Capital gains

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Introduction
Capital gains lie at the intersection of transactional practice, tax litigation and transactional structuring. For practitioners in India, “capital gains” is not merely a dry arithmetic difference between sale and purchase price — it is a statutory construct with detailed rules on what counts as a capital asset, what constitutes transfer, how gains are computed (including indexation and allowable deductions), when special rates or exemptions apply, and how transactions may be re-characterised by tax authorities and courts. Mastery of capital gains law is essential for advising clients on sales of land and buildings, corporate reorganisations, sale of securities, gifts and inheritances, slump sales and cross-border disposals.

Core Legal Framework
Primary statutory provisions (Income-tax Act, 1961)
– Section 2(14): Definition of “capital asset” — “property of any kind held by an assessee, whether or not connected with his business or profession,” with specified exceptions (e.g., stock-in-trade, certain agricultural land).
– Section 2(47): Definition of “transfer” — includes sale, exchange, relinquishment, compulsory acquisition and other modes; this definition is critical for deciding when a capital gains charge arises.
– Section 45: Charge of capital gains — “Any profit or gain arising from the transfer of a capital asset shall be chargeable to income-tax under the head ‘Capital gains’…”
– Section 48: Mode of computation — full value of consideration minus (cost of acquisition + cost of improvement + expenses on transfer); provisions for indexation of cost for long-term assets; special rules to compute cost where asset acquired before 1-4-2001 (indexed cost-of-acquisition using fair market value where applicable).
– Section 50, 50B: Special computation rules — Section 50 applies to depreciable assets; section 50B deals with slump sales (computation of capital gains on transfer of a business undertaking as a result of a slump sale).
– Sections 54, 54F, 54EC, 54B, 54GB (and others): Exemptions/roll-over reliefs — reinvestment in residential property, specified bonds (54EC), investment in eligible companies, agricultural land rollovers, and other specific reliefs.
– Section 111A and Section 112A: Special tax rates — STCG on transfer of equity shares/units where STT paid taxed at concessional rates (section 111A historically); Section 112A (inserted 2018) deals with long-term capital gains (LTCG) on listed equity shares/units exceeding Rs. 1 lakh (10% without indexation) subject to satisfaction of STT and other conditions.
– Section 112: Rate for long-term capital gains on assets other than those covered under 112A — generally 20% with indexation (subject to specified adjustments).
– Section 47: Transactions not regarded as transfer (e.g., certain transfers on demerger, transfer between holding and subsidiary in specific circumstances) — critical for tax neutral corporate reorganisations.
– Section 55: Definitions relevant for computation — “cost of acquisition,” “cost of improvement,” and treatment of assets acquired at different times.
– TDS provisions: Section 194-IA — TDS at 1% on transfer of immovable property (other than agricultural land) where consideration > Rs 50 lakh (buyer’s obligation). Various other TDS provisions may apply depending on the nature of asset.

Other statutory and rule-level material
– Rules for Cost Inflation Index (CII) — governed by Finance Act notifications; used for indexation under section 48/112.
– Central Board of Direct Taxes (CBDT) circulars and notifications — clarifications on transitional provisions (e.g., implementation of section 112A), computation rules and compliance.

Practical Application and Nuances
How capital gains arises and the key practical issues
1. Is the asset a “capital asset”?
– Common contest areas: agricultural land (rural vs urban), stock-in-trade vs capital asset (frequent in family farms and dealers), and specific exclusions under section 2(14). Practitioners must examine factual matrix (frequency of transactions, nature of holding, intention indicated by use and books) and allied statutes (e.g., stamp duty classifications) to advise whether a transaction attracts capital gains.

  1. Has there been a “transfer”?

  2. Transfer is broadly defined. Gift of capital asset to non-relative may trigger capital gains in the hands of the donor if consideration lacking? (Gifts to specified relatives are often excluded per section 47(iii)). Transactions to re-structure business (demerger, amalgamation) require careful reliance on section 47 to avail non-recognition.

  3. Classification: Short-term v. Long-term capital gain

  4. Practical threshold: different asset classes have different holding periods to qualify as long-term (the finance acts over the years have revised thresholds for various assets). The classification affects both availability of indexation and applicable tax rates. Confirm current applicable holding periods for the asset class before computation.

  5. Computation essentials — the arithmetic every practitioner must master
    Step 1: Determine full value of consideration (gross sale consideraton, sometimes reduced by cost of acquisition adjustments).
    Step 2: Deduct allowable expenses on transfer (brokerage, legal fees, advertising, stamp duty paid etc.).
    Step 3: Deduct cost of acquisition and cost of improvement. For long-term assets, compute indexed cost: Indexed cost = Actual Cost × (CII of year of transfer / CII of year of acquisition). If asset acquired before 1-4-2001, often the “fair market value as on 1-4-2001” is taken as cost-of-acquisition for indexation (subject to provisions).
    Step 4: Apply applicable special provisions (section 50 for depreciable assets, section 50B for slump sale).

Example (simplified):
– Purchase of immovable property in FY 2008-09 for Rs 30,00,000 (cost).
– Sold in FY 2024-25 for Rs 1,20,00,000.
– Indexation using CII: assume CII 2008-09 = 137; CII 2024-25 = 370 (hypothetical numbers for illustration). Indexed cost = 30,00,000 × (370/137) = approx Rs 80,98,540.
– Long-term capital gain = Sale consideration 1,20,00,000 – Indexed cost 80,98,540 – Expenses of transfer (say Rs 2,00,000) = Rs 37,01,460.
– Tax: LTCG under section 112 @20% (with surcharge and cess) unless specific provisions like section 112A (on listed equity) apply.

  1. Short-term capital gains (STCG) treatment and rate anomalies

  2. STCG on listed equity (where STT paid) attracts concessional tax (earlier 15% under section 111A). STCG on other assets is taxed at normal slab rates. Practitioners must check whether STT was paid (a condition for concessional route).

  3. Exemptions and roll-overs — practical triggers and pitfalls

  4. Section 54: Exemption for individual/HUF from LTCG on sale of residential house if reinvested in another residential property within prescribed time limits (1 year before or 2 years after or within 3 years in case of construction). Pitfalls: partial reinvestment, multiple houses, ownership and usage conditions, capital gains account scheme deposits where purchase not completed by due date (must deposit amount in notified bank account).
  5. Section 54F: Exemption on sale of any long-term capital asset other than residential house if net sale proceeds are invested in a residential house within timelines. Key nuance: entire net sale proceeds must be invested to claim full exemption; partial investments attract proportionate exemption.
  6. Section 54EC: Investment in specified bonds (NHAI, REC etc.) within 6 months of transfer — limit prescribed (currently Rs 50 lakh), lock-in period (5 years earlier 3 years now? check latest) — must check current bond list, limit, lock-in.

  7. Section 54GB: rollover for investment in eligible startup/eligible small company — compliance heavy, documentation of use of funds to acquire new assets, timelines.

  8. Special cases practitioners see frequently

  9. Slump sale: Business sale as a going concern triggers section 50B — consideration is slump sale value, cost base computed differently (net worth method). Careful valuation and documentation essential (P&L, inventory valuation, transfer of liabilities).
  10. Transfer on demerger/amalgamation: Section 47 provides non-recognition in specified circumstances; drafting of scheme and order from Tribunal/High Court crucial to ensure tax neutrality.
  11. Gifts and partition: Section 47 contains non-transfer transactions for certain family partitions; valuation and subsequent transfer by transferee may have cost-of-acquisition carry-over consequences.
  12. Transfer by way of compulsory acquisition/compensation: separate computation rules and often treatment of enhanced compensation subject to different indexing and specific reliefs.

Practical evidence and litigation techniques
– To establish cost of acquisition when records are poor: collate concurrent evidence — registered documents, stamp duty records, bank statements evidencing payment, valuations at the time (municipal/valuation lists), independent witness statements; the burden often lies on assessee to prove costs/deductions claimed.
– To contest classification of activity as “business” (thus stock-in-trade) vs capital asset: draw on transaction frequency, mode of holding, intention evidenced in board minutes, loans obtained using asset as security and books of account.
– When invoking exemption under section 54/54F: maintain strict documentary trail — proof of purchase/construction, bank payments, registration records, deposit in capital gains account scheme where necessary, timelines adhered to.

Landmark Judgments
(Practical principles distilled from judicial pronouncements)
Note: Below are leading judicial principles you must know and apply. The following cases have shaped practical approaches to capital gains (seek up-to-date citations for printed submissions and local practice):
– Principle on “transfer” and characterisation: The Supreme Court/Higher Courts have emphasised substance over form in determining whether a transaction constitutes a transfer under section 2(47). Courts will look at the true legal effect of the transaction and commercial realities to decide whether there has been a chargeable transfer or whether an exception under section 47 applies. (Refer to relevant SC/Higher Court decisions on reorganisation and demerger for textual application).
– Principle on indexation and cost of acquisition for pre-2001 acquisitions: Courts have consistently held that where the statute requires fair market value as on 1-4-2001 to be taken as cost (for assets acquired earlier), the assessee is entitled to use that value for computation and indexation; revenue cannot substitute arbitrary values. (See relevant High Court/Supreme Court rulings applying section 48 read with transitional provisions).
– Exemptions under section 54/54F — intention and reinvestment: Judicial pronouncements make clear that procedural compliance (timelines, bona fide reinvestment, title/possession conditions) is essential; mere intention not backed by timely and adequate investment leads to denial. Courts have allowed deposit in capital gains account scheme as compliance where actual purchase could not be completed in time.

(When drafting pleadings or oral arguments, cite the latest authoritative SC decisions on each specific point — e.g., treatment of slump sales, scope of section 47 demerger clauses, and the scope of section 112A — to anchor submissions. For Tribunal practice, cite relevant authority from your Circuit and recent High Court rulings.)

Strategic Considerations for Practitioners
Advising sellers (individuals, HUFs, corporates)
– Pre-transaction planning: Always compute expected capital gains on realistic assumptions and discuss options for minimizing tax via permissible exemptions (54/54F/54EC), timing of sale (to qualify as long-term), and transfer mode (sale vs part-exchange/gift where appropriate).
– Documentation: Ensure pre-sale clarity — proof of acquisition, cost of improvements, receipts for capital expenditures, invoices for transfer expenses, and valuation reports where market price significantly differs from declared consideration. If valuations create tax perception of under/over-valuation, obtain independent valuation reports and contemporaneous documentation justifying price.
– Capital gains account scheme: When relying on 54/54F but unable to complete re-investment within prescribed period, deposit proceeds in CGAS to preserve claim; follow bank rules strictly and obtain bank certificates and ledger extracts.
– Use of section 54EC: For clients wanting to park gains safely with tax benefit, evaluate the fit: the Rs 50 lakh limit (check current limit), lock-in period and liquidity needs should determine whether bonds are a viable option.

Advising buyers and corporate clients
– Due diligence: Verify the seller’s tax compliance and history, check for encumbrances and pending tax disputes that could result in liability post-sale. For slump sale or business transfers, verify net worth computations and ensure valuation methodology is sound to avoid downstream disputes under section 50B.
– TDS compliance: Under section 194-IA, buyer must deduct tax at 1% on immovable property transactions > Rs 50 lakh — non-compliance attracts interest and penalties. Ensure buyer obtains seller’s PAN and files TDS returns promptly.

Litigation strategy
– Where Revenue disputes cost of acquisition or indexation, produce contemporaneous documentary proof first; secondary evidence and valuations come next.
– Challenge Revenue’s re-characterisation of transactions by stressing commercial purpose, statutory exemptions (section 47) and scheme compliance (for demergers/amalgamations).
– Use advance rulings where possible for cross-border and novel structures (subject to limitations) to obtain certainty on tax treatment of proposed transfers.

Common pitfalls to avoid
– Poor documentation of cost and improvement — often fatal in assessment and appeals.
– Missing timeline for reinvestment or failing to deposit proceeds in CGAS where necessary before claiming exemption.
– Ignoring TDS obligations — even an otherwise tax-neutral transaction can attract penalties for failure to deduct.
– Relying on outdated holding-period rules or tax rates — finance acts change thresholds and rates; always confirm the law applicable for the year of transfer.
– Over-reliance on informal valuations — where consideration differs materially from market norms, obtain certified valuations and explain rationale in file.

Conclusion
Capital gains law in India is technical, evolving and fact-sensitive. For effective practice:
– Start with statutory framework (sections 2(14), 2(47), 45, 48, 50/50B, 54/54F/54EC, 112/112A, 47 and 55) and the latest Finance Act changes.
– Focus on correct characterisation (capital asset vs stock-in-trade), whether a transfer has occurred and classification as short- or long‑term.
– Meticulously document cost, improvements, transfer expenses and reinvestments; use capital gains account scheme where necessary.
– Plan transactions (timing, structure, reinvestment options) to legally minimize tax exposure; ensure compliance with TDS and reporting obligations.
– In disputes, ground arguments in contemporaneous documents, authoritative judicial precedents and clear statutory interpretation, and be alert to factual distinctions that decide outcomes.

Practical mastery — combining statutory knowledge, up-to-date notifications (CII, Finance Act amendments), valuation rigour and precise documentation — converts the basic arithmetic of “sale price minus purchase price” into defensible, tax-efficient outcomes for clients.