Capital Gain Compensation Recd From Central Government

7
CAPITAL GAINS
7.1 Introduction
In this chapter on capital gains, the discussion begins with the definition of capital asset and
transfer and then the various circumstances under which capital gains tax is levied are
enumerated. There are certain transactions which are not to be regarded as transfer for the
purposes of capital gains. These transactions have also been discussed in this chapter. For
computing long-term capital gains, knowledge of cost inflation index is necessary. Again, there
is a separate method of computation of capital gains in respect of depreciable assets. Also,
there are exemptions from capital gains under certain circumstances. All these are discussed
in this chapter.
Section 45 provides that any profits or gains arising from the transfer of a capital asset
effected 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”.
7.2 Capital Asset

(1) Definition
According to section 2(14), a capital asset means property of any kind held by an assessee,
whether or not connected with his business or profession, but does not include—
(i) any stock-in-trade, consumable stores or raw materials held for the purpose of the
business or profession of the assessee;
(ii) personal effects, that is to say, movable property (including wearing apparel and
furniture) held for personal use by the assessee or any member of his family dependent on
him, but excludes
(a) jewellery;
(b) archaeological collections;
(c) drawings;
(d) paintings;
(e) sculptures; or
(f) any work of art.
© The Institute of Chartered Accountants of India

Capital Gains 7.2
Note - Jewellery includes -

(a) 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;
(b) precious or semi-precious stones, whether or not set in any furniture, utensil or other
article or worked or sewn into any wearing apparel.
(iii) Rural agricultural land in India i.e. agricultural land in India which is not situated in any
specified area.
(iv) 6½% Gold Bonds, 1977, or 7% Gold Bonds, 1980, or National Defence Gold Bonds,
1980, issued by the Central Government;
(v) Special Bearer Bonds, 1991 issued by the Central Government;
(vi) Gold Deposit Bonds issued under the Gold Deposit Scheme, 1999 notified by the Central
Government.
(2) Rural Agricultural Lands - We can note from the above definition that only rural
agricultural lands in India are excluded from the purview of the term ‘capital asset’. Hence
urban agricultural lands constitute capital assets. Accordingly, agricultural land situated within
the limits of any municipality or cantonment board having a population of 10,000 or more
according to the latest census will be considered as capital asset. Further, agricultural land
situated in areas lying within a distance of 8 kms from the local limits of such municipality or
cantonment board will also be considered as capital asset. The condition here is that such
areas must be notified by the Central Government having regard to the extent and scope of
their urbanisation and other relevant considerations. Consequently, any capital gain arising
from the transfer of the abovementioned agricultural lands will be liable to income-tax.
Explanation regarding gains arising on the transfer of urban agricultural land - The Explanation
to section 2(1A) clarifies that capital gains arising from transfer of any agricultural land
situated in any non-rural area (as explained above) will not constitute agricultural revenue
within the meaning of section 2(1A). In other words, the capital gains arising from the transfer
of such urban agricultural lands would not be treated as agricultural income for the purpose of
exemption under section 10(1). Hence, such gains would be exigible to tax under section 45.
(3) Other capital assets - It is not possible to enumerate the forms which a capital asset
can take. Goodwill, leasehold rights, a partner’s right or share in the firm, a manufacturing
licence and the right to subscribe for share of a company etc. are all examples of capital
asset.
(4) Jewellery - As noted above, jewellery is treated as capital asset and the profits or
gains arising from the transfer of jewellery held for personal use are chargeable to tax under
the head “capital gains”. For this purpose, the expression ‘jewellery’ includes the following:
(i) 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 stones and whether or not worked or sewn into any wearing apparel;

7.3 Income Tax
(ii) Precious or semi-precious stones, whether or not set in any furniture, utensil or other
article or worked or sewn into any wearing apparel.
(5) Zero Coupon Bond – Section 2(48) defines the expression ‘Zero Coupon Bond”. As
per this definition, ‘zero coupon bond’ means a bond issued by any infrastructure capital
company or infrastructure capital fund or a public sector company or a scheduled bank on or
after 1st June, 2005, in respect of which no payment and benefit is received or receivable
before maturity or redemption from such issuing entity and which the Central Government may
notify in this behalf. Accordingly, the Central Government has specified the following bonds to
be issued on or before 31.3.2009 as zero coupon bonds –
(i) 10 year zero coupon bonds of HUDCO, SIDBI, NABARD and IDFC;
(ii) 15 year zero coupon bonds of HUDCO;
(iii) 15 year zero coupon bonds of Power Finance Corporation; and
(iv) 10 year zero coupon bonds of National Housing Bank.
The Central Government has also specified the following bonds to be issued on or before
31.3.2011 as zero coupon bonds –
(i) Bhavishya Nirman Bond, a ten year zero coupon bond of National Bank of Agriculture and
Rural Development (NABARD), to be issued on or before 31.3.2011
(ii) ten year Deep Discount Bond (Zero Coupon Bond) of Rural Electrification Corporation
Limited (REC) to be issued on or before 31.3.2011.
The income on transfer of a ZCB (not being held as stock-in-trade) is to be treated as capital
gains. Section 2(47)(iva) provides that maturity or redemption of a ZCB shall be treated as a
transfer for the purposes of capital gains tax. ZCBs held for not more than 12 months would
be treated as short term capital assets. Where the period of holding of ZCBs is more than 12
months, the resultant long term capital gains arising on maturity or redemption would be
treated in the same manner as applicable to capital gains arising from the transfer of other
listed securities or units covered by section 112. Thus, where the tax payable in respect of
any income arising from transfer of ZCBs exceeds 10% of the amount of capital gains before
giving effect to the provisions of the second proviso to section 48 on indexation, then, such
excess shall be ignored for the purpose of computing the tax payable.
The terms “infrastructure capital company” and “infrastructure capital fund” have been defined
in section 2(26A) and 2(26B), respectively. For details, refer Chapter 1- Basic Concepts.
7.3 Short-term and long-term capital assets

Section 2(42A) defines short-term capital asset as a capital asset held by an assessee for not
more than 36 months immediately preceding the date of its transfer. Therefore, a capital
asset held by an assessee for more than 36 months immediately preceding the date of its
transfer is a long-term capital asset.
However, in the case of company shares, various securities listed in a recognised Stock
Exchange in India, units of the Unit Trust of India and of Mutual Funds specified under section

Capital Gains 7.4
10(23D) or a Zero Coupon Bond, the said assets will be considered as long-term capital
assets if they are held for more than 12 months. Further, in the case of a capital asset being a
share or any other security or a right to subscribe to any share or security where such right is
renounced in favour of any other person, the period shall be calculated for treating the capital
asset as a short-term capital asset from the date of allotment of such share or security or from
the date of offer of such right by the company or institution concerned.
Security - This term has the same meaning assigned to it in section 2(b) of Securities
Contracts (Regulation) Act, 1956.
Determination of period of holding - The following points must be noted in this regard:
(i) In the case of a share held in a company in liquidation, the period subsequent to the date
on which the company goes into liquidation should be excluded.
(ii) Section 49(1) specifies some special circumstances under which capital asset becomes
the property of an assessee. For example, an assessee may get a capital asset on a distribu-
tion of assets on the partition of a HUF or he may get a gift or he may get the property under a
will or from succession, inheritance etc. In such cases, the period for which the asset was held
by the previous owner should be taken into account.
(iii) In the case of shares held in an amalgamated company in lieu of shares in the
amalgamating company, the period will be counted from the date of acquisition of shares in
the amalgamating company.
(iv) In the case of a capital asset being a share or any other security or a right to subscribe to
any share or security where such right is renounced in favour of any other person, the period
shall be calculated from the date of allotment of such share or security or from the date of
offer of such right by the company or institution concerned.
(v) In respect of other capital assets, the period for which any capital asset is held by the
assessee shall be determined in accordance with any rules made by the CBDT in this behalf.
(vi) In the case of a capital asset, being a financial asset, allotted without any payment and
on the basis of holding of any other financial asset the period shall be reckoned from the date
of the allotment of such financial asset.
(vii) In the case of a capital asset being shares in an Indian company, which becomes the
property of the assessee in consideration of a demerger, the period of holding shall include
the period for which the shares were held in the demerged company by the assessee.
(viii) In the case of a capital asset being equity shares, or trading or clearing rights, of a stock
exchange acquired by a person pursuant to demutualization or corporatisation of a recognised
stock exchange in India as referred to in clause (xiii) of section 47, there shall be included
while calculating the period of holding of such assets the period, for which the person was a
member of the recognised stock exchange immediately prior to such demutualization or
corporatisation.
(ix) In the case of a capital asset, being any specified security or sweat equity shares allotted
or transferred, directly or indirectly, by the employer free of cost or at concessional rate to his

7.5 Income Tax
employees (including former employee or employees), the period shall be reckoned from the
date of allotment or transfer of such specified security or sweat equity shares.
Specified security” means the securities as defined in section 2(h) of the Securities Contracts
(Regulation) Act, 1956 and, where employees’ stock option has been granted under any plan
or scheme therefor, includes the securities offered under such plan or scheme.
“Sweat equity shares” means equity shares issued by a company to its employees or directors
at a discount or for consideration other than cash for providing know-how or making available
rights in the nature of intellectual property rights or value additions, by whatever name called.
In respect of capital assets other than those listed above, the period of holding shall be
determined subject to any rules which the Board may make in this behalf.
7.4 Transfer: What it means [Section 2(47)]

The Act contains an inclusive definition of the term ‘transfer’. Accordingly, transfer in relation
to a capital asset includes the following types of transactions :—
(i) the sale, exchange or relinquishment of the asset; or
(ii) the extinguishment of any rights therein; or
(iii) the compulsory acquisition thereof under any law; or
(iv) the owner of a capital asset may convert the same into the stock-in-trade of a business
carried on by him. Such conversion is treated as transfer; or
(v) the maturity or redemption of a Zero Coupon Bond; or
(vi) Part-performance of the contract : Sometimes, possession of an immovable property is
given in consideration of part-performance of a contract. For example, A enters into an agree-
ment for the sale of his house. The purchaser gives the entire sale consideration to A. A
hands over complete rights of possession to the purchaser since he has realised the entire
sale consideration. Under Income-tax Act, the above transaction is considered as transfer; or
(vii) Lastly, there are certain types of transactions which have the effect of transferring or enabling
the enjoyment of an immovable property. For example, a person may become a member of a co-
operative society, company or other association of persons which may be building houses/flats.
When he pays an agreed amount, the society etc. hands over possession of the house to the
person concerned. No conveyance is registered. For the purpose of income-tax, the above
transaction is a transfer. Even power of attorney transactions are covered.
7.5 Scope and year of chargeability [Section 45]

(i) General Provision [Section 45(1)] - Any profits or gains arising from the transfer of a
capital asset effected in the previous year (other than exemptions covered under this chapter)
shall be chargeable to Income-tax under this head in the previous year in which the transfer
took place.
(ii) Receipts from insurance parties [Section 45(1A)] - Where any person receives any
money or other assets under any insurance from an insurer on account of damage to or

Capital Gains 7.6
destruction of any capital asset, as a result of flood, typhoon, hurricane, cyclone, earthquake
or other convulsion of nature, riot or civil disturbance, accidental fire or explosion or because
of action by an enemy or action taken in combating an enemy (whether with or without
declaration of war), then, any profits or gains arising from receipt of such money or other
assets shall be chargeable to income-tax under the head “Capital gains” and shall be deemed
to be the income of the such person for the previous year in which money or other asset was
received.
For the purposes of section 48, the value of any money or the fair market value of other assets
on the date of such receipt shall be deemed to be the full value of the consideration received
or accruing as a result of the transfer of such capital assets.
(iii) Conversion or treatment of a capital asset as stock-in-trade [Section 45(2)] - A
person who is the owner of a capital asset may convert the same or treat it as stock-in-trade of
the business carried on by him. As noted above, the above transaction is a transfer. As per
section 45(2), the profits or gains arising from the above conversion or treatment will be
chargeable to income-tax as his income of the previous year in which such stock-in-trade is
sold or otherwise transferred by him. In order to compute the capital gains, the fair market
value of the asset on the date of such conversion or treatment shall be deemed to be the full
value of the consideration received as a result of the transfer of the capital asset.
Illustration 1
A is the owner of a car. On 1-4-2011, he starts a business of purchase and sale of motor cars.
He treats the above car as part of the stock-in-trade of his new business. He sells the same on
31-3-2012 and gets a profit of ` 1 lakh. Discuss the tax implication.
Solution
Since car is a personal asset, conversion or treatment of the same as the stock-in-trade of his
business will not be trapped by the provisions of section 45(2). Hence A is not liable to capital
gains tax.
Illustration 2
X converts his capital asset (acquired on June 10, 1988 for ` 60,000) into stock-in-trade in
March 10, 2011. The fair market value on the date of the above conversion was ` 3,00,000.
He subsequently sells the stock-in-trade so converted for ` 4,00,000 on June 10, 2011.
Discuss the tax implication.
Solution
Since the capital asset is converted into stock-in-trade during the previous year relevant to the A.Y.
2011-12, it will be a transfer under section 2(47) during the P.Y.2010-11. However, the profits or
gains arising from the above conversion will be chargeable to tax during the A.Y. 2012-13, since
the stock-in-trade has been sold only on June 10, 2011. For this purpose, the fair market value on
the date of such conversion (i.e. 10th March, 2011) will be the full value of consideration.
The capital gains will be computed after deducting the indexed cost of acquisition from the full
value of consideration. The cost inflation index for 1988-89 i.e., the year of acquisition is 161

7.7 Income Tax
and the index for the year of transfer i.e., 2010-11 is 711. The indexed cost of acquisition is
60,000 × 711/161 = ` 2,64,969. Hence, ` 35,031 (i.e. ` 3,00,000 – ` 2,64,969) will be
treated as long-term capital gains chargeable to tax during the A.Y.2012-13. During the same
assessment year, ` 1,00,000 (` 4,00,000 - ` 3,00,000) will be chargeable to tax as business
profits.
Year of chargeability - Capital gains are chargeable as the income of the previous year in
which the sale or transfer takes place. In other words, for determining the year of
chargeability, the relevant date of transfer is not the date of the agreement to sell, but the
actual date of sale i.e., the date on which the effect of transfer of title to the property as
contemplated by the parties has taken place [Alapati Venkatramiah v. CIT [1965] 57 ITR 185
(SC)]. Thus, in the case of any immovable property of the value exceeding ` 100, the title to
the property cannot pass from the transferor to the transferee until and unless a deed of
conveyance is executed and registered. Mere delivery of possession of the immovable
property could not itself be treated as equivalent to conveyance of the immovable property. In
the case of any movable property, the title to which would pass immediately on delivery of the
property in accordance with the agreement to sell, the transfer will be complete on such
delivery. However, as already noted, Income-tax Act has recognised certain transactions as
transfer in spite of the fact that conveyance deed might not have been executed and
registered. Power of Attorney sales as explained above or co-operative society transactions
for acquisition of house are examples in this regard.
(iv) Transfer of beneficial interest in securities [Section 45(2A)] - As per section 45(2A),
where any person has had at any time during the previous year any beneficial interest in any
securities, then, any profits or gains arising from the transfer made by the Depository or
participant of such beneficial interest in respect of securities shall be chargeable to tax as the
income of the beneficial owner of the previous year in which such transfer took place and shall
not be regarded as income of the depository who is deemed to be the registered owner of the
securities by virtue of sub-section (1) of section 10 of the Depositories Act, 1996. For the
purposes of section 48 and proviso to section 2(42A), the cost of acquisition and the period of
holding of securities shall be determined on the basis of the first-in-first-out (FIFO) method.
When the securities are transacted through stock exchanges it is the established procedure that
the brokers first enter into contracts for purchase/sale of securities and thereafter, follow it up with
delivery of shares, accompanied by transfer deeds duly signed by the registered holders. The
seller is entitled to receive the consideration agreed to as on the date of contract. Thus, it is the
date of broker's note that should be treated as the date of transfer in case of sale transactions of
securities provided such transactions are followed up by delivery of shares and also the transfer
deeds. Similarly, in respect of the purchasers of the securities, the holding period shall be reckoned
to take place directly between the parties and not through stock exchanges. The date of contract of
sale as declared by the parties shall be treated as the date of transfer provided it is followed up by
actual delivery of shares and the transfer deeds.
Where securities are acquired in several lots at different points of time, the First-In-First-Out
(FIFO) method shall be adopted to reckon the period of the holding of the security, in cases
where the dates of purchase and sale could not be correlated through specific numbers of the

Capital Gains 7.8
scrips. In other words, the assets acquired last will be taken to be remaining with the assessee
while assets acquired first will be treated as sold. Indexation, wherever applicable, for long-
term assets will be regulated on the basis of the holding period determined in this manner -
CBDT Circular No. 704, dated 28.4.1995.
“Beneficial owner” means a person whose name is recorded as such with a depository.
“Depository” means a company formed and registered under the Companies Act, 1956 and
which has been granted a certificate of registration under sub-section (1A) of section 12 of the
Securities and Exchange Board of India Act, 1992.
“Security” means such security as may be specified by SEBI.
(v) Introduction of capital asset as capital contribution [Section 45(3)] - Where a person
transfers a capital asset to a firm, AOP or BOI in which he is already a partner/member or is
to become a partner/member by way of capital contribution or otherwise, the profits or gains
arising from such transfer will be chargeable to tax as income of the previous year in which
such transfer takes place. For this purpose, the value of the consideration will be the amount
recorded in the books of account of the firm, AOP or BOI as the value of the capital asset.
Illustration 3
A is the owner of a foreign car. He starts a firm in which he and his two sons are partners. As
his capital contribution, he transfers the above car to the firm. The car had cost him
` 2,00,000. The same is being introduced in the firm at a recorded value of ` 3,50,000.
Discuss.
Solution
Car is not capital asset but is a personal effect. Section 45(3), as explained above, covers
only cases of transfer of capital asset as contribution and not personal effects. Hence, the
above transaction will not be subject to capital gains tax.
(vi) Distribution of capital assets on a firm’s dissolution [Section 45(4)] - The profits or
gains arising from the transfer of capital assets by way of distribution of capital assets on the
dissolution of a firm or AOP or BOI or otherwise shall be chargeable to tax as the income of
the firm etc. of the previous year in which such transfer takes place. For this purpose, the fair
market value of the asset on the date of such transfer shall be the full value of consideration.
The Bombay High Court made a landmark judgment in Commissioner of Income-tax v. A.N.
Naik Associates (2004) 136 Taxman 107. The Court applied the “mischief rule” about
interpretation of statutes and pointed out that the idea behind the introduction of sub-section
(4) in section 45 was to plug in a loophole and block the escape route through the medium of
the firm. The High Court observed that the expression ‘otherwise’ has not to be read ejusdem
generis with the expression ‘dissolution of a firm or body of individuals or association of
persons’. The expression ‘otherwise’ has to be read with the words ‘transfer of capital assets
by way of distribution of capital assets’. If so read, it becomes clear that even when a firm is in
existence and there is a transfer of capital asset, it comes within the expression ‘otherwise’
since the object of the amendment was to remove the loophole which existed, whereby capital
gains tax was not chargeable. Therefore, the word ‘otherwise’ takes into its sweep not only

7.9 Income Tax
cases of dissolution but also cases of subsisting partners of a partnership, transferring assets
in favour of retiring partners.
(vii) Compensation on compulsory acquisition [Section 45(5)] - Sometimes, a building or
some other capital asset belonging to a person is taken over by the Central Government by
way of compulsory acquisition. In that case, the consideration for the transfer is determined by
the Central Government. When the Central Government pays the above compensation, capital
gains may arise. Such capital gains are chargeable as income of the previous year in which
such compensation is received.
Enhanced Compensation - Many times, persons whose capital assets have been taken over
by the Central Government and who get compensation from the government go to the court of
law for enhancement of compensation. If the court awards a compensation which is higher
than the original compensation, the difference thereof will be chargeable to capital gains in the
year in which the same is received from the government. For this purpose, the cost of
acquisition and cost of improvement shall be taken to be nil.
Reduction of enhanced compensation - Where capital gain has been charged on the
compensation received by the assessee for the compulsory acquisition of any capital asset or
enhanced compensation received by the assessee and subsequently such compensation is
reduced by any court, tribunal or any authority, the assessed capital gain of that year shall be
recomputed by taking into consideration the reduced amount. This re-computation shall be
done by way of rectification under section 155.
Death of the transferor - It is possible that the transferor may die before he receives the
enhanced compensation. In that case, the enhanced compensation or consideration will be
chargeable to tax in the hands of the person who received the same.
(viii) Repurchase of mutual fund units referred to in section 80CCB [Section 45(6)] - The
difference between the repurchase price and the amount invested will be chargeable to tax in
the previous year in which such repurchase takes place or the plan referred to in section
80CCB is terminated.
Note - Since the tax treatment accorded to a LLP and a general partnership is the same, the
conversion from a general partnership firm to an LLP will have no tax implications if the rights
and obligations of the partners remain the same after conversion and if there is no transfer of
any asset or liability after conversion. However, if there is a change in rights and obligations
of partners or there is a transfer of asset or liability after conversion, then the provisions of
section 45 would get attracted.
7.6 Capital gains on distribution of assets by companies in

liquidation [Section 46]
(1) Where the assets of a company are distributed to its shareholders on its liquidation, such
distribution shall not be regarded as a transfer by the company for the purposes of section 45
[Section 46(1)]. The above section is restricted in its application to the circumstances
mentioned therein i.e., the assets of the company must be distributed in specie to
shareholders on the liquidation of the company. If, however, the liquidator sells the assets of

Capital Gains 7.10
the company resulting in a capital gain and distributes the funds so collected, the company will
be liable to pay tax on such gains.
(2) Shareholders receive money or other assets from the company on its liquidation. They
will be chargeable to income-tax under the head ‘capital gains’ in respect of the market value
of the assets received on the date of distribution, or the moneys so received by them. The
portion of the distribution which is attributable to the accumulated profits of the company is to
be treated as dividend income of the shareholder under section 2(22)(c). The same will be
deducted from the amount received/fair market value for the purpose of determining the
consideration for computation of capital gains.
(3) Capital gains tax on subsequent sale by the shareholders - If the shareholder, after
receipt of any such asset on liquidation of the company, transfers it within the meaning of
section 45 at a price which is in excess of his cost of acquisition determined in the manner
aforesaid, such excess becomes taxable in his hands under section 45.
7.7 Capital gains on buyback, etc. of shares [Section 46A]
Any consideration received by a shareholder or a holder of other specified securities from any
company on purchase of its own shares or other specified securities held by such shareholder
or holder of other specified securities shall be chargeable to tax on the difference between the
cost of acquisition and the value of consideration received by the holder of securities or by the
shareholder, as the case may be, as capital gains. The computation of capital gains shall be
made in accordance with the provisions of section 48.
Such capital gains shall be chargeable in the year in which such shares/securities were
purchased by the company. For this purpose, “specified securities” shall have the same
meaning as given in Explanation to section 77A of the Companies Act, 1956.
7.8 Transactions not regarded as transfer [Section 47]

Section 47 specifies certain transactions which will not be regarded as transfer for the purpose
of capital gains tax:
(1) Any distribution of capital assets on the total or partial partition of a HUF;
(2) Any transfer of a capital asset under a gift or will or an irrevocable trust;
However, this clause shall not include transfer under a gift or an irrevocable trust of a capital
asset being shares, debentures or warrants allotted by a company directly or indirectly to its
employees under the Employees' Stock Option Plan or Scheme offered to its employees in
accordance with the guideliness issued in this behalf by the Central Government.
(3) Any transfer of a capital asset by a company to its subsidiary company.
Conditions -(i) The parent company must hold the whole of the shares of the subsidiary
company; (ii) The subsidiary company must be an Indian company.
(4) Any transfer of capital asset by a subsidiary company to a holding company;

7.11 Income Tax
Conditions - (i) The whole of shares of the subsidiary company must be held by the holding
company; (ii) The holding company must be an Indian company.
Exception - The exemption mentioned in 3 or 4 above will not apply if a capital asset is
transferred as stock-in-trade.
(5) 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.
(6) Any transfer in a scheme of amalgamation of shares held in an Indian company by the
amalgamating foreign company to the amalgamated foreign company.
Conditions -(i) At least 25 percent of the shareholders of the amalgamating foreign company
must continue to remain shareholders of the amalgamated foreign company; (ii) Such transfer
should not attract capital gains in the country in which the amalgamating company is
incorporated.
(7) Any transfer, in a scheme of amalgamation of a banking company with a banking
institution sanctioned and brought into force by the Central Government under section 45(7) of
the Banking Regulation Act, 1949, of a capital asset by such banking company to such
banking institution.
(8) Any transfer by a shareholder in a scheme of amalgamation of shares held by him in the
amalgamating company.
Conditions - (i) The transfer is made in consideration of the allotment of any share in the
amalgamated company to him; (ii) The amalgamated company is an Indian company.
Illustration 4
M held 2000 shares in a company ABC Ltd. This company amalgamated with another
company during the previous year ending 31-3-2012. Under the scheme of amalgamation, M
was allotted 1000 shares in the new company. The market value of shares allotted is higher by
` 50,000 than the value of holding in ABC Ltd. The Assessing Officer proposes to treat the
transaction as an exchange and to tax ` 50,000 as capital gain. Is he justified?
Solution
In the above example, assuming that the amalgamated company is an Indian company, the
transaction is squarely covered by the exemption explained above and the proposal of the
Assessing Officer to treat the transaction as an exchange is not justified.
(9) Any transfer in a demerger, of a capital asset by the demerged company to the resulting
company, if the resulting company is an Indian company.
(10) Any transfer in a demerger, of a capital asset, being a share or shares held in an Indian
company, by the demerger foreign company to the resulting foreign company.
Conditions - (i) The shareholders holding at least three-fourths in value of the shares of
the demerged foreign company continue to remain shareholders of the resulting foreign
company; and
(ii) Such transfer does not attract tax on capital gains in the country, in which the demerged

Capital Gains 7.12
foreign company is incorporated.

However, the provisions of sections 391 to 394 of the Companies Act, 1956, shall not apply in
case of demergers referred to in this clause.
(11) any transfer in a business reorganisation, of a capital asset by the predecessor co-
operative bank to the successor co-operative bank.
(12) any transfer by a shareholder, in a business reorganisation, of a capital asset being a
share or shares held by him in the predecessor co-operative bank if the transfer is made in
consideration of the allotment to him of any share or shares in the successor co-operative
bank.
Note – Refer to section 44DDB for the meanings of “business reorganisation”, “predecessor
co-operative bank” and “successor co-operative bank”.
(13) Any transfer or issue of shares by the resulting company, in a scheme of demerger to the
shareholders of the demerged company if the transfer or issue is made in consideration of
demerger of the undertaking.
(14) Any transfer of bonds or shares referred to in section 115AC(1).
Conditions - (i) The transfer must be made outside India; (ii) The transfer must be made by
the non-resident to another non-resident.
(15) Any transfer of agricultural lands effected before 1-3-1970.
(16) Any transfer of any of the following capital asset to the government or to the University
or the National Museum, National Art Gallery, National Archives or any other public museum
or institution notified by the Central Government to be of (national importance or to be of)
renown throughout any State :
(i) work of art
(ii) archaeological, scientific or art collection
(iii) book
(iv) manuscript
(v) drawings
(vi) paintings
(vii) photographs
(viii) printings.
(17) Any transfer by way of conversion of bonds or debentures, debenture stock or deposit
certificates in any form, of a company into shares or debentures of that company.
(18) Any transfer by way of conversion of Foreign Currency Exchangeable Bonds into shares
or debentures of a company.
(19) Transfer by way of exchange of a capital asset being membership of a recognised stock
exchange for shares of a company to which such membership is transferred.

7.13 Income Tax
Conditions - (i) Such exchange is effected on or before 31st December, 1998 and (ii) such
shares are retained by the transferor for a period of not less than three years from the date of
transfer.
(20) Capital gains arising from the transfer of land under a scheme prepared and sanctioned
under section 18 of the Sick Industrial Companies (Special Provisions) Act, 1985, by a sick
industrial company which is managed by its workers’ co-operative.
Conditions - Such transfer is made in the period commencing from the previous year in which
the said company has become a sick industrial company and ending with the previous year
during which the entire net worth of such company becomes equal to or exceeds the
accumulated losses.
(21) Where a firm is succeeded by a company or where an AOP or BOI is succeeded by a
company in the course of demutualisation or corporatisation of a recognised stock exchange
in India, any transfer of a capital asset or intangible asset (in the case of a firm).
Conditions - (i) All assets and liabilities of the firm or AOP or BOI relating to the business
immediately before the succession become the assets and liabilities of the company;
(ii) All the partners of the firm immediately before the succession become the shareholders of
the company and the proportion in which their capital accounts stood in the books of the firm
on the date of succession remains the same;
(iii) The partners of the firm do not receive any consideration or benefit in any form, directly or
indirectly, other than by way of allotment of shares in the company.
(iv) The partners of the firm together hold not less than 50% of the total voting power in the
company, and their shareholding continues in such manner for a period of 5 years from the
date of succession.
(v) The corporatisation of a recognised stock exchange in India is carried out in accordance
with a scheme for demutualisation or corporatisation approved by SEBI.
(22) any transfer of a membership right by a member of recognised stock exchange in India
for acquisition of shares and trading or clearing rights in accordance with a scheme for
demutualization or corporatisation approved by SEBI.
(23) any transfer of a capital asset or intangible asset by a private company or unlisted public
company to a LLP or any transfer of a share or shares held in a company by a shareholder on
conversion of a company into a LLP in accordance with section 56 and section 57 of the
Limited Liability Partnership Act, 2008, shall not be regarded as a transfer for the purposes of
levy of capital gains tax under section 45, subject to fulfillment of certain conditions, namely:
(i) the total sales, turnover or gross receipts in business of the company should not exceed
` 60 lakh in any of the three preceding previous years;
(ii) the shareholders of the company become partners of the LLP in the same proportion as
their shareholding in the company;
(iii) no consideration other than share in profit and capital contribution in the LLP arises to
the shareholders;

Capital Gains 7.14
(iv) the erstwhile shareholders of the company continue to be entitled to receive at least
50% of the profits of the LLP for a period of 5 years from the date of conversion;
(v) all assets and liabilities of the company become the assets and liabilities of the LLP; and
(vi) no amount is paid, either directly or indirectly, to any partner out of the accumulated
profit of the company for a period of 3 years from the date of conversion.
(24) Where a sole proprietary concern is succeeded by a company in the business carried out
by it, as a result of which the sole proprietary concern transfers or sells any capital asset or
intangible asset to such company.
Conditions - (i) All assets and liabilities of the sole proprietary concern relating to the
business immediately before the succession become the assets and liabilities of the company;
(ii) The sole proprietor holds not less than 50% of the total voting power in the company, and
his shareholding continues in such manner for a period of 5 years from the date of succession;
(iii) The sole proprietor does not receive any consideration or benefit in any form, directly or
indirectly, other than by way of allotment of shares in the company.
(25) Any transfer in a scheme for lending of any securities under an agreement or
arrangement which the assessee has entered into with the borrower of such securities and
which is subject to the guidelines issued by SEBI or the RBI.
(26) Any transfer of a capital asset in a scheme of reverse mortgage under a scheme made
and notified by the Central Government.
Illustration 5
In which of the following situations capital gains tax liability does not arise?
(i) Mr. A purchased gold in 1970 for ` 25,000. In the P.Y. 2011-12, he gifted it to his son at
the time of marriage. Fair market value (FMV) of the gold on the day the gift was made
was ` 1,00,000.
(ii) A house property is purchased by a Hindu undivided family in 1945 for ` 20,000. It is
given to one of the family members in the P.Y. 2011-2012 at the time of partition of the
family. FMV on the day of partition was ` 12,00,000.
(iii) Mr. B purchased 50 convertible debentures for ` 40,000 in 1995 which are converted in
to 500 shares worth ` 85,000 in November 2011 by the company.
Solution
We know that capital gains arise only when we transfer a capital asset. The liability of capital
gains tax in the situations given above is discussed as follows:
(i) As per the provisions of section 47(iii), transfer of a capital asset under a gift is not
regarded as transfer for the purpose of capital gains. Therefore, capital gains tax liability
does not arise in the given situation.
(ii) As per the provisions of section 47(i), transfer of a capital asset (being in kind) on the
total or partial partition of Hindu undivided family is not regarded as transfer for the

7.15 Income Tax
purpose of capital gains. Therefore, capital gains tax liability does not arise in the given
situation.
(iii) As per the provisions of section 47(x), transfer by way of conversion of bonds or
debentures, debenture stock or deposit certificates in any form of a company into shares
or debentures of that company is not regarded as transfer for the purpose of capital
gains. Therefore, capital gains tax liability does not arise in the given situation.
7.9 Important Definitions

(a) Amalgamation [Section 2(1B)] - “Amalgamation”, in relation to companies, means the
merger of one or more companies with another company or the merger of two or more
companies to form one company (the company or companies which so merge being referred
to as the amalgamating company or companies and the company with which they merge or
which is formed as a result of the merger, as the amalgamated company) in such a manner
that -
(i) all the property of the amalgamating company or companies immediately before the
amalgamation becomes the property of the amalgamated company by virtue of the
amalgamation;
(ii) all the liabilities of the amalgamating company or companies immediately before the
amalgamation become the liabilities of the amalgamated company by virtue of the amalgama-
tion;
(iii) shareholders holding not less than three-fourth in value of the shares in the amalgamating
company or companies (other than shares already held therein immediately before the
amalgamation by, or by a nominee for, the amalgamated company or its subsidiary) become
shareholders of the amalgamated company by virtue of the amalgamation, otherwise than as a
result of the acquisition of the property of one company by another company pursuant to the
purchase of such property by the other company or as a result of the distribution of such property
to the other company after the winding up of the first mentioned company.
(b) Demerger [Section 2(19AA)] - “Demerger”, in relation to companies, means the transfer,
pursuant to a scheme of arrangement under sections 391 to 394 of the Companies Act, 1956,
by a demerged company of its one or more undertaking to any resulting company in such a
manner that -
(i) all the property of the undertaking, being transferred by the demerged company,
immediately before the demerger, becomes the property of the resulting company by virtue of
the demerger;
(ii) all the liabilities relatable to the undertaking, being transferred by the demerged
company, immediately before the demerger, become the liabilities of the resulting company by
virtue of the demerger;
(iii) the property and the liabilities of the undertaking or undertakings being transferred by the
demerged company are transferred at values appearing in its books of account immediately
before the demerger;

Capital Gains 7.16
(iv) the resulting company issues, in consideration of the demerger, its shares to the
shareholders of the demerged company on a proportionate basis;
(v) the shareholders holding not less than three-fourths in value of the shares in the
demerged company (other than shares already held therein immediately before the demerger,
or by a nominee for, the resulting company or, its subsidiary) become shareholders of the
resulting company or companies by virtue of the demerger, otherwise than as a result of the
acquisition of the property or assets of the demerged company or any undertaking thereof by
the resulting company;
(vi) the transfer of the undertaking is on a going concern basis;
(vii) the demerger is in accordance with the conditions, if any, notified under sub-section (5)
of section 72A by the Central Government in this behalf.
Explanation 1 - For the purposes of this clause, “undertaking” shall include any part of an
undertaking, or a unit or division of an undertaking or a business activity taken as a whole, but
does not include individual assets or liabilities or any combination thereof not constituting a
business activity.
Explanation 2 - For the purposes of this clause, the liabilities referred to in sub-section (ii),
shall include-
(a) the liabilities which arise out of the activities or operations of the undertaking;
(b) the specific loans or borrowings (including debentures) raised, incurred and utilised
solely for the activities or operations of the undertaking; and
(c) in cases, other than those referred to in clause (a) or clause (b), so much of the amounts
of general or multipurpose borrowings, if any, of the demerged company as stand in the same
proportion which the value of the assets transferred in a demerger bears to the total value of
the assets of such demerged company immediately before the demerger.
Explanation 3 - For determining the value of the property referred to in sub-clause (iii), any
change in the value of assets consequent to their revaluation shall be ignored.
Explanation 4 - For the purposes of this clause, the splitting up or the reconstruction of any
authority or a body constituted or established under a Central, State or Provincial Act, or a
local authority or a public sector company, into separate authorities or bodies or local
authorities or companies, as the case may be, shall be deemed to be a demerger if such split
up or reconstruction fulfils such conditions as may be notified by the Central Government in
the Official Gazette.
“Demerged company” means the company whose undertaking is transferred, pursuant to a
demerger, to a resulting company.
7.10 Withdrawal of exemption in certain cases

Section 47A provides for withdrawal of the benefit of exemption given by section 47 in certain
cases.

7.17 Income Tax
As noted above, capital gains arising from the transfer of a capital asset by a company to its
wholly owned subsidiary company is exempt from tax. Similarly, capital gains arising from the
transfer of a capital asset by the subsidiary company to the holding company is also exempt
from tax, provided under both circumstances the transferee is an Indian company.
Section 47A provides that the above exemption will be withdrawn in the following cases:
(1) Where at any time before the expiry of eight years from the date of transfer of a capital
asset referred to above, such capital asset is converted by the transferee company or is treat-
ed by it as stock-in-trade of its business;
(2) Where before eight years as noted above, the parent company or its nominee ceases to
hold the whole of the share capital of the subsidiary company.
In the above two cases, the amount of capital gains exempt from tax by virtue of the
provisions contained in section 47 will be deemed to be the income of the transferor company
chargeable under the head ‘capital gains’ of the year in which such transfer took place.
(3) Capital gains not charged to tax under clause (xi) of section 47 shall be deemed to be the
income chargeable under the head “capital gains” of the previous year in which such transfer
took place if the shares of the company received in exchange for transfer of membership in a
recognised stock exchange are transferred at any time before the expiry of three years of such
transfer.
(4) Where any of the conditions laid down in section 47 for succession of a firm or sole
proprietary concern by a company are not complied with, the amount of profits or gains arising
from the transfer of such capital asset or intangible asset shall be deemed to be the profits
and gains chargeable to tax of the successor company for the previous year in which the
conditions are not complied with.
(5) If subsequent to the conversion of a company into an LLP, any of the conditions laid
down in section 47(xiiib) are not complied with, the capital gains not charged under section 45
would be deemed to be chargeable to tax in the previous year in which the conditions are not
complied with, in the hands of the LLP or the shareholder of the predecessor company, as the
case may be.
7.11 Mode of computation of capital gains

(i) The income chargeable under the head ‘capital gains’ shall be computed by deducting
the following items from the full value of the consideration received or accruing as a result of
the transfer of the capital asset:
(1) Expenditure incurred wholly and exclusively in connection with such transfer.
(2) The indexed cost of acquisition and indexed cost of any improvement thereto.
(ii) However, no deduction shall be allowed in computing the income chargeable under the
head “Capital Gains” in respect of any amount paid on account of securities transaction tax
under Chapter VII of the Finance (No.2) Act, 2004.
Under section 48, the cost of acquisition will be increased by applying the cost inflation index

Capital Gains 7.18
(CII). Once the cost inflation index is applied to the cost of acquisition, it becomes indexed
cost of acquisition. This means an amount which bears to the cost of acquisition, the same
proportion as CII for the year in which the asset is transferred bears to the CII for the first year
in which the asset was held by the assessee or for the year beginning on 1st April, 1981,
whichever is later. Similarly, indexed cost of any improvement means an amount which bears
to the cost of improvement, the same proportion as CII for the year in which the asset is
transferred bears to the CII for the year in which the improvement to the asset took place. CII
for any year means such index as the Central Government may, having regard to 75% of the
average rise in the consumer price index for urban non-manual employees for the immediately
preceding previous year to that year by notification in the Official Gazette, specify in this
behalf.
Note - The benefit of indexation will not apply to the long-term capital gains arising from the
transfer of bonds or debentures other than capital indexed bonds issued by the Government.
In case of depreciable assets (discussed later), there will be no indexation or the capital gains
will always be short-term capital gains.
(iii) Cost Inflation Index

The cost inflation indices for the financial years so far have been notified as under:
Financial Year Cost Inflation Index Financial Year Cost Inflation Index
1981-82 100 1997-98 331
1982-83 109 1998-99 351
1983-84 116 1999-00 389
1984-85 125 2000-01 406
1985-86 133 2001-02 426
1986-87 140 2002-03 447
1987-88 150 2003-04 463
1988-89 161 2004-05 480
1989-90 172 2005-06 497
1990-91 182 2006-07 519
1991-92 199 2007-08 551
1992-93 223 2008-09 582
1993-94 244 2009-10 632
1994-95 259 2010-11 711
1995-96 281 2011-12 785
1996-97 305
As noted above, for the financial year 1981-82, CII is 100 and the CII for each subsequent year
would be determined in such a way that 75% of the rise in consumer price index for urban non-
manual employees would be reflected in the rise in CII. It would be seen that the date of transfer
of an asset would be immaterial as long as it is within a particular financial year. That means,

7.19 Income Tax
transfer of assets in any part of the year would be subject to indexation using the same CII as
applicable to an asset transferred on 1st April of the year. The effect is that all the assets
transferred during the year will be deemed to be sold on the first day of the year.
(iv) Special provision for non-residents - In order to give protection to non-residents who
invest foreign exchange to acquire capital assets, section 48 contains a proviso. Accordingly,
in the case of non-residents, capital gains arising from the transfer of shares or debentures of
an Indian company is to be computed as follows:
The cost of acquisition, the expenditure incurred wholly and exclusively in connection with the
transfer and the full value of the consideration are to be converted into the same foreign
currency with which such shares were acquired. The resulting capital gains shall be
reconverted into Indian currency. The aforesaid manner of computation of capital gains shall
be applied for every purchase and sale of shares or debentures in an Indian company. Rule
115A is relevant for this purpose.
7.12 Ascertainment of Cost in Specified Circumstances [Section 49]

A person becomes the owner of a capital asset not only by purchase but also by several other
methods. Section 49 gives guidelines as to how to compute the cost under different
circumstances.
(1) In the following cases, the cost of acquisition of the asset shall be deemed to be cost for
which the previous owner of the property acquired it. To this cost, the cost of improvement to
the asset incurred by the previous owner or the assessee must be added:
Where the capital asset became the property of the assessee:
(i) on any distribution of assets on the total or partition of a HUF;
(ii) under a gift or will;
(iii) by succession, inheritance or devaluation;
(iv) on any distribution of assets on the liquidation of a company;
(v) under a transfer to revocable or an irrevocable trust;
(vi) under any transfer by a holding company to its 100% subsidiary Indian company or vice
versa;
(vii) under any scheme of amalgamation by the amalgamating company to the amalgamated
Indian company;
(viii) by transfer of shares held in an Indian company in a scheme of amalgamation by the
amalgamating foreign company to the amalgamated foreign company;
(ix) by transfer of capital asset by a banking company to a banking institution in a scheme of
amalgamation of the banking company with the banking institution;
(x) under any such transfer of a capital asset in a business reorganization by the
predecessor co-operative bank to the successor co-operative bank;
(xi) under any such transfer by a shareholder in a business reorganisation, of a capital asset

Capital Gains 7.20
being a share or shares held by him in the predecessor co-operative bank if the transfer
is made in consideration of the allotment to him of any share or shares in the successor
co-operative bank;
(xii) on conversion of a company into an LLP;
(xiii) by conversion by an individual of his separate property into a HUF property, by the mode
referred to in section 64(2).
The cost of acquisition of the asset is the cost for which the previous owner acquired the asset
as increased by the cost of any improvement of the assets incurred or borne by the previous
owner or the assessee, as the case may be.
(2) Where shares in an amalgamated company which is an Indian company become the
property of the assessee in consideration of the transfer of shares held by him in the
amalgamating company under a scheme of amalgamation, the cost of acquisition to him of the
shares in the amalgamated company shall be taken as the cost of acquisition of the shares in
the amalgamating company [Section 49(2)].
This also applies in relation to business reorganization of a co-operative bank as referred to in
section 44DB. The cost of acquisition of shares in the amalgamated co-operative bank, which
became the property of the assessee by virtue of a transfer as a result of business
reorganisation shall be the cost of acquisition to him of the shares in the amalgamating co-
operative bank.
(3) It is possible that a person might have become the owner of shares or debentures in a
company during the process of conversion of bonds or debentures, debenture stock or deposit
certificates. In such a case, the cost of acquisition to the person shall be deemed to be that
part of the cost of debentures, debenture stock, bond or deposit certificate in relation to which
such asset is acquired by that person [Section 49(2A)].
(4) Where the capital gain arises from the transfer of specified security or sweat equity
shares referred to in section 17(2)(vi), the cost of acquisition of such security or shares shall
be the fair market value which has been taken into account for perquisite valuation [Section
49(2AA)].
(5) If a shareholder of a company receives rights in a partnership firm as consideration for
transfer of shares on conversion of a company into a LLP, then the cost of acquisition of the
capital asset being rights of a partner referred to in section 42 of the LLP Act, 2008 shall be
deemed to be the cost of acquisition to him of the shares in the predecessor company,
immediately before its conversion [Section 49(2AAA)].
(6) Where the capital gain arises from the transfer of specified security or sweat equity
shares, the cost of acquisition of such security or shares shall be the fair market value which
has been taken into account while computing the value of fringe benefits under clause (ba) of
sub-section (1) of section 115WC [Section 49(2AB)].
The value of fringe benefits would be the fair market value of the specified security or sweat
equity shares on the date on which the option vests with employee as reduced by the amount
actually paid by, or recovered from the employee in respect of such security or shares. Fair
market value means the value determined in accordance with the method prescribed by the

7.21 Income Tax
CBDT. This fair market value would be taken as the cost of acquisition of the specified
security or sweat equity shares. It may be noted that the amount recovered from the
employee is not to be deducted for determining the cost of acquisition.
Note – It may be noted that fringe benefit tax is not applicable from A.Y.2010-11 and
therefore, the fair market value of the specified securities and sweat equity shares would be
taxed as a perquisite in the hands of the employees w.e.f. A.Y.2010-11. Therefore, if
specified securities or sweat equity shares have been subject to FBT in the hands of the
employer upto A.Y.2009-10, the provisions of section 49(2AB) would apply for determination
of the cost of acquisition at the time of transfer. However, if the specified securities or sweat
equity shares have been taxed as a perquisite in the hands of the employees w.e.f. A.Y.2010-
11, the provisions of section 49(2AA) would apply for determination of the cost of acquisition
at the time of transfer of such securities/shares by the employee.
(7) In the case of a demerger, the cost of acquisition of the shares in the resulting company
shall be the amount which bears to the cost of acquisition of shares held by the assessee in
the demerged company the same proportion as the net book value of the assets transferred in
a demerger bears to the net worth of the demerged company immediately before such
demerger [Section 49(2C)].
section 44DB. The cost of acquisition of the shares in the resulting co-operative bank shall be
the amount which bears to the cost of acquisition of shares held by the assessee in the
demerged co-operative bank, the same proportion as the net book value of the assets
transferred in a demerger bears to the net worth of the demerged co-operative bank
immediately before demerger i.e.,
B
Cost of acquisition of shares in the resulting co-operative bank = A×
C
A = Cost of acquisition of shares held in the demerged co-operative bank
B = Net book value of the assets transferred in a demerger
C = Net worth of the demerged co-operative bank i.e. the aggregate of the paid up share
capital and general reserves as appearing in the books of account of the demerged company
immediately before the demerger.
(8) Further, the cost of acquisition of the original shares held by the shareholder in the
demerged company shall be deemed to have been reduced by the amount as so arrived under
the sub-section (2C) [Section 49(2D)].
section 44DB. The cost of acquisition of the original shares held by the shareholder in the
demerged co-operative bank shall be deemed to have been reduced by the amount so arrived
at in (6) above.
For the above purpose, “net worth” means the aggregate of the paid up share capital and
general reserves as appearing in the books of account of the demerged company immediately
before the demerger.

Capital Gains 7.22
Normally speaking, capital gains must be computed after deducting from the sale price the
cost of acquisition to the assessee. The various provisions mentioned above form an
exception to this general principle.
(9) Where the capital gain arises from the transfer of such property which has been subject
to tax under section 56(2)(vii) or section 56(2)(viia), the cost of acquisition of the property shall
be deemed to be the value taken into account for the purposes of section 56(2)(vii)/(viia). [For
illustration, see Chapter 8 “Income from Other Sources” under section 56(2)(vii)]
7.13 Cost of improvement [Section 55]

(1) Goodwill of a business, etc.: 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, the cost of improvement shall be taken to be nil.
(2) Any other capital asset: (i) Where the capital asset became the property of the
previous owner or the assessee before 1-4-1981, cost of improvement means all expenditure
of a capital nature incurred in making any addition or alteration to the capital asset on or after
the said date by the previous owner or the assessee.
(ii) In any other case, cost of improvement means all expenditure of a capital nature incurred
in making any additions or alterations to the capital assets by the assessee after it became his
property. However, there are cases where the capital asset might become the property of the
assessee by any of the modes specified in section 49(1). In that case, cost of improvement
means capital expenditure in making any addition or alterations to the capital assets incurred
by the previous owner.
However, cost of improvement does not include any expenditure which is deductible in
computing the income chargeable under the head “Income from house property”, “Profits and
gains of business or profession” or “Income from other sources”.
Illustration 6
Mr. X & sons, HUF, purchased a land for ` 40,000 in 1991-92. In 1995-96, a partition takes
place when Mr. A, a coparcener, is allotted this plot valued at ` 80,000. In 1996-97, he had
incurred expenses of ` 1,85,000 towards fencing of the plot. Mr. A sells this plot of land for `
15,00,000 in 2011-12 after incurring expenses to the extent of ` 20,000. You are required to
compute the capital gain for the A.Y. 2012-13.
Financial year Cost Inflation Index
1991-92 199
1995-96 281
1996-97 305
2011-12 785

7.23 Income Tax
Solution
Computation of taxable capital gains for the A.Y. 2012-13

Particulars ` `
Sale consideration 15,00,000
Less: Expenses incurred for transfer 20,000
14,80,000
Less: (i) Indexed cost of acquisition (40,000 × 785/281) 1,11,744
(ii) Indexed cost of improvement (1,85,000 × 785/305) 4,76,148 5,87,892
Long term capital gains 8,92,108
Illustration 7
Mr. B purchased convertible debentures for ` 5,00,000 during August 1998. The debentures
were converted into shares in September 2002. These shares were sold for ` 15,00,000 in
August, 2011. The brokerage expenses is ` 50,000. You are required to compute the capital
gains in case of Mr. B for the assessment year 2012-13.
Financial Year Cost Inflation Index
1998-99 351
2002-03 447
2005-06 497
2011-12 785
Solution
Computation of Capital Gains of Mr. B for the A.Y.2012-13
Particulars `
Less: Expenses on transfer i.e. Brokerage paid 50,000
Net consideration 14,50,000
Less: Indexed cost of acquisition (5,00,000 × 785/447) 8,78,076
Long term capital gain 5,71,924
Note : For the purpose of computing capital gains, the holding period is considered from the
date of allotment of these shares i.e. September 2002 – August 2010.
Illustration 8
Mr. C purchases a house property for ` 1,06,000 on May 15, 1963. The following expenses
are incurred by him for making addition/alternation to the house property:
`
a. Cost of construction of first floor in 1972-73 1,35,000

Capital Gains 7.24
b. Cost of construction of the second floor in 1983-84 3,10,000

c. Reconstruction of the property in 1992-93 2,50,000
Fair market value of the property on April 1, 1981 is ` 4,50,000. The house property is sold by
Mr. C on August 10, 2011 for ` 80,00,000 (expenses incurred on transfer: ` 50,000).
Compute the capital gain for the assessment year 2012-13.
1981-82 100
1983-84 116
1992-93 223
2011-12 785
Solution
Computation of capital gain of Mr.C for the A.Y.2012-13
Particulars ` `
Gross sale consideration 80,00,000
Less: Expenses on transfer 50,000
Net sale consideration 79,50,000
Indexed cost of acquisition (Note 1) 35,32,500
Indexed cost of improvement (Note 2) 29,77,890 65,10,390
Long-term capital gain 14,39,610
Notes:
Indexed cost of acquisition is computed as follows:
` 4,50,000 × 785/100 = ` 35,32,500
Fair market value on April 1, 1981 (actual cost of acquisition is ignored as it is lower than
market value on April 1, 1981.)
Indexed cost of improvement is determined as under: `
Construction of first floor in 1972-73 Nil
(expenses incurred prior to April 1, 1981 are not considered)
Construction of second floor in 1983-84 (i.e., ` 3,10,000 × 785 / 116) 20,97,845
Alternation/reconstruction in 1992-93 (i.e., ` 2,50,000 × 785 / 223) 8,80,045
Indexed cost of improvement 29,77,890
7.14 Cost of Acquisition [Section 55]

(i) Goodwill of a business or a trademark or brand name associated with a business
or a right to manufacture, produce or process any article or thing, or right to carry on
any business, tenancy rights, stage carriage permits and loom hours - In the case of the
above capital assets, if the assessee has purchased them from a previous owner, the cost of

7.25 Income Tax
acquisition means the amount of the purchase price. For example, if A purchases a stage
carriage permit from B for ` 2 lacs, that will be the cost of acquisition for A.
(ii) Self-generated assets - There are circumstances where it is not possible to visualise
cost of acquisition. For example, suppose a doctor starts his profession. With the passage of
time, the doctor acquires lot of reputation. He opens a clinic and runs it for 5 years. After 5
years he sells the clinic to another doctor for ` 10 lacs which includes ` 2 lacs for his
reputation or goodwill. Now a question arises as to how to find out the profit in respect of
goodwill. It is obvious that the goodwill is self-generated and hence it is difficult to calculate
the cost of its acquisition. However, it is certainly a capital asset. The Supreme Court in CIT v.
B.C. Srinivasa Shetty [1981] 128 ITR 294 (SC) held that in order to bring the gains on sale of
capital assets to charge under section 45, it is necessary that the provisions dealing with the
levy of capital gains tax must be read as a whole. Section 48 deals with the mode of
computing the capital gains. Unless the cost of acquisition is correctly ascertainable, it is not
possible to apply the provisions of section 48. Self-generated goodwill is such a type of capital
asset where it is not possible to visualise cost of acquisition. Once section 48 cannot be
applied, the gains thereon cannot be brought to charge.
This decision of the Supreme Court was applicable not only to self-generated goodwill of a
business but also to other self-generated assets like tenancy rights, stage carriage permits,
loom hours etc. In order to supersede the decision of the Supreme Court cited above, section
55 was amended. Accordingly, in case of self-generated assets namely, goodwill of a business
or a trademark or brand name associated with a business or a right to manufacture, produce
or process any article or thing, or right to carry on any business, tenancy rights, stage carriage
permits, or loom hours, the cost of acquisition will be taken to be nil. However, it is significant
to note that the above amendment does not cover self-generated goodwill of a profession. So,
in respect of self-generated goodwill of a profession and other self-generated assets not
specifically covered by the amended provisions of section 55, the decision of the Supreme
Court in B. C. Srinivasa Setty’s case will still apply.
(iii) Other assets - n the following cases, cost of acquisition shall not be nil, but will be
deemed to be the cost for which the previous owner of the property acquired it:
Where the capital asset became the property of the assessee—
(1) On any distribution of assets on the total or partial partition of a Hindu undivided family.
(2) Under a gift or will.
(3) By succession, inheritance or devolution.
(4) On any distribution of assets on the liquidation of a company.
(5) Under a transfer to a revocable or an irrevocable trust.
(6) Under any such transfer referred to in sections 47(iv), (v), (vi), (via) or (viaa).
(7) Where the assessee is a Hindu undivided family, by the mode referred to in section 64(2).
(iv) Financial assets - Many times persons who own shares or other securities become
entitled to subscribe to any additional shares or securities. Further, they are also allotted

Capital Gains 7.26
additional shares or securities without any payment. Such shares or securities are referred to
as financial assets in Income-tax Act. Section 55 provides the basis for ascertaining the cost
of acquisition of such financial assets.
(1) In relation to the original financial asset on the basis of which the assessee becomes
entitled to any additional financial assets, cost of acquisition means the amount actually paid
for acquiring the original financial assets.
(2) In relation to any right to renounce the said entitlement to subscribe to the financial
asset, when such a right is renounced by the assessee in favour of any person, cost of
acquisition shall be taken to be nil in the case of such assessee.
(3) In relation to the financial asset, to which the assessee has subscribed on the basis of the said
entitlement, cost of acquisition means the amount actually paid by him for acquiring such asset.
(4) In relation to the financial asset allotted to the assessee without any payment and on the
basis of holding of any other financial assets, cost of acquisition shall be taken to be nil in the
case of such assessee. In other words, where bonus shares are allotted without any payment
on the basis of holding of original shares, the cost of such bonus shares will be nil in the
hands of the original shareholder. However, in respect of bonus shares allotted before 1.4.81,
although the cost of acquisition of the shares is nil, the assessee may opt for the fair market
value as on 1.4.81 as the cost of acquisition of such bonus shares.
(5) In the case of any financial asset purchased by the person in whose favour the right to
subscribe to such assets has been renounced, cost of acquisition means the aggregate of the
amount of the purchase price paid by him to the person renouncing such right and the amount
paid by him to the company or institution for acquiring such financial asset.
(6) In relation to equity shares allotted to a shareholder of a recognised stock exchange in
India under a scheme for demutualisation or corporatisation approved by SEBI, the cost of
acquisition shall be the cost of acquiring his original membership of the exchange.
(7) The cost of a capital asset, being trading or clearing rights of a recognised stock
exchange acquired by a shareholder (who has been allotted equity share or shares under
such scheme of demutualisation or corporatisation), shall be deemed to be nil.
(v) Any other capital asset - (1) Where the capital asset become the property of the
assessee before 1-4-1981 cost of acquisition means the cost of acquisition of the asset to the
assessee or the fair market value of the asset on 1-4-1981 at the option of the assessee.
(2) Where the capital asset became the property of the assessee by any of the modes
specified in section 49(1), it is clear that the cost of acquisition to the assessee will be the cost
of acquisition to the previous owner. Even in such cases, where the capital asset became the
property of the previous owner before 1-4-1981, the assessee has got a right to opt for the fair
market value as on 1-4-1981.
(3) Where the capital asset became the property of the assessee on the distribution of the
capital assets of a company on its liquidation and the assessee has been assessed to capital
gains in respect of that asset under section 46, the cost of acquisition means the fair market
value of the asset on the date of distribution.

7.27 Income Tax
(4) A share or a stock of a company may become the property of an assessee under the
following circumstances :
(a) the consolidation and division of all or any of the share capital of the company into
shares of larger amount than its existing shares.
(b) the conversion of any shares of the company into stock,
(c) the re-conversion of any stock of the company into shares,
(d) the sub-division of any of the shares of the company into shares of smaller amount, or
(e) the conversion of one kind of shares of the company into another kind.
In the above circumstances the cost of acquisition to the assessee will mean the cost of
acquisition of the asset calculated with reference to the cost of acquisition of the shares or
stock from which such asset is derived.
(vi) 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.
Illustration 9
ABC Ltd., converts its capital asset acquired for an amount of ` 50,000 in June, 1991 into
stock-in-trade in the month of November, 2008. The fair market value of the asset on the date
of conversion is ` 2,00,000. The stock-in-trade was sold for an amount of ` 3,50,000 in the
month of December, 2011. What will be the tax treatment?

1991-92 199
2008-09 582
2011-12 785
Solution
The capital gains on the sale of the capital asset converted to stock-in-trade is taxable in the
given case as the conversion was done after April 1, 1985. It arises in the year of conversion
(i.e. P.Y. 2008-09) but will be taxable only in the year in which the stock-in-trade is sold (i.e.
P.Y. 2011-12). Profits from business will also be taxable in the year of sale of the stock-in-
trade (i.e. P.Y. 2011-12).
Gross Total Income for the A.Y.2012-13 is calculated as under:
Particulars ` `
Profits and Gains from Business or Profession
Sale proceeds of the stock-in-trade 3,50,000
Less : Cost of the stock-in-trade (FMV on the date of conversion) 2,00,000 1,50,000

Capital Gains 7.28
Long Term Capital Gains

Full value of the consideration (FMV on the date of the conversion) 2,00,000
Less : Indexed cost of acquisition (50,000 x 582/199) 1,46,231 53,769
Gross Total Income 2,03,769
Note: For the purpose of indexation, the cost inflation index of the year in which the asset is
converted into stock-in-trade should be considered.
Illustration 10
Ms.Usha purchases 1,000 equity shares in X Ltd. at a cost of ` 15 per share (brokerage 1%)
in January 1978. She gets 100 bonus shares in August 1980. She again gets 1100 bonus
shares by virtue of her holding on February 1985. Fair market value of the shares of X Ltd. on
April 1, 1981 is ` 25. In January 2012, she transfers all her shares @ ` 120 per share
(brokerage 2%).
Compute the capital gains taxable in the hands of Ms. Usha for the A.Y. 2012-13 assuming:
(a) X Ltd is an unlisted company and securities transaction tax was not applicable at the time
of sale.
(b) X ltd is a listed company and the shares are sold in a recognised stock exchange and
securities transaction tax was paid at the time of sale.
1981-82 100
1984-85 125
2011-12 785
Solution
(a) Computation of capital gains for the A.Y. 2012-13
Particulars `
1000 Original shares
Sale proceeds (1000 × ` 120) 1,20,000
Less : Brokerage paid (2% of ` 1,20,000) 2,400
Less : Indexed cost of acquisition [` 25 × 1000 × 785/100] 1,96,250
Long term capital loss (A) 78,650
100 Bonus shares
Sale proceeds (100 × ` 120) 12,000
Less : Brokerage paid (2% of ` 12,000) 240
Net sale consideration 11,760
Less : Indexed cost of acquisition [` 25 × 100 × 785/100] [note] 19,625
Long term capital loss (B) 7,865

7.29 Income Tax
1100 Bonus shares

Sale proceeds (1100 × ` 120) 1,32,000
Less: Brokerage paid (2% of ` 1,32,000) 2,640
Less: Cost of acquisition NIL
Long term capital gain (C) 1,29,360

∴ Long term capital gain (A+B+C) 42,845
Note: Cost of acquisition of bonus shares acquired before 1.4.1981 is the FMV as on
1.4.1981 (being the higher of the cost or the FMV as on 1.4.1981).
(b) The long-term capital gains on transfer of equity shares through a recognized stock
exchange on which securities transaction tax is paid is exempt from tax under section
10(38). Hence, the taxable capital gain is Nil.
Illustration 11
On January 31, 2012, Mr. A has transferred self-generated goodwill of his profession for a
sale consideration of ` 70,000 and incurred expenses of ` 5,000 for such transfer. You are
required to compute the capital gains chargeable to tax in the hands of Mr. A for the
assessment year 2012-13.
Solution
The transfer of self-generated goodwill of profession is not chargeable to tax. It is based upon the
Supreme Court’s ruling in CIT vs. B.C. Srinivasa Shetty. Hence, there is no taxable capital gains.
Illustration 12
Mr. R holds 1000 shares in Star Minus Ltd., an unlimited company, acquired in the year 1981-
82 at a cost of ` 25,000. He has been offered right shares by the company in the month of
August, 2011 at ` 40 per share, in the ratio of 2 for every 5 held. He retains 50% of the rights
and renounces the balance right shares in favour of Mr. Q for ` 10 per share in September
2011. All the shares are sold by Mr. R for ` 200 per share in January 2012 and Mr. Q sells his
shares in December 2011 at ` 130 per share.
What are the capital gains taxable in the hands of Mr.R and Mr.Q?
1981-82 100
2011-12 785
Solution
Computation of capital gains in the hands of Mr. R for the A.Y.2012-13
Particulars `
1000 Original shares
Sale proceeds (1000 × ` 200) 2,00,000

Capital Gains 7.30
Less : Indexed cost of acquisition [` 25,000 × 785/100] 1,96,250

Long term capital gain (A) 3,750
200 Right shares

Sale proceeds (200 × ` 200) 40,000
Less : Cost of acquisition [` 40 × 200] [note 1] 8,000
Short term capital gain (B) 32,000
200 Right shares renounced in favour of Mr. Q

Sale proceeds (200 × ` 10) 2,000
Less : Cost of acquisition [note 2] NIL
Short term capital gain (C) 2,000

Capital Gains (A+B+C) 37,750
Note 1: Since the holding period of these shares is less than 1 year, they are short term
capital assets and hence cost of acquisition will not be indexed.
Note 2: The cost of the rights renounced in favour of another person for a consideration is
taken to be nil. The consideration so received is taxed as short-term capital gains in full. The
period of holding is taken from the date of the rights offer to the date of the renouncement.
Computation of capital gains in the hands of Mr. Q for the A.Y.2012-13

Particulars `
200 shares :
Sale proceeds (200 × ` 130) 26,000
Less : Cost of acquisition [200 shares × (` 10 + ` 40)] [note] 10,000
Short term capital gain 16,000
Note: The cost of the rights is the amount paid to Mr. R as well as the amount paid to the
company. Since the holding period of these shares is less than 1 year, they are short term
capital assets and hence, cost of acquisition should not be indexed.
7.15 Computation of capital gains in case of depreciable asset

[Section 50]
(i) Section 50 provides for the computation of capital gains in case of depreciable assets. It
may be noted that where the capital asset is a depreciable asset forming part of a block of
assets, section 50 will have overriding effect in spite of anything contained in section 2(42A)
which defines a short-term capital asset.
Accordingly, where the capital asset is an asset forming part of a block of assets in respect of

7.31 Income Tax
which depreciation has been allowed, the provisions of sections 48 and 49 shall be subject to
the following modification:
Where the full value of consideration received or accruing for the transfer of the asset plus the
full value of such consideration for the transfer of any other capital asset falling with the block
of assets during previous year exceeds the aggregate of the following amounts namely:
(1) expenditure incurred wholly and exclusively in connection with such transfer;
(2) WDV of the block of assets at the beginning of the previous year;
(3) the actual cost of any asset falling within the block of assets acquired during the previous year
such excess shall be deemed to be the capital gains arising from the transfer of short-term
capital assets.
Where all assets in a block are transferred during the previous year, the block itself will cease
to exist. In such a situation, the difference between the sale value of the assets and the WDV
of the block of assets at the beginning of the previous year together with the actual cost of any
asset falling within that block of assets acquired by the assessee during the previous year will
be deemed to be the capital gains arising from the transfer of short- term capital assets.
(ii) Cost of acquisition in case of power sector assets [Section 50A]: With respect to the
power sector, in case of depreciable assets referred to in section 32(1)(i), the provisions of
sections 48 and 49 shall apply subject to the modification that the WDV of the asset (as
defined in section 43(6)), as adjusted, shall be taken to be the cost of acquisition.
7.16 Capital gains in respect of slump sales [Section 50B]

(i) Any profits or gains arising from the slump sale effected in the previous year shall be
chargeable to income-tax as capital gains arising from the transfer of long-term capital assets
and shall be deemed to be the income of the previous year in which the transfer took place.
Short term capital gains - Any profits and gains arising from such transfer of one or more
undertakings held by the assessee for not more than thirty-six months shall be deemed to be
short-term capital gains [Sub-section (1)].
(ii) The net worth of the undertaking or the division, as the case may be, shall be deemed to
be the cost of acquisition and the cost of improvement for the purposes of sections 48 and 49
in relation to capital assets of such undertaking or division transferred by way of such sale and
the provisions contained in the second proviso to section 48 shall be ignored [Sub-section (2)].
(iii) Every assessee in the case of slump sale shall furnish in the prescribed form along with
the return of income, a report of a chartered accountant indicating the computation of net
worth of the undertaking or division, as the case may be, and certifying that the net worth of
the undertaking or division has been correctly arrived at in accordance with the provisions of
this section [Sub-section (3)].
Explanation 1 to the section defines the expression "net worth" as the aggregate value of total
assets of the undertaking or division as reduced by the value of liabilities of such undertaking

Capital Gains 7.32
or division as appearing in the books of account. However, any change in the value of assets
on account of revaluation of assets shall not be considered for this purpose.
Explanation 2 provides that the aggregate value of total assets of such undertaking or division
shall be as follows:
(i) In the case of depreciable assets: the written down value of block of assets determined in
accordance with the provisions contained in sub-item (C) of item (i) of section 43(6)(c);
(ii) In case of capital assets in respect of which the whole of the expenditure has been
allowed or is allowable as a deduction under section 35AD : Nil;
(ii) for all other assets : Book value.
7.17 Special Provision for Full Value of Consideration in Certain

Cases [Section 50C]
(i) Where the consideration received or accruing as a result of transfer of a capital asset,
being land or building or both, is less than the value adopted or assessed or assessable by
any authority of a State Government (Stamp Valuation Authority) for the purpose of payment
of stamp duty in respect of such asset, such value adopted or assessed or assessable shall
be deemed to be the full value of the consideration received or accruing as a result of such
transfer. [Sub-section (1)].
(ii) Where the assessee claims before an Assessing Officer that the value so adopted or
assessed or assessable by the authority for payment of stamp duty exceeds the fair market value
of the property as on the date of transfer and the value so adopted or assessed or assessable by
such authority has not been disputed in any appeal or revision or no reference has been made
before any other authority, court or High Court, the Assessing Officer may refer the valuation of the
capital asset to a valuation officer as defined in section 2(r) of the Wealth-tax Act, 1957. Where
any reference has been made before any other authority, Court or the High Court, the provisions of
section 16A (relating to reference to Valuation Officer), section 23A (dealing with appealable orders
before Commissioner (Appeals), section 24 (order of Appellate Tribunal), section 34AA
(appearance by registered valuer), section 35 (rectification of mistakes) and section 37 (power to
take evidence on oath) of the Wealth-tax Act, 1957, shall, with necessary modifications, apply in
relation to such reference as they apply in relation to a reference made by the Assessing Officer
under sub-section (1) of section 16A of that Act [Sub-section (2)].
(iii) Where the value ascertained by such valuation officer exceeds the value adopted or
assessed or assessable by the Stamp authority the value adopted or assessed or assessable
shall be taken as the full value of the consideration received or accruing as a result of the
transfer [Sub-section (3)].
(iv) The term “assessable” has been added to cover transfers executed through power of
attorney. The term ‘assessable’ has been defined to mean the price which the stamp valuation
authority would have, notwithstanding anything to the contrary contained in any other law for
the time being in force, adopted or assessed, if it were referred to such authority for the
purposes of the payment of stamp duty.

7.33 Income Tax
7.18 Advance money received [Section 51]

It is possible for an assessee to receive some advance in regard to the transfer of capital
asset. Due to the break-down of the negotiation, the assessee may have retained the
advance. Section 51 provides that while calculating capital gains, the above advance retained
by the assessee must go to reduce the cost of acquisition. However, if advance has been
received and retained by the previous owner and not the assessee himself, then the same will
not go to reduce the cost of acquisition of the assessee.
Illustration 13
Mr. Kay purchases a house property on April 10, 1978 for ` 35,000. The fair market value of
the house property on April 1, 1981 was ` 70,000. On August 31, 1984, Mr. Kay enters into an
agreement with Mr. Jay for sale of such property for ` 1,20,000 and received an amount of `
10,000 as advance. However, as Mr. Jay did not pay the balance amount, Mr. Kay forfeited
the advance. In May 1987, Mr. Kay constructed the first floor by incurring a cost of ` 50,000.
Subsequently, in September 1987, Mr. Kay gifted the house to his friend Mr. Dee. On
February 10, 2012, Mr. Dee sold the house for ` 8,00,000.
1981-1982 100
1984-1985 125
1987-1988 150
2011-2012 785
You are required to compute the capital gains taxable in the hands of Mr. Dee for the
assessment year 2012-13.
Solution
Computation of taxable capital gains of Mr.Dee for A.Y.2012-13
Particulars ` `
Less: Indexed cost of acquisition (note) 3,66,333
Indexed cost of improvement (note) 2,61,667 6,28,000
Long-term capital gain 1,72,000
Note: For the purpose of capital gains, holding period is considered from the date on which
the house was purchased by Mr. Kay, till the date of sale. However, indexation of cost of
acquisition is considered from the date on which the house was gifted by Mr. Kay to Mr. Dee,
till the date of sale. i.e. from September 1987 (P.Y. 1987-88) to February 2012 (P.Y. 2011-12).
Indexed cost of acquisition = (70,000 × 785/150) = ` 3,66,333
Indexed cost of improvement = (50,000 × 785/150) = ` 2,61,667
Amount forfeited by previous owner, Mr. Kay, will not be considered.

Capital Gains 7.34
Illustration 14
Mr. X purchases a house property in December 1975 for ` 1,25,000 and an amount of
` 75,000 was spent on the improvement and repairs of the property in March, 1981. The
property was proposed to be sold to Mr.Z in the month of May, 2003 and an advance of
` 40,000 was taken from him. As the entire money was not paid in time, Mr.X forfeited the
advance and subsequently sold the property to Mr.Y in the month of March, 2012 for
` 30,00,000. The fair value of the property on April 1, 1981 was ` 3,90,000. What is the
capital gain chargeable in the hands of Mr.X for the A.Y. 2012-13?
1981-82 100
2003-04 463
2011-12 785
Solution
Capital gains in the hands of Mr. X for the A.Y. 2012-13 is computed as under:
Particulars `
Sale proceeds 30,00,000
Less : Indexed cost of acquisition [Note 1] 27,47,500
Indexed cost of improvement [Note 2] -
Long term capital gains 2,52,500
Note 1: Computation of indexed cost of acquisition
Cost of acquisition (higher of fair market value as on April 1, 1981 and the 3,90,000
actual cost of acquisition)
Less : Advance taken and forfeited 40,000
Cost for the purposes of indexation 3,50,000
Indexed cost of acquisition (` 3,50,000 x 785/100) 27,47,500
Note 2 : Any improvement cost incurred prior to 1.4.1981 is to be ignored when fair market
value as on 1.4.1981 is taken into consideration.
7.19 Exemption of capital gains

(i) Capital Gains on sale of residential house [Section 54]
Eligible assessees – Individual & HUF
Conditions to be fulfilled
 There should be a transfer of residential house (buildings or lands appurtenant thereto)
 It must be a long-term capital asset
 Income from such house should be chargeable under the head “Income from house
property”

7.35 Income Tax
 A new residential house should be –

 purchased within 1 year before or 2 years after the date of transfer (or)
 constructed within a period of 3 years after the date of transfer.
In CIT v. Ananda Basappa (2009) 309 ITR 329, the Karnataka High Court observed that where
the assessee had purchased two adjacent flats in the same building and made suitable
modification to treat them as a single residential unit, exemption under section 54 would be
available in respect of investment made in both the flats. Similar ruling was pronounced by
the Karnataka High Court in CIT v. Smt. K.G. Rukminiamma (2011) 331 ITR 211, where it was
held that the assessee was entitled to exemption in respect of investment in four flats in the
same building, where the property owned by the assessee was developed by the builder, who
constructed eight residential flats in the said property, four of which was given to the
assessee.
Quantum of Exemption
 If cost of new residential house≥ Capital gains, entire capital gains is exempt.
 If cost of new residential house < Capital gains, capital gains to the extent of cost of new
residential house is exempt
Examples
 Example 1 - If the capital gains is ` 5 lakhs and the cost of the new house is ` 7 lakhs,
then the entire capital gains of ` 5 lakhs is exempt.
 Example 2 - If capital gains is ` 5 lakhs and cost of new house is ` 3 lakhs, then capital
gains is exempt only upto ` 3 lakhs. Balance ` 2 lakhs is taxable @ 20%.
Consequences of transfer of new asset before 3 years
 If the new asset is transferred before 3 years from the date of its acquisition, then cost of
the asset will be reduced by capital gains exempted earlier for computing short-term
capital gains.
 Continuing Example 1, if the new house was sold after 2 years for ` 8 lakhs, then short
term capital gain chargeable to tax would be –
Net Consideration 8,00,000
Less: Cost of acquisition 7,00,000
Less: Capital gains exempt earlier 5,00,000 2,00,000
Short term capital gains chargeable to tax 6,00,000
Illustration 15
Mr. Cee purchased a residential house on July 20, 2008 for ` 10,00,000 and made some
additions to the house incurring ` 2,00,000 in August 2008. He sold the house property in
April 2011 for ` 20,00,000. Out of the sale proceeds, he spent ` 5,00,000 to purchase
another house property in September 2011.

Capital Gains 7.36

2006-07 519
2007-08 551
2011-12 785
What is the amount of capital gains taxable in the hands of Mr. Cee for the A.Y.2012-13?
Solution
The house is sold before 36 months from the date of purchase. Hence, the house is a short-
term capital asset and no benefit of indexation would be available.
Particulars `
Less: Cost of acquisition 10,00,000
Cost of improvement 2,00,000
Short-term capital gains 8,00,000
Note: The exemption of capital gains under section 54 is available only in case of long-term
capital asset. As the house is short-term capital asset, Mr. Cee cannot claim exemption under
section 54. Thus, the amount of taxable short-term capital gains is ` 8,00,000.
(ii) Capital Gains on transfer of agricultural land [Section 54B]

Eligible assessee – Individual
 There should be a transfer of urban agricultural land.
 Such land must have been used for agricultural purposes either by the assessee himself
or his parents in the 2 immediately preceding years.
 He should purchase another agricultural land (urban or rural) within 2 years from the date
of transfer.
Quantum of exemption
 If cost of new agricultural land ≥ Capital gains (short-term or long-term), entire capital
gains is exempt.
 If cost of new agricultural land < Capital gains (short-term or long-term), capital gains to
the extent of cost of new agricultural land is exempt.
Examples
 Example 1 - If the capital gains is ` 3 lakhs and the cost of the new agricultural land is
` 4 lakhs, then the entire capital gains of ` 3 lakhs is exempt.
 Example 2 - If capital gains is ` 3 lakhs and cost of new agricultural land is ` 2 lakhs,
then capital gains is exempt only upto ` 2 lakhs.

7.37 Income Tax
Consequences of transfer of new agricultural land before 3 years

 If the new agricultural land is transferred before 3 years from the date of its acquisition,
then cost of the land will be reduced by capital gains exempted earlier for computing
short-term capital gains.
 However, if the new agricultural land is a rural agricultural land, there would be no capital
gains on transfer of such land.
Continuing Example 1, if the new agricultural land (urban land) is sold after, say, 2 years for
` 6 lakhs, then short term capital gain chargeable to tax would be –
Less: Cost of new agricultural land
Cost of acquisition 4,00,000
Less: Capital gains exempt earlier 3,00,000
1,00,000
Short-term capital gains chargeable to tax 5,00,000
(iii) Capital Gains on transfer by way of compulsory acquisition of land and building
[Section 54D]
Eligible assessee – Any assessee
 There must be compulsory acquisition of land and building forming part of an industrial
undertaking.
 The land and building should have been used by the assessee for purposes of the business
of the industrial undertaking in the 2 years immediately preceding the date of transfer.
 The assessee must purchase any other land or building or construct any building (for
shifting or re-establishing the existing undertaking or setting up a new industrial
undertaking) within 3 years from the date of transfer.
 If cost of new asset
≥ Capital gains, entire capital gains (short-term or long-term) is
exempt.
 If cost of new asset < Capital gains, capital gains (short-term or long-term) to the extent
of cost of new asset is exempt.
Consequences of transfer of new asset before 3 years
 If the new asset is transferred before 3 years from the date of its acquisition, then cost of the
asset will be reduced by capital gains exempted earlier for computing short-term capital gains.
Illustration 16
PQR Ltd., purchased a building for industrial undertaking in May 2003, at a cost of ` 4,00,000.

Capital Gains 7.38
The above property was compulsorily acquired by the State Government at a compensation of
` 8,00,000 in the month of January, 2012. The compensation was received in March, 2012.
The company purchased another building for its industrial undertaking at a cost of ` 1,00,000
in the month of March, 2012. What is the amount of the capital gains chargeable to tax in the
hands of the company for the A.Y. 2012-13?
2003-04 463
2011-12 785
Solution
Computation of capital gains in the hands of PQR Ltd. for the A.Y.2012-13
Particulars `
Sale proceeds (Compensation received) 8,00,000
Less : Indexed cost of acquisition [` 4,00,000 × 785/463] 6,78,186
1,21,814
Less : Exemption under section 54D (Cost of acquisition of new undertaking) 1,00,000
Taxable long term capital gain 21,814
(iv) Capital Gains not chargeable on investment in certain bonds [Section 54EC]
Eligible assessee – Any assessee
 There should be transfer of a long-term capital asset.
 Such asset can also be a depreciable asset held for more than 36 months.
 The capital gains arising from such transfer should be invested in a long-term specified
asset within 6 months from the date of transfer.
 Long-term specified asset means specified bonds, redeemable after 3 years, issued by
the National Highways Authority of India (NHAI) or the Rural Electrification Corporation
Limited (RECL).
 The assessee should not transfer or convert or avail loan or advance on the security of
such bonds for a period of 3 years from the date of acquisition of such bonds.
Other points
 In case of conversion of capital asset into stock in trade and subsequent sale of stock in
trade - period of 6 months to be reckoned from the date of sale of stock in trade for the
purpose of section 54EC exemption [CBDT Circular No.791 dated 2-6-2000].
 Receipt of money on liquidation of company – is chargeable to tax in the hands of
shareholders [Section 46(2)] – However, there is no transfer of capital asset in such a
case – Therefore, exemption under section 54EC is not available – CIT v. Ruby Trading
Co. (P) Ltd. 259 ITR 54 (Raj.)

7.39 Income Tax
 Capital gains or amount invested in specified bonds, whichever is lower.
Violation of condition
 In case of transfer or conversion of such bonds or availing loan or advance on security of
such bonds before the expiry of 3 years, the capital gain exempted earlier shall be taxed
as long-term capital gain in the year of violation of condition.
(v) Capital gains in cases of investment in residential house [Section 54F]

Eligible assessees: Individuals / HUFs
 There must be transfer of a long-term capital asset, not being a residential house.
 Transfer of plot of land is also eligible for exemption
 The assessee should -
• Purchase a residential house within a period of 1 year before or 2 years after the
date of transfer; or
• Construct a residential house within 3 years from the date of transfer.
 The assessee should not own more than one residential house on the date of transfer.
 The assessee should not –
• purchase any other residential house within a period of one year or
• construct any other residential house within a period of 3 years
from the date of transfer of the original asset.
 If cost of new residential house
≥ Net sale consideration of original asset, entire capital
gains is exempt.
 If cost of new residential house < Net sale consideration of original asset, only
proportionate capital gains is exempt i.e.
Amount invested in new residential house
LTCG×
Net sale consideration
Illustration 17
From the following particulars, compute the taxable capital gains of Mr.D for A.Y.2012-13-
Cost of jewellery [Purchased in F.Y.1990-91] ` 1,82,000
Sale price of jewellery sold in Jan 2012 ` 8,50,000

Capital Gains 7.40
Expenses on transfer ` 7,000

Residential house purchased in March 2012 ` 5,00,000
Solution
Computation of taxable capital gains for A.Y.2012-13
Particulars `
Gross consideration 8,50,000
Less: Expenses on transfer 7,000
Less: Indexed cost of acquisition (1,82,000 × 785/182) 7,85,000
58,000
Less: Exemption under section 54F
(58,000 × 5,00,000/8,43,000) 34,401
Taxable capital gains 23,599
Consequences if the new house is transferred within a period of 3 years
 Short-term capital gains would arise on transfer of the new house; and
 The capital gains exempt earlier under section 54F would be taxable as long-term capital gains.
In the given illustration, if the new residential house is sold for ` 6,00,000 after say,
1 year, then
 ` 1,00,000 [i.e. ` 6,00,000 (-) ` 5,00,000] would be chargeable as short-term capital
gain of that year in which the new house is sold.
 ` 34,401, being the capital gains exempt earlier, would be taxable as long-term capital
gains of that year in which the new house is sold.
(vi) Capital gains for shifting of industrial undertaking from urban areas [Section 54G]
Eligible assessees: Any assessee
 There should be a shifting of the industrial undertaking from an urban area to any other area
 There should be a transfer of machinery, plant, building or land or any right in building or
land used for the business of an industrial undertaking situated in an urban area.
 Such transfer should be in the course of or in consequence of shifting the industrial
undertaking from an urban area to any other area.
 The capital gain (short-term or long-term) should be utilized for any of the following
purposes within 1 year before or 3 years after the date of transfer –
• purchase of new plant and machinery
• acquisition of building or land or construction of building

7.41 Income Tax
• expenses on shifting of the industrial undertaking from the urban area to the other
area
• such other expenditure as the Central Government may specify
 If cost of new assets plus expenses incurred for the specified purpose≥ Capital gains,
entire capital gains (short-term or long-term) is exempt.
 If cost of new assets plus expenses incurred for the specified purpose < Capital gains,
capital gains (short-term or long-term) to the extent of such cost and expenses is exempt.
Consequences if the new asset is transferred within a period of 3 years
 If the new asset is transferred within a period of 3 years of its purchase or construction,
then the capital gain, which was exempt earlier under section 54G would be deducted
from the cost of acquisition of the new asset for the purpose of computation of short-
term capital gains in respect of the transfer of the new asset
(vii) Exemption of capital gains on transfer of certain capital assets in case of shifting
of an industrial undertaking from an urban area to any SEZ [Section 54GA]
Eligible assesses – Any assessee
 There must be transfer of capital assets
 Such transfer must be effected in the course of, or in consequence of the shifting of an
industrial undertaking from an urban area to any SEZ, whether developed in an urban
area or not.
 The capital asset should be either machinery or plant or building or land or any rights in
building or land used for the purposes of the business of an industrial undertaking
situated in an urban area.
 The assessee should, within a period of 1 year before or 3 years after the date of
transfer,
• purchase machinery or plant for the purposes of business of the industrial
undertaking in the SEZ;
• acquire building or land or construct building for the purposes of his business in the
SEZ;
• shift the industrial undertaking and transfer the establishment of such undertaking to
the SEZ; and
• incur expenses for such other purposes as may be specified in a scheme framed by
the Central Government.
 If cost of new assets plus expenses incurred for shifting
≥ Capital gains, entire capital

Capital Gains 7.42
gains (short-term or long-term) is exempt.

 If cost of new assets plus expenses incurred for shifting < Capital gains, capital gains
(short-term or long-term) to the extent of such cost and expenses is exempt.
Consequences if the new asset is transferred within a period of 3 years
 If the new asset is transferred within a period of 3 years of its purchase or construction,
then the capital gain, which was exempt earlier under section 54G would be deducted
from the cost of acquisition of the new asset for the purpose of computation of short-
term capital gains in respect of the transfer of the new asset.
(viii) Capital Gains Account Scheme (CGAS) - Under sections 54, 54B, 54D, 54F, 54G and
54GA, capital gains is exempt to the extent of investment of such gains / net consideration (in
the case of section 54F) in specified assets within the specified time. If such investment is not
made before the date of filing of return of income, then the capital gain or net consideration (in
case of exemption under section 54F) has to be deposited under the CGAS.
Time limit - Such deposit in CGAS should be made before filing the return of income or on or
before the due date of filing the return of income, whichever is earlier. Proof of such deposit
should be attached with the return. The deposit can be withdrawn for utilization for the
specified purposes in accordance with the scheme.
Consequences if the amount deposited in CGAS is not utilized within the stipulated time
of 2 years / 3 years - If the amount deposited is not utilized for the specified purpose within
the stipulated period, then the unutilized amount shall be charged as capital gain of the
previous year in which the specified period expires. In the case of section 54F, proportionate
amount will be taxable.
CBDT Circular No.743 dated 6.5.96 clarifies that in the event of death of an individual before
the stipulated period, the unutilized amount is not chargeable to tax in the hands of the legal
heirs of the deceased individual. Such unutilized amount is not income but is a part of the
estate devolving upon them.
(ix) Extension of time for acquiring new asset or depositing or investing amount of
Capital Gain [Section 54H] - In case of compulsory acquisition of the original asset, where
the compensation is not received on the date of transfer, the period available for acquiring a
new asset or making investment in CGAS under sections 54, 54B, 54D, 54EC and 54F would
be considered from the date of receipt of such compensation and not from the date of the
transfer.
7.20 Reference to Valuation Officer [Section 55A]

Section 55A provides that the Assessing Officer may refer the valuation of a capital asset to a
Valuation Officer in the following circumstances with a view to ascertaining the fair market
value of the capital asset for the purposes of capital gains -
(i) In a case where the value of the asset as claimed by the assessee is in accordance with
the estimate made by a registered valuer, if the Assessing Officer is of the opinion that
the value so claimed is less than its fair market value.

7.43 Income Tax
(ii) If the Assessing Officer is of the opinion that the fair market value of the asset exceeds the
value of the asset as claimed by the assessee by more than 15% of the value of asset as
claimed or by more than ` 25,000 of the value of the asset as claimed by the assessee.
(iii) The Assessing Officer is of the opinion that, having regard to the nature of asset and
other relevant circumstances, it is necessary to make the reference.
Where any such reference is made as per this section, the provisions of section 16A of the
Wealth-tax Act shall be applicable in relation to such reference as they apply in relation to a
reference made by the Assessing Officer under section 16A of that Act.
7.21 Short term capital gains tax in respect of equity shares/ units of
an equity oriented fund [Section 111A]
(i) This section provides for a concessional rate of tax (i.e. 15%) on the short-term capital
gains on transfer of -
(1) an equity share in a company or
(2) a unit of an equity oriented fund.
(ii) The conditions for availing the benefit of this concessional rate are –
(1) the transaction of sale of such equity share or unit should be entered into on or after
1.10.2004, being the date on which Chapter VII of the Finance (No. 2) Act, 2004 came into
force; and
(2) such transaction should be chargeable to securities transaction tax under the said Chapter.
(iii) The proviso to this section provides that in the case of resident individuals or HUF, if the basic
exemption is not fully exhausted by any other income, then the short-term capital gain will be reduced
by the unexhausted basic exemption limit and only the balance would be taxed at 15%. However, the
benefit of availing the basic exemption limit is not available in the case of non-residents.
(iv) Deductions under Chapter VI-A cannot be availed in respect of such short-term capital
gains on equity shares of a company or units of an equity oriented mutual fund included in the
total income of the assessee.
The expression “equity oriented fund” has the same meaning assigned to it in the explanation
to section 10(38) of the Act i.e. “Equity oriented fund” means a fund –
(1) where the investible funds are invested by way of equity shares in domestic companies
to the extent of more than 65% of the total proceeds of such fund; and
(2) which has been set up under a scheme of a Mutual Fund specified under clause (23D).
7.22 Tax on long-term capital gains [Section 112]

(i) Where the total income of an assessee includes long-term capital gains, tax is payable
by the assessee @20% on such long-term capital gains. The treatment of long-term capital

Capital Gains 7.44
gains in the hands of different types of assessees are as follows -

(1) Resident individual or Hindu undivided family:Income-tax payable at normal rates on
total income as reduced by long-term capital gains plus 20% on such long-term capital gains.
However, where the total income as reduced by such long-term capital gains is below the
maximum amount which is not chargeable to income-tax then such long-term capital gains
shall be reduced by the amount by which the total income as so reduced falls short of the
maximum amount which is not chargeable to income-tax and the tax on the balance of such
long-term capital gains will be calculated @ 20%.
(2) Domestic Company: Long-term capital gains will be charged @ 20%.
(3) Non-corporate non-resident / foreign company: Long-term capital gains will be
charged @20%.
(4) Residents (other than those included in (i) above): Long-term capital gains will be
charged @20%.
(ii) The proviso to section 112 states that where the tax payable in respect of any income
arising from the transfer of listed securities or units or zero coupon bonds, being long-term
capital assets, exceeds 10% of the amount of capital gains before indexation, then such
excess shall be ignored while computing the tax payable by the assessee.
(iii) For this purpose, "listed securities" means securities as defined by section 2(h) of the
Securities Contracts (Regulation) Act, 1956; and "unit" means unit of a mutual fund specified
under section 10(23D) or of the Unit Trust of India.
(iv) The provisions of section 112 make it clear that the deductions under chapter VIA cannot be
availed in respect of the long-term capital gains included in the total income of the assessee.
7.23 Exemption of long term capital gains on sale of equity shares/

Units of an equity oriented fund [Section 10(38)]
(i) Section 10(38) exempts long term capital gains on sale of equity shares of a company or
units of an equity oriented fund on or after 1.10.2004, being the date on which Chapter VII of
the Finance (No.2) Act, 2004 comes into force.
(ii) This exemption is available only if such transaction is chargeable to securities
transaction tax.
(iii) However, such long term capital gains exempt under section 10(38) shall be taken into a
account in computing the book profit and income tax payable under section 115JB.
(iv) For the purpose of this clause, “Equity oriented fund” means a fund –
(1) where the investible funds are invested by way of equity shares in domestic companies
to the extent of more than 65% of the total proceeds of such fund; and
(2) which has been set up under a scheme of Mutual Fund specified under clause (23D).
(v) The percentage of equity share holding of the fund should be computed with reference to
the annual average of the monthly averages of the opening and closing figures.

7.45 Income Tax
7.24 Securities Lending and Borrowing Scheme

Securities and Exchange Board of India (SEBI) vide Circular No. MRD/DoP/SE/DEP/Cir. 14/2007,
dated 20-12-2007, has decided to permit all classes of investors (individuals, institutional, etc.) to
short sell. Further, with a view to provide a mechanism for borrowing of securities to enable
settlement of securities sold short, SEBI has also decided to put in place a full-fledged Securities
Lending and Borrowing (SLB) Scheme for all market participants in the Indian securities market
under the overall framework of Securities Lending Scheme, 1997 of SEBI.
In this context, the following taxation issues have arisen in respect of transactions under the
scheme of securities lending -
(i) Would the lending/borrowing of securities under the Securities Lending Scheme amount
to a transfer under section 2(47) in the hands of the lender?
(ii) Would lending/borrowing of the securities be subject to Securities Transaction Tax
(STT)?
The Lending and Borrowing of Securities under the new scheme notified by SEBI vide Circular
No. MRD/DoP/SE/DEP/Cir.14/2007, dated 20-12-2007 is in accordance with the overall
framework of the Securities Lending Scheme of 1997. Accordingly, the provisions of section
47(xv) will be equally applicable in respect of the transactions under the new scheme.
Securities Transaction Tax (STT) is levied on purchase or sale of an equity share, unit and
derivative, under such circumstances as specified in section 98 of the Finance (No. 2) Act,
2004. The transactions in the nature of lending and borrowing under the new scheme do not
fall within the scope of section 98 to the Finance (No.2) Act, 2004. Therefore, the transactions
of lending and borrowing are not liable to Securities Transaction Tax (STT).

Capital Gain Compensation Recd From Central Government

Uploaded by

Copyright:

Available Formats

Capital Gain Compensation Recd From Central Government

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Capital Gain Compensation Recd From Central Government

Uploaded by

Copyright:

Available Formats

7

7.2 Capital Asset

© The Institute of Chartered Accountants of India

Note - Jewellery includes -

© The Institute of Chartered Accountants of India

7.3 Short-term and long-term capital assets

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

7.4 Transfer: What it means [Section 2(47)]

7.5 Scope and year of chargeability [Section 45]

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

7.6 Capital gains on distribution of assets by companies in

© The Institute of Chartered Accountants of India

7.8 Transactions not regarded as transfer [Section 47]

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

foreign company is incorporated.

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

7.9 Important Definitions

© The Institute of Chartered Accountants of India

7.10 Withdrawal of exemption in certain cases

© The Institute of Chartered Accountants of India

7.11 Mode of computation of capital gains

© The Institute of Chartered Accountants of India

(iii) Cost Inflation Index

© The Institute of Chartered Accountants of India

7.12 Ascertainment of Cost in Specified Circumstances [Section 49]

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

7.13 Cost of improvement [Section 55]

© The Institute of Chartered Accountants of India

Computation of taxable capital gains for the A.Y. 2012-13

© The Institute of Chartered Accountants of India

b. Cost of construction of the second floor in 1983-84 3,10,000

7.14 Cost of Acquisition [Section 55]

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

Financial year Cost Inflation Index

© The Institute of Chartered Accountants of India

Long Term Capital Gains

© The Institute of Chartered Accountants of India

1100 Bonus shares

© The Institute of Chartered Accountants of India

Less : Indexed cost of acquisition [` 25,000 × 785/100] 1,96,250

200 Right shares

200 Right shares renounced in favour of Mr. Q

Computation of capital gains in the hands of Mr. Q for the A.Y.2012-13

7.15 Computation of capital gains in case of depreciable asset

© The Institute of Chartered Accountants of India

7.16 Capital gains in respect of slump sales [Section 50B]

© The Institute of Chartered Accountants of India

7.17 Special Provision for Full Value of Consideration in Certain