Chapter 32

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Capital Gain
Capital Gains

ncome, under the Income Tax Act, includes gains derived on transfer of a Capital Asset. Capital Gain
is the profit or gain arising from the transfer of a capital asset effected during the previous year. To start
with we need to understand the meaning of these two terms.
Capital Asset [Section 2(14)]
Capital Asset means property of any kind held by a tax payer including property held for his business or
profession. It includes all corporeal and tangible properties as well as all kinds of rights in property. The
gains on transfer of assets in relation to which there is no cost of acquisition like self generated goodwill,
trademark, brand name of a business, tenancy rights, stage carriage permits, loom hours, right to
manufacture, produce or process any article or thing or right to carry on any business are also taxable as
capital gains. However, certain assets are expressly excluded from the definition of Capital Asset.
Transfer of these assets would not attract capital gain. These are enumerated below:
1.

Stock-in-trade, consumable stores and raw material held for purposes of the assessees business or
profession.

2.

Personal effects i.e. movable property like wearing apparel, furniture, motor vehicles etc. held for
personal use of the tax payer or any member of his family dependent on him. However jewellery,
even if it is for personal use, is always to be treated as capital asset.

3.

Agricultural land in India. However land falling within municipal limits or boundaries of a cantonment
board of an area having population of 10,000 or more as per the last census are not agricultural lands
and are treated as capital assets. Agricultural lands situated within 8 kilometers from the municipal
limits are also treated as capital assets if such peripheral area has been notified by the Central
Government for this purpose. (for definition of agricultural land refer to module Tax Terms)

4.

Certain specified Gold Bonds.

5.

Special Bearer Bonds, 1991, issued by the Central Government.

Cost of acquisition of the asset

The Act defines the cost of acquisition in section 55(2) of the Income Tax Act and there is also a provision of
calculating the notional cost of acquisition in certain specific cases. The cost of acquisition of an asset is, in
simple terms, the value for which it was acquired and which mainly involve a capital expense.
Cost of improvement
Cost of improvement includes all expenditure of a capital nature incurred after March 31, 1981 by an
assessee in making any additions to the capital asset and also includes expenditure incurred to protect
or complete the title to the capital asset and to cure such title from any defect. The expenditure incurred
therefore should increase the value of the capital asset. The cost of improvement, however, does not
include any expenditure which is otherwise deductible in computing the income chargeable as income
from house property; profit and gains of business or profession; or income from other sources.

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The cost of improvement in relation to goodwill or trade mark or brand name associated with business, or a
right to manufacture, produce or process any article or thing or right to carry on any business is taken as nil.
In cases where the capital asset became the property of the assessee on account of certain transfers
which are not regarded as transfer for the purposes of capital gains, the cost of improvement would mean
only expenditure of capital nature incurred by the assessee or the previous owner after March 31,1981.
Types of capital gains
Having caculated capital gain we need to understand how it is taxed. Under the Indian Income Tax Act
there are two categories of capital gains namely - long term capital gains and short term capital gains.
The difference from the point of view of the assessee is the difference in the incidence of tax on these
two types of capital gains. Ordinarily a capital asset held for 36 months or less is called a short term
capital asset and if the holding period of an asset increases to more than 36 months, the asset is known
as long term capital asset. However, in relation to shares of a company, the units of Unit Trust of India
or any specified Mutual Fund or any security traded in any recognised Indian stock exchange, the
holding period for being considered as short term capital asset is twelve months or less. The capital gain
on the transfer of the long term capital asset is termed Long Term Capital Gains and the capital gain on
the transfer of short term capital asset is termed Short Term Capital Gains.
The short-term capital gain is included in the total income of an assessee and charged to tax along with
the other incomes at the normal rates in force. However, in case of long term capital gain the tax payable
is 20% (with indexation) or 10% (without indexation) whichever is less. Further in case of equities, where
security transaction tax is paid, there is no long term capital gain and short term capital gain is only
charged at 10%. Indexation is given after next paragraph.
Computation of LONG TERM CAPITAL Gains tax
Resident Individuals and Hindu Undivided Families
For computing the tax on long term capital gains first the total taxable income of the assessee is reduced
by the amount of long term capital gains included in the total income and then the tax is calculated on the
balance income as if it were the total taxable income of the assessee. To this figure the tax on long term
capital gain is added.
However, where the total income as reduced by long term capital gains is below the maximum amount
not chargeable to income tax, then long term capital gain shall be chargeable only on so much of the
capital gains which together with the other income exceeds the maximum amount not chargeable to tax.
For example, let us suppose Mr. A for assessment year 1997-98 has long term capital gains of Rs.
50,000 and his income from other sources is Rs. 60,000 . Since no tax is payable on total income up to
Rs. 100,000, tax on Rs. 10,000 (Rs. 50,000 + Rs. 60,000 - Rs. 100,000) only will be chargeable at the
rate of long term capital gain.
It has also been provided that deductions under Chapter VIA (for example 80G, 80C etc.) shall not be
allowed from capital gains.
Indexed cost of acquisition and of improvement for long-term capital gains
Where capital gain arises from the transfer of the long term capital asset, the cost of acquisition and cost
of improvement are linked to a Cost Inflation Index notified by the Central Government. Long term Capital
Gains will be computed by deducting from the full value of the consideration the expenditure incurred in
connection with the transfer, the indexed cost of acquisition and the indexed cost of improvement.

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The method of indexation provides the assessee with a protection against inflation and erosion of the real
worth of his investment. It has been provided that the cost of acquisition or the cost of improvement shall
be increased proportionately to the increase in the general cost inflation index. This index begins from
April 1, 1981, and as on that date its figure is taken at 100 and the figures for successive financial years
is notified by the Government from time to time.
EXEMPTIONS FROM CAPITAL GAINS TAXATION
There are number of exemptions provided by the Act where gains on transfer of a capital asset, though
otherwise taxable, are not liable to tax if certain conditions are satisfied.
Transfer of a Residential House ( Sec 54)
Long term capital gains arising on transfer of a residential house ( i.e. building or land appurtenant
thereto) is exempt if the amount of capital gains is utilised in acquiring another residential house, either
by purchase or by construction. Exemption is also available if the investment is made partly in the land
and partly in construction of residential house. The benefit is, however, available only to individuals and
Hindu undivided families.
If the investment cost of new residential house exceeds the amount of capital gains, there is no tax.
Where the cost of new house is less than the amount of capital gains, the gain in excess of the cost of
new house is taxed as capital gains.
Where the acquisition of new asset is by purchase, the investment in new house must be made within
one year before or 2 years after the date of transfer of original asset. Construction of new house must be
completed within 3 years of the date of transfer of the original asset.
If the investment in the new asset has not been made by the due date for furnishing the return of income
for the relevant assessment year, the un -utilised amount of capital gains must be deposited before the
due date of filing of return in a separate bank account under the Capital Gains Account Scheme ,1988. If
the amount deposited is not utilised wholly or partly for the purpose of purchase or construction of the
new asset within 3 years the un-utilised portion shall be taxable as capital gains in the previous year in
which the period of three years expires.
Transfer of Agricultural lands (Sec 54B)
This exemption is available only to individuals. The conditions for exemption of capital gains are as under :
(i)

Land transferred must have been used at least for two years immediately before the transfer by the
tax payer or his parents for agricultural purposes.

(ii)

Tax payer must acquire within two years of the date of transfer another piece of land for use for
agricultural purposes.

(iii) Asset acquired must not again be transferred within 3 years of its purchase.
Where the cost of new agricultural land exceeds the amount of capital gains on transfer of original land,
there is no capital gains tax. If the cost of new asset is less than the amount of capital gains, the gain in
excess of the cost of new asset is alone liable to tax. If the new asset is not acquired by the due date for
filing the return of income for the relevant assessment year, the un-utilised amount of capital gain must
be deposited in a bank account under the Capital Gains Account Scheme, 1988. Thereafter the new
agricultural land must be acquired within the time period specified by making appropriate withdrawals
from the scheme. If the whole or part of the amount is not utilised in acquiring the new asset then the unutilised portion of the deposited amount shall be taxable as capital gains of the previous year in which the
period of two years expires.

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Where the new asset is transferred within 3 years of its purchase, the exemption is withdrawn in the
sense that the cost of new asset is treated as reduced by the amount of capital gains treated as exempt
at the time of original transfer.
Exemption for acquiring a residential house ( Section 54F)
This exemption is available only to individuals and Hindu Undivided Families in whose case there is a
capital gain arising from the transfer of any long term capital asset other than a residential house . The
following conditions have to be satisfied for claiming the exemption :
(i)

the tax payer should purchase a residential house within 1 year before or two years after the date of
transfer of the asset in question, or should construct such a residential house within 3 years of that
date ( herein after called the new asset); and

(ii)

the tax payer must not own any other residential house on the date of transfer of the asset in
question other than the new asset and also should not purchase within one year after the date of the
transfer any residential house other than the new asset and also should not construct within a period
of three years from the date of transfer any residential house other than the new asset. If conditions
stated above are violated, the exemption granted is withdrawn in the sense that the capital gains
exempted is treated as long term capital gains of the year in which such other residential house is
purchased or constructed.

The exemption is available to the assessee if the investment in new residential house is equal to or more
than the net consideration in respect of the original asset. However, if the investment in new asset falls
short of the net consideration, the amount of capital gain not chargeable to tax is equal to:
(Cost of new asset x Long term capital gains) / Net consideration received
For the purposes of this section the net consideration means the full value of the consideration received
or accruing as a result of the transfer of the capital asset as reduced by any expenditure incurred wholly
or exclusively in connection with such transfer.
The exemption may not be allowed if the net consideration which is not utilised till the date for filing of the
return of income of the relevant year is not deposited in a bank account under the Capital Gains Account
Scheme,1988 before the due date of filing of return of income. If the sums deposited are not utilised
wholly or partly for the purpose of new residential house within the time period specified , then the
difference between the capital gains exempted earlier and the capital gains utilised shall be treated as
capital gains of the previous year in which the period of three years expires. Similarly the exemption is
also withdrawn if the residential house acquired is transferred within 3 years from the date of its purchase
or construction. In such cases the capital gain exempted is treated as long term capital gain of the year
in which residential house is transferred.
Exemption Under Section 54 EC
One has to satisfy the following conditions to claim exemption under Section 54EC.

A long-term capital asset is transferred by an assessee (who may be an individual, firm, company,
or any other person) during the previous year.

Within 6 months from the date of transfer of the asset, the assessee should invest the whole or any
part of capital gain in long-term specified assets. Long-term specified asset means any bond
redeemable after 3 years issued on or after April 1, 2006, by the National Highways Authority of
India or by Rural Electrification Corporation Limited.

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If the cost of specified asset is more than the capital gain, the whole of capital gains shall be exempt
from tax. If however, the amount invested in specified assets is less than the capital gain, then the
amount of exemption is equal to the amount invested in specified asset.

If the specified assets are transferred (or converted into money or any loan/advance is taken on the
security of specified assets) within 3 years from the date of their acquisition, the amount of capital
gains arising from the transfer of original asset which was not charged to tax, will be deemed to be
the income by way of long-term capital gains of the previous year in which specified assets are
transferred, etc.

The cost of specified assets which is considered for the purpose of section 54EC shall not be eligible
for tax rebate under section 88.

Exemption U/s 54GA

This exemption is available for capital gain on transfer of assets in case of shifting of industrial undertaking
from urban area to any SEZ.

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Chapter Review
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