopted by the Stamp duty authority at the time of acquisition is not treated as cost of acquisition. (2) The expression 'indexed cost of acquisition' is explained in Section 5.4.2.1. Indexed cost of acquisition may be required to be computed under any of the following five situations : (a) Capital asset is acquired by the assessee himself before April 1, 1981. (b) Capital asset is acquired by the assessee himself on or after April 1, 1981. (c) The Capital asset devolved on the assessee from the previous owner before April 1, 1981 u/s 49(1) and the previous owner acquired the asset originally before April 1, 1981. (d) (e) The Capital asset devolved on the assessee from the previous owner on or after April 1,1981 u/s 49(1) and the previous owner acquired it originally before April 1, 1981. The capital asset devolved on the assessee from the previous owner on or after April 1, 1981 u/s 49(1) and the previous owner also acquired it originally on or after April 1, 1981. For computing the indexed cost of acquisition relating to the above situations, the following five formulae will be applicable : (1) Fair market value of the Cost inflation index (CII) asset on April 1, 1981 or of the year in which cost of acquisition, whichever the asset is transferred is higher Cost inflation index for the year 1981-82 (2) Cost of acquisition CII of the year in which the asset is transferred CII of the year in which the asset is acquired (3) F.M.V. of the asset on April 1, CII of the year 1981 or cost of of acquisition in which the asset is
to the previous owner, which- transferred ever is higher CII of the year 1981-82 (4) F.M.V. of the asset on April CII of the year in which 1, 1981 or cost of acquisition the asset is transferred of the previous owner, whichever is higher CII for the year 1981-92 (5) Cost of acquisition to the CII of the year in which the previous owner asset is transferred CII of the year in which the asset was first held by the assessee 5.4.2.2 Indexed Cost of improvement As per Explanation (iv) to section 48, "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. Indexed cost of improvement is also required to be computed under any of the five above stated situations. The formulae for computing indexed cost of improvement in respect of these five situations are as follows : (1) Cost of improvement incurred CII of the year in which the on or after April 1, 1981 asset is transferred CII of the year in which the improvement took place (2) Cost of improvement CII of the year in which the transfer took place CII of the year in which the improvement took place (3) Cost of improvement incurred CII of the year in which the by the assessee on or after April asset is transferred 1, 1981 CII of the year in which the improvement took place (4) Cost of improvement incurred CII of the year in which by the assessee and the previous the asset is transferred owner on or after April 1, 1981 CII of the year in which the improvement took place (5) Cost of improvement incurred CII of the year in which the by the assessee and the asset is transferred previous owner
CII of the year in which the improvement took place 5.4.3 Examples illustrating the application of the formula for computation of indexed cost of acquisition and indexed cost of improvement The application of the formulae given under 5.4.2.1 and 5.4.2.2 above can be understood with the help of the following examples : Example 5.7 Mr. X acquired a house for Rs. 1 lac in 1978 and constructed first floor in 1979 at a cost of Rs. 1 lac. Fair market value of the house on April 1, 1981 was Rs. 4 lac. Mr. X incurred Rs. 5 lac in 2004-05 for constructing second floor to the house. He sold the house on Jan. 9, 2009 for Rs. 50 lac. He paid Rs. 50,000 by way of brokerage to the dealer. What shall be the taxable income from long term capital gains by using 100, 480 and 582 to be the cost inflation index for the previous years 1981-82, 2004-05 and 2008-09 respectively? Solution : Computation of income from long term capital gains of Mr. X for the assessment year 2009-10 Particulars Amount (Rs.) Sales consideration 50,00,000 Less : Transfer expenses 50,000 Indexed Cost of acquisition [4,00,000x582/100] 23,28,000 Indexed cost of improvement [5,00,000x582/480] 6,06,250 29,84,250 Income from long term capital gains 20,15,750 Note : Since fair market value as on April 1,1981 is higher than actual cost of acquisition, the fair market value will be taken to be the cost of acquisition. Example 5.8 : Mr. X sold a house on Dec. 15, 2008 for Rs. 25 lac. which he purchased in 2004-05