52 Tax Planning for Capital Gains

8/13/2019 52 Tax Planning for Capital Gains

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TAX PLANNING FOR CAPITAL GAINS

Dr. Girish AhujaM.Com., Ph.D, FCA

Chartered Accountant

Capital gain arises on the transfer of a capital asset. Therefore there are two pre-requisites for capital gain to arise viz .

(a ) There should be a capital asset(b) Such capital asset should be transferred during the previous year.

Capital asset is widely defined as property of any kind held by the assessee

whether connected with his business or not but does not include any stock-in-trade, personal effects, rural agricultural land, etc.1. Although jewellery is a capital asset but utensils and other items of preciousmetal may be a personal effectIn the definition of jewellery, only ornaments made of precious metal are included.Thus, items other than ornaments, made of precious metals can be treated aspersonal effects provided they are commonly and ordinarily used or intended to beused for personal or household use.Silver utensils of the type which were used in the kitchen or in the dining room ofthe assessee were held to be personal effects and not capital assets. [ CIT v

Sitadevi N. Poddar (1984) 148 ITR 506 (Bom)].But silver bars, sovereign, bullion and silver coins were held not to be effectsmeant for personal use even if they are placed before Goddess Lakshmi at thetime of Puja. [ Maharaja Rana Hemanth Singhji (H E G ) v CIT (1976) 103 ITR 61(SC)].Items of silverware including dinner plates of different sizes, finger bowls, jugswere held to be personal effects. [ CIT v Benarashilal Kataruka (1990) 185 ITR 493(Cal)]. But at the same time, a large number of the same type of silver articlescannot be treated as having been held for personal use and the assessingauthority has to find out as to what are the articles which should reasonably be held

by the assessee for personal use. [ Ramanathan Chettiar R v CIT (1985) 152 ITR493 (Mad)].Gold caskets, gold tray, gold cups, saucers, spoons and photo frames were notregarded as personal effects intended for personal or household use. [ Poddar (GS ) v CWT (1965) 57 ITR 207 (Bom)].


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The expression intended for personal or household use did not mean capable ofbeing intended for personal use or household use. It meant normally commonlyand ordinarily intended for personal or household use. It was further observed thatmerely because the gold caskets were kept in the showcase, they could not betreated as part of furniture. In order to be a personal effect, it is not essential thatthe person himself should use it every day, it is enough if it is used on ceremonialoccasions or as and when desired by the assessee.2. Capital gain v Business incomeWhether a particular asset is stock-in-trade or capital asset does not depend uponthe nature of the article, but the manner in which it is held. The same item may bestock-in-trade in the hands of the assessee who deals in that item. But it will becapital asset in the case of an assessee who uses it for earning income or holds asan investment. For example, a dealer in real estate holds a piece of land or house

property as stock-in-trade. But it will be a capital asset in the hands of a personwho holds it as an investment and derives income from leasing or renting of theproperty.Even stock-in-trade may become capital asset in certain circumstances and viceversa . If an assessee who deals in certain goods or commodities as trader, onclosure of the business, retains the existing stocks as investment, the stocks willbecome capital asset in his hands from the time of closure, not withstanding thatthey were stock-in-trade earlier in his hands. Even in the course of a business, anassessee may try to transfer some of the stock-in-trade from his trading activityand decide to hold them as investment. The stocks so held would assume the

character of capital asset from the date of such holding. This may usually happenin the case of dealer in shares and real estate. But in all these cases, the findingwill be one of fact depending upon the intention and conduct of the assesseesupported by direct and circumstantial evidence. Similarly, when a capital asset isconverted into stock-in-trade, the same will no longer be capital asset. However,this situation is covered by section 45(2).Investment in land or sale of land after plotting whether business income orcapital gain : Normally, the purchase of land represents investment of money inland. [ CIT v Jawahar Development Association (1981) 127 ITR 431 (MP)].

A transaction of purchase and sale of land cannot be assumed, without more, to be

a venture in the nature of a trade.It is well settled that the mere fact that property was purchased with the intention ofselling it at a profit is not conclusive on the question whether an isolatedtransaction of purchase and resale is an adventure in the nature of trade. If thereare relevant facts besides the fact of purchase and resale, it is open to come to the


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conclusion that the transaction is one in the nature of trade. [ Gurdial Naraindas &Co . v CIT (1963) 50 ITR 633 (Bom)].The activity of an assessee in dividing the land into plots and not selling it as asingle unit as he purchased, goes to establish that he was carrying on business inreal property and it is a business venture. [ Raja J. Rameshwar Rao v CIT (1961)42 ITR 179 (SC)].Ordinarily, where a person acquired land with a view to selling it later afterdeveloping it and actually divided the land into plots and sold the same in parcels,the activity could only be described as a business adventure. Generally speaking,the original intention of the party in purchasing the property, the magnitude of thetransaction of purchase, the nature of the property, the length of its ownership andholding, the conduct and subsequent dealings of the assessee in respect of theproperty, the manner of its disposal and the frequency and multiplicity of

transactions afforded valuable guides in determining whether the assessee wascarrying on a trading activity and whether a particular transaction should bestamped with the character of a trading adventure. [ CIT v Trivedi (V.A .) (1988) 172ITR 95 (Bom)].In order to hold that an activity is in the nature of an adventure in the nature oftrade there must be positive material to prove that the assessee intended to tradein such an activity and in the absence of evidence the sale of immovable propertyconsisting land could give rise only capital accretion. If the land owner developedthe land, expended the money, laid roads convert the land into house sites andwith the view to get better price it will not be considered as an adventure in the

nature of trade to give any business profit. [CIT v A. Mohammed Mohideen (1989)176 ITR 393 (Mad)] Assessee had purchased a plot of land in 1958. In view of the Urban Land (Ceilingand Regulation) Act, 1976, she applied for construction of group housing on theexcess land and sold the land to a developer and builder. The Assessing Officerheld that the instalments received from the builder is business income. TheTribunal held that it is not business income as there was no adventure in thenature of trade. On reference, the Delhi High Court upheld the decision of theTribunal and held as under:"The plot was purchased in the year 1958 and after the operation of law, namely,

the Urban Land (Ceiling and Regulation) Act, 1976, it was not possible for theassessee to retain the land. It was very clear that on the assessee's part there wasonly an intention to transfer the land and not the portion that may be constructed bythe builder on a future date. Clause 3 of the agreement merely provided the modeof payment. On the facts and in the circumstances of the case, the Tribunal was


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right in holding that there was no adventure in the nature of trade and therebydeleting business income of Rs. 11,87,387 from the income of the assessee." [ CIT v Radha Bai (2005) 272 ITR 264 (Del)].Where some land, which was contributed by partners as capital and used as brickfield and later given for development, upholding the finding of the Tribunal, it washeld that the firm did not acquire the land, with a view to sell it at a profit. It wastreated in the accounts as a fixed asset given to other for outright developmentwithout the assessee itself plotting it out, so that it had continued to be a capitalasset. There was no scope, it was found, for holding it either as business or evenan adventure in the nature of trade. [ CIT v Mohakampur Ice & Cold Storage (2006)281 ITR 354 (All)].What was necessary was to find out the intention of the assessee at the time of thepurchase of land. Where the land was never purchased by the assessee. She

acquired the same on the basis of a will on the death of her husband. She sold thesame in parcels because the huge area could not be sold in one transaction. Suchan activity could not amount to trade or business within the meaning of the Act.[CIT v Sushila Devi Jain (2003) 259 ITR 671 (P&H)].Shares held as personal investment by a share broker : Where the assessee, ashare broker purchased certain shares as personal assets and had been showingthe same in his wealth-tax returns, it was held that the profit on such shares shouldbe taxable as capital gains and not as business income as these shares werecapital assets and not stock-in-trade of the business. [ ACIT v Kethan Kumar A.Shah (2000) 108 Taxman 23 (Ker). See also CIT v Rewa Shankar A. Kothari

(2006) 155 Taxman 214 (Guj)]. A company can hold shares as stock-in-trade for the purpose of doing business ofbuying and sale of such shares, while at the same time it can also hold othershares as its capital for the purpose of earning dividend income. Thus, where thefinding was that the shares in question were never treated by the assessee asstock-in-trade and they were held for earning dividend only, it was held that theTribunal was right in law in holding that the profit on sale of such shares was to betreated as capital gains. [ CIT v N.S.S. Investments Pvt. Ltd. (2005) 277 ITR 149(Mad)]Where it was an admitted position that the land in question was held as a capital

asset by the assessee and not as a business asset and it had also been noticedthat the assessee had relinquished the land in lieu of forest department allowinguse of their land for laying down the drainage and the question was as to whetherloss arising on such transfer could be allowed as a business loss, it was held thatthe loss arising on account of transfer of land to the forest department in lieu of the


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use of forest land for laying the drainage for discharge of effluent, was capital lossand could not be allowed as a business loss. [ Shreyans Industries Ltd. v Jt. CIT(2005) 277 ITR 433 (P&H)]3. Transfer in a development agreementDevelopment agreement is not an agreement for sale simpliciter . It is an executoryagreement, whereby the developer undertakes to put up a superstructure on thatpart or portion of land retained by the owner in consideration of transfer ofremaining part. Development agreement is not a sale simpliciter , because there isan element of builder's contract with the only difference that the consideration isnot cash, but in kind i.e. constructed portion on the retained land. An agreement forsale can be enforced in a court of law by a decree ordering specific performance,with the court itself acting as the transferor, where the owner does not carry out theobligations either under the agreement for sale or the court decree. In development

agreement one cannot expect construction to be undertaken by the developer,once a breach has occurred, so that there is only damages for the party, who hassuffered the breach. There cannot be specific performance in the sense ordinarilyunderstood in enforcement of agreement for sale.

All the same, a development agreement was treated as an agreement for sale in Ashok Leyland Finance Ltd. v Appropriate Authority (1997) 230 ITR 398 (Mad). Asimilar view was taken in Ashis Mukherji v Union of India (1996) 222 ITR 168 (Pat)and Ansal Properties and Industries Ltd. v Appropriate Authority (1999) 236 ITR793 (Del). But in Mahabodhi Society of India v Union of India (1994) 209 ITR 412(Cal), it was held that it is not an agreement for sale, which can come within the

purview of Chapter XXC. Calcutta High Court has also recognised developmentagreement as a business agreement. [ Madgul Udyog v CIT (1990) 184 ITR 484(Cal) approved in CIT v Podar Cements Pvt. Ltd. (1997) 226 ITR 625 (SC)].Treatment of development agreement under Chapter XXC as an agreement forsale cannot possibly mean that in every case, the development agreement can betaken as an agreement for sale simpliciter , though this was the inference drawn bythe authorities and sometimes conceded by the taxpayer to purchase peace.It is in the above context, that one has to take care to avoid the inference oftransfer on mere signing of the agreement. A development agreement may besilent as to the date of possession, in which case it can be assumed that there is

no possession, which accompanies development agreement. It is advisable thatdevelopment agreement specifically stipulates possession with owner tillobligations undertaken by the developer is discharged with only right of entry fordeveloper or his nominees to discharge the obligations undertaken in theagreements.


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If the development agreement had granted an unqualified, uninterrupted andirrevocable right of possession to the developer, it will be difficult to avoid liability inthe year in which development agreement was executed, though there is apossible argument that the possession is not in the capacity of a buyer, but only asa builder, the property itself is not for enjoyment by the developer but by theprospective flat owners. Such an argument can be taken and defended,notwithstanding the possible hassles with the Income-tax Department. Even if sucha stand is taken, liability cannot be postponed till completion of the agreement, ifthere are registered sales prior to completion. Proportionate profit therefrom willhave to be accounted.If on a bare reading of a contract in its entirety, an Assessing Officer comes to theconclusion that in the guise of the agreement for sale, a development agreement iscontemplated under which the developer applies for permissions from various

authorities either under power of attorney or otherwise and in the name of theassessee, then the Assessing Officer is entitled to take the date of the contract asthe date of the transfer in view of section 2(47)( v ). In this very case, the date onwhich developer obtained a commencement certificate is not within the accountingyear ending 31-3-1996. At the same time, if one reads the contract as a whole it isclear that a dichotomy is contemplated between the limited power of attorneyauthorizing the developer to deal with the property as an irrevocable license toenter upon the property after the developer obtains the requisite approvals ofvarious authorities. In fact the limited power of attorney may not be given but onceunder the agreement a limited power of attorney is intended to be given to the

developer to deal with the property then the date of contract would be the relevantdate to decide the date of transfer under section 2(47)( v ) and in which event thequestion of substantial performance of the contract thereafter does not arise. Thispoint has not been considered by any of the authorities below. No judgment hasbeen shown to exist on this point. Therefore, although there is concurrent finding offact there is no merit in the argument of the assessee that the court should go onlyby the date of actual possession and not by the date on which the irrevocablelicense was given. If the contract read as a whole indicates passing of ortransferring of complete control over the property in favour of the developer thenthe date of the contract would be relevant to decide the year of chargeability.[Chaturbhuj Dwarkadas Kapadia v CIT (2003) 260 ITR 491 (Bom)].But, the agreement/contract on its own may not allow possession to be takeninstantaneously, but it may spell out a transaction by which the possession willpass at the future point of time. Under the terms of a contract, normally, a series ofacts or transactions that would at one point of time or the other take place infurtherance of the contract will be recorded. What is contemplated by section


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2(47)( v ) is a transaction which has direct and immediate bearing on allowing thepossession to be taken in part performance of the contract of transfer. It is at thatpoint of time that the deemed transfer takes place. True, entering into theagreement/contract is a transaction in a broad sense but, when the agreementenvisages an event or act on the happening or doing of which alone thepossession is allowed to be taken in part performance of the contract, thetransaction of the nature contemplated by sub-clause ( v ) cannot be said to haveoccurred before that date. The date of entering into the agreement cannot be thedetermining factor in such a case, even though the agreement envisages a futuretransaction pursuant to which possession will be allowed to be taken. However, itneeds to be clarified that it is not possible to lay down a rigid proposition that anagreement, as such, can never be construed as a transaction allowing possessionto be taken in part-performance. [ Jasbir Singh Sarkaria, In re (2007) 164 Taxman

108 (AAR-New Delhi)].4. Transfer is a pre-requisite for taxing capital gainCapital gain arises only when there is a transfer of capital asset. If the capital assetis not transferred or if there is any transaction which is not regarded as transfer,there will not be any capital gain. However w.e.f. assessment year 2000-2001section 45(1A) has been inserted to provide that in case of profits or gains frominsurance claim due to damage or destruction of property, there will be capital gainon such deemed transfer although no asset has been actually transferred in suchcase.Judicial decisions Whether a transaction constitute transfer or not

(1) Redemption of bonds constitutes transfer as there is extinguishment of right byoperation of contract and also a relinquishment of right in the asset in lieu of whichthe assessee received cash from the competent authority. Thus, in either of thesituations, the case was covered by the definition of section 2(47). [ Pervij WangChuk Basi v JCIT (2007) 290 ITR (AT) 266 (Mum)].The maturity or redemption of zero coupon bonds shall be treated as transfer.(2) Mere delivery on the Sale of motor vehicle is a transfer : In the case of sale ofmotor vehicles, mere delivery of the physical possession is sufficient to constitutetransfer, the entries in the R.C. book will be made only after the transfereebecomes the owner under Motor Vehicles Act, 1988. [ CIT v Salkia Transport

Associates (1983) 143 ITR 39 (Cal)].(3) Conversion of preference shares into equity shares is a transfer : Although theconversion of debentures into equity shares is not regarded as transfer but if thepreference shares are converted into equity shares, it will be regarded as a transferand there will be capital gain to the shareholder on the date of allotment of equity


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shares in exchange of preference shares and the full consideration in this caseshall be fair market value of equity shares on the date of its allotment. [ CIT vTrustees of HEH the Nizams Second Supplementary Family Trust (1976) 102 ITR248 (AP)]. Conversion of preference share into ordinary shares amounts to transferin hands of the shareholders. [ CIT v Motors and General Stores P. Ltd. (1967) 66ITR 692 (SC)](4) Where an assessee gives up the right to claim specific performance for

purchase of immovable property it is relinquishment of a capital asset and thustransfer : The assessee had entered into an agreement to purchase certainproperty. Both parties reserved the right to specific performance of the agreement.Nearly four years thereafter, again another agreement was entered into in thenature of deed of cancellation, by which the assessee agreed for termination of theearlier agreement and allowed the owner of the land to sell the said property to any

person and at any price of his choice. As a consideration for this, the assesseewas paid a sum of Rs. 6,00,000 apart from being refunded the advance of Rs.40,000. The question that arose for consideration was as to whether the amount ofRs. 6,00,000 received by the assessee from the vendor could be treated as capitalgains in the hands of the assessee. [ K.R. Srinath v Asstt. CIT (2004) 268 ITR 436(Mad)].(5) Redemption of preference shares by a company is a transfer in the hands ofshareholders and they will be liable to capital gain for the same. [ Anarkali Sarabai vCIT (1997) 90 Taxman 509 (SC)].(6) Succession of the firm by a company is not a transfer if following conditions are

satisfied : Any transfer of a capital asset or intangible asset by a firm to a companyas a result of succession of the firm by a company in the business carried on by thefirm is not a transfer provided the following conditions are satisfied:

(a ) all the assets and liabilities of the firm or AOP/BOI as the case may be,relating to the business immediately before the succession become the assets andliabilities of the company;

(b) all the partners of the firm immediately before the succession become theshareholders of the company in the same proportion in which their capital accountsstood in the books of the firm on the date of the succession;

(c ) the partners of the firm do not receive any consideration or benefit, directly or

indirectly, in any form or manner, other than by way of allotment of shares in thecompany;

(d ) the aggregate of the shareholding in the company of the partners of the firmis not less than 50% of the total voting power in the company and theirshareholding continues to be as such for a period of 5 years from the date of the


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succession [Section 47( xiii )]; and(e ) the demutualisation or corporatisation of a recognized stock exchange in

India is carried out in accordance with a scheme of corporatisation which isapproved by the SEBI;(7) Succession of the sole proprietary concern by a company is not a transfer iffollowing conditions are satisfied : Where a sole proprietary concern is succeededby a company in the business carried on by it as a result of which the soleproprietary concern sells or otherwise transfers any capital asset or intangibleasset to the company, it will not be regarded as transfer provided the followingconditions are satisfied:

(a ) all the assets and liabilities of the sole proprietory concern relating to thebusiness immediately before the succession become the assets and liabilities ofthe company;

(b) the shareholding of the sole proprietor in the company is not less than 50%,of the total voting power in the company and his shareholding continues to remainas such for a period of 5 years from the date of the succession; and

(c ) the sole proprietor does not receive any consideration or benefit, directly orindirectly, in any form or manner, other than by way of allotment of shares in thecompany [Section 47( xiv )];(1) Transfer can be made to the existing company but the partners/ proprietorshould hold at least 50% of the equity capital of the company and their/his shareholding should continue to remain as such.(2) The exemption in case of succession by the company is allowed to a proprietaryfirm or partnership firm carrying on business. It is not allowed in case of profession.(3) Section 47( xiii ) and ( xiv ) exempts the capital gain in transfer of capital asset.Stock in trade is not a capital asset and as such if it is transferred at profits, it willbe taxable as business income in the hands of a firm or sole proprietary firm as thecase may be.(8) There is no transfer in family settlement : Where a family settlement/arrangement is arrived at in order to avoid continuous friction and to maintainpeace among the family members, the family arrangement is governed by theprinciples which are not applicable to dealing between strangers. So, such bonafide realignment of interest, by way of effecting family arrangements among thefamily members would not amount to transfer. [ CIT v A.L. Ramanathan (2000) 245ITR 494 (Mad)]. In this case the court followed the decision of the Supreme Courtin general law laid down in the case of Kale v Deputy Director of Consolidation(1976) AIR 1976 SC 807. See also CIT v Kay Arr Enterprises (2008) 299 ITR 348(Mad)]


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(9) Capital loss not allowed unless there is a transfer : Capital loss can arise onlywhen the capital asset is transferred. There cannot be a capital loss if the capitalasset has become valueless. [ Natarajan (C.A. ) v CIT (1973) 92 ITR 347 (Mad); CIT v R. Chidambaranatha Mudaliar (1999) 240 ITR 552 (Mad)]. Similarly, there is nocapital loss if the earnest money paid by the intending purchasers is forfeited.[Sterling Investment Corporation Ltd. (1980) 123 ITR 441 (Bom)].(10) Giving up the right to obtain conveyance of immovable property amounts totransfer of a capital asset : Where the assessee had paid the earnest money andacquired right to obtain conveyance of immovable property, such earnest moneypaid shall be cost of acquisition of such right and if such right is given up, there is atransfer of a capital asset and the compensation received for giving up such right isthe consideration price. [ CIT v Vijay Flexible Container (1990) 186 ITR 693(Bom)].

(11) No capital gain if a firm is incorporated as a limited company under Part IX ofCompanies Act, 1956 : Where a partnership firm is incorporated as a companyunder the provisions of Part IX of the Companies Act, Neither section 45(1) norsection 45(4) shall be attracted even though there was transfer of assets from firmto newly constituted company. [ CIT v Texsprin Engg. & Mfg. Works (2003) 263 ITR345 (Bom)].5. Capital assets can either be short-term capital asset or long-term capital asset(A) Short-term capital asset: A capital asset held by an assessee for not more than36 months immediately preceding the date of its transfer is known as a short termcapital asset.

However, the following assets shall be treated as short-term capital assets if theyare held for not more than 12 months (instead of 36 months mentioned above)immediately preceding the date of its transfer:

(a ) Equity or Preference shares held in a company.(b) Any other security listed in a recognised stock exchange in India.(c ) Units of the Unit Trust of India or units of a Mutual Fund specified u/s

10(23D).(d ) Zero coupon bonds.

(B) Long-term capital asset: It means a capital asset which is not a short-termcapital asset. In other words, if the asset is held by the assessee for more than 36months or 12 months, as the case may be, such an asset will be treated as a long-term capital asset.Thus, period of holding of a capital asset is relevant for determining whether capitalasset is short-term or long-term.Exclusion/inclusion of certain period for computing the period of holding of an asset


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Case Exclusion/Inclusion of period

(i ) Shares held in acompany in liquidation

Exclude the periodsubsequent to the date ofliquidation

(ii ) Property acquired in anymode given under section49(1) ( e.g. by way of giftwill, etc.)

Include the holding periodof previous owner also.

(iii ) Shares in an Indian Amalgamated Companyacquired in a scheme of

Amalgamation

Include the holding periodof shares in the

Amalgamating Companyby the Assessee.

(iv ) Shares in IndianResulting companyacquired in case ofdemerger

Include the holding periodof shares in the DemergedCompany by the Assessee

(v ) (a ) Trading or clearingrights of recognised stockexchange pursuant to itsdemutualisation orcorporatisation

Include the period for whichthe person was a memberof the recognised stockexchange in India

(b) equity shares in acompany acquired by aperson pursuant to thedemutualisation orcorporatisation ofrecognised stock exchange

do

Holding period in case of share or any other securityThe period of holding, in the following circumstances will be computed as under:1. Right to subscribe to sharesor any other securities (may becalled as financial assetssubscribed to by the assesseeon the basis of right to subscribeto such financial assets.

The period shall bereckoned from thedate of allotment ofsuchfinancial asset.

2. Right to subscribe to share orany other securities acquired by

do


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a person in whose favour theright has been renounced by theexisting holder.3. Period of holding of the rightby a person who has renouncedthe right.

The period shall bereckoned from thedate of offer of suchright by the companyor institution to thedate ofrenouncement , whichin normalcircumstances will beshort-term.

4. Period of holding of afinancial asset allotted withoutany payment and on the basis ofholding of any other financialasset e.g. bonus shares.

The period will bereckoned from thedate of allotment ofsuch financial asset(not from the date ofallotment of theoriginal shares).

(C) Judicial decisions for determining period of holding(i ) Property constructed on a land purchased earlier : In case of property isconstructed on a site purchased much earlier, the question arises whether theperiod of holding the asset i.e. , the property, should be reckoned from the date ofcompletion of the construction of the property or from the date of acquisition of theland. The correct position is that the asset consists of two components: (1) Landand (2) Building. When the property is sold, the period of holding has to bereckoned separately for the land and the building. The consideration received canalso be split into two parts relating to each component.In CIT v Vimal Chand Golecha (1993) 201 ITR 442 (Raj), the land was purchasedin 1962 and building was constructed thereon in the accounting years relevant toassessment years 1968-69, 1969-70 and 1970-71. The building was sold in 1970.It was held that the gains attributable to land were assessable as long-term capital

gains. The gains attributed to the building were however, short-term capital gains.Similar decision was held in the cases of CIT v Lakshmi B. Menon (2003) 264 ITR76 (Ker) and CIT v C.R. Subramanian (2000) 242 ITR 342 (Kar)].

Agreeing with the above Rajasthan High Court view, it has been held that land canbe considered a separate capital asset even if a building is constructed thereon.


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assessee was entitled to deduction from such gains as per law. [ CIT v JindasPanchand Gandhi (2005) 279 ITR 552 (Guj)](iii ) Period of holding of shares where call money is paid after allotment : Where theshares are acquired by the assessee from a company and the payment is made tothe company even after allotment of shares as and when the call is made by thecompany, the period of holding of such shares shall be considered from the date ofallotment of shares even though the call money has been paid after allotment ofsuch shares.(iv) Right to acquire any house property : Where a flat is booked with a builderunder a letter of allotment or an agreement for sale, this would represent only aright to acquire a flat and if such right is acquired more than 36 months back, itbecomes a long-term asset. However, when the possession of the flat is taken, theperiod of holding would once again commence from the date of the possession of

the flat as the small right to acquire a flat merged into larger right and small rightupon a merger would loose its existence.(v ) Holding need not be as capital asset : The entire period of holding i.e. , from thedate of initial acquisition upto the date of transfer has to be taken into account inorder to decide whether it is a long-term capital asset although it may not havebeen held as capital asset initially. [ Keshavji Karsondas v CIT (1994) 207 ITR 737(Bom)].6. Computation of capital gainThe income chargeable under the head 'Capital gains' shall be computed, bydeducting from the full value of the consideration received or accruing as a resultof the transfer of the capital asset, the following amounts, namely:

(i ) expenditure incurred wholly and exclusively in connection with such atransfer;

(ii ) the cost of acquisition of the asset and the cost of any improvement thereto.However, in the case of long-term capital gain, the cost of acquisition and cost ofimprovement mentioned above will be substituted by the words 'indexed cost ofacquisition' and 'indexed cost of improvement' respectively.(A) Judicial decision on consideration price(1) Receipt of consideration in instalments : Even if the full value of considerationagreed upon is received in instalments in different years, the entire value ofconsideration has to be taken into account for computing the capital gains whichbecome chargeable in the year of transfer.(2) Capital gains arise on accrual basis : Capital gain is attracted, the moment theassessee has acquired the right to receive the price. It is not necessary that theconsideration should have been actually received. What the parties did


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subsequently will not have any bearing on the liability of the assessee to tax of theyear in which the right to receive the consideration arises. [ T.V. Sundaram Iyengar& Sons Ltd. v CIT (1959) 37 ITR 26 (Mad)].(B) Judicial decision on cost of acquisition(1) Interest on money borrowed for acquiring capital assets will form part of cost ofasset : Interest on loan taken for acquiring a capital asset will become part of thecost of acquisition. [ CIT v Mithlesh Kumari (1973) 92 ITR 9 (Del)]. However,interest payable on provident fund loan (interest so payable is credited to theprovident fund account of the assessee) is not deductible interest on expenditure[Vashisht Bhargava v ITO (1975) 99 ITR 148 (Del)]. As regards interest on theasset acquired by the assessee carrying on business or profession, interest beforethe asset is put to use shall form part of cost of the asset but any interest due orpaid after the asset is put to use shall be treated as revenue expense.

(2) Sum paid for discharge of mortgage : Where the property has been mortgagedby the previous owner during his lifetime and the assessee, after inheriting thesame, has discharged the mortgage debt, the amount paid by him for the purposeof clearing off the mortgage shall be regarded as cost of acquisition under section48 read with section 55(2) of the Act. [ Arunachalam (RM ) v CIT (1997) 227 ITR222 (SC)] The position is, however, different where the mortgage is created by theowner after he has acquired the property. The clearing off of the mortgage debt byhim prior to transfer of the property would not entitle him to claim deduction undersection 48 of the Act because in such a case he did not acquire any interest in theproperty subsequent to his acquiring the same. [ Jagadish Chandran (V.S.M.R. ) v

CIT (1997) 227 ITR 240 (SC)].(3) Cost of acquisition of bonus shares or any other financial asset allotted without

payment : The cost of acquisition in relation to the financial assets ( i.e. share or anyother security) allotted to the assessee on or after 1-4-1981 without any paymentand on the basis of holding of any other financial asset , shall be taken to be nil.Therefore, the cost of bonus shares/security shall be taken to be nil and the entiresale consideration received on the transfer of the bonus shares/security shall betreated as capital gains. However, in case bonus shares have been allotted to theassessee before 1-4-1981 , although the cost of such bonus shares is nil but theassessee may opt for market value as on 1-4-1981 as the cost of acquisition of

such bonus shares.The cost of acquisition of original shares shall be the amount actually paid toacquire the original shares.(4) Cost of acquisition of an asset acquired from the previous owner in any modegiven u/s 49(1) : In this case, the cost of acquisition is taken as the cost to the


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previous owner and it is this cost which will have to be indexed. For the purpose ofindexation the year in which the asset was first held by the assessee (not theprevious owner) is to be considered. The indexation will be done as under:Cost of acquisition to the previous owner

CII of the year of transfer

CII of the year in which the asset is first held by the assessee

However, in the case of Mrs. Pushpa Sofat (2002) 81 ITD 1 (Chd)(SMC), theindexation of cost was allowed from the date of acquisition of the asset by theprevious owner and not the date when the asset was acquired by the assesseefrom the previous owner under any mode given under section 49(1).Similarly in Kamal Mishra v ITO (2008) 19 SOT 251 (Del) it was held that theindexation of cost will be allowed with reference to the year in which the previousowner acquired the asset.7. Treatment of advance money receivedWhere any capital asset, was on any previous occasion, the subject of negotiationsfor its transfer, any advance or other money received and retained by the assessee in respect of such negotiations, shall be deducted from the cost for which the assetwas acquired or the written down value or the fair market value , as the case maybe, in computing the cost of acquisition.It may be observed that only when the advance or other money has been(a ) received, and ( b) retained or forfeited by the assessee , then only it has to bededucted from the cost of the asset. If such an advance was received and retainedby any previous owner, the same shall not be deducted from the cost of the asset.If the advance money forfeited was received by the assessee before 1-4-1981 andthe assessee has assumed the F.M.V. of the asset as on 1-4-1981 as the cost ofacquisition, such advance money received (though before 1-4-1981) shall also bededucted as in the section it is written that it will be deducted from the fair marketvalue .

A situation may arise where advance money forfeited is more than the cost of'acquisition'. In such a case, the excess of the advance money forfeited over thecost of 'acquisition' of such asset shall be a capital receipt not taxable [ TravancoreRubber & Tea Co. Ltd. v CIT (2000) 243 ITR 158 (SC)].For purposes of section 51, no distinction is made between moneys received andretained by way of 'advance' and 'other money'. The phrase 'other money' wouldcover, for example, deposits made by the purchaser for guaranteeing dueperformance of the contracts and not forming part of the consideration. The moniesreceived on the previous occasions and retained by the vendor/assessee cannot,therefore, be treated as a revenue receipt. [ Travancore Rubber & Tea Co. Ltd. v


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CIT (2000) 243 ITR 158 (SC)].The provisions of section 51 seems to be illogical after the introduction of theconcept of indexed cost of acquisition as in this case the cost of acquisition will befirst reduced by the amount of advance money received and thereafter it will beindexed.Treatment in the hands of vendee : Forfeiture of earnest money by the vendor, ifdue to default on the part of the vendee, will not amount to relinquishment of a rightin that asset. Therefore the amount forfeited will not be allowed as a capital lossunder head capital gains. [ CIT v Sterling Investment Corporation Ltd . (1980) 123ITR 441 (Bom)].On the other hand, if the vendor commits a default and the vendee receives somecompensation besides the refund of the earnest money paid by him, suchcompensation shall be subject to capital gains as it will amount to relinquishmentof a right by the vendee.Where the assessee had paid the earnest money and acquired right to obtainconveyance of immovable property, such earnest money paid shall be cost ofacquisition of such right and if such right is given up, there is a transfer of a capitalasset and the compensation received for giving up such right is the considerationprice. [ CIT v Vijay Flexible Container (1990) 186 ITR 693 (Bom)].8. Capital gain on transfer of a capital asset by way of distribution on thedissolution of a firm, AOP/BOIThe profits or gains arising from the transfer of a capital asset in specie to thepartners/members thereof by way of distribution on the dissolution of a firm or otherassociation of persons or body of individuals (not being a company or acooperative society) or otherwise , shall be chargeable to tax as the income of thefirm, association or body, of the previous year in which the said transfer takesplace. In such a case, there will be a capital gain to the firm/AOP, etc. For thepurposes of computation of capital gain, the fair market value of the asset on thedate of such transfer shall be deemed to be the full value of the considerationreceived or accruing as a result of transfer, instead of the value at which it is givento the partner/ member.Interpretation of the words "dissolution or otherwise ": The Act has used the words"dissolution or otherwise" in the aforesaid case. The word "otherwise" used aboveshould take colour from the preceding word i.e . dissolution. In other words, theword "otherwise" should mean something like dissolution. For example, if a firmconsists of two partners X & Y, and Y retires from the firm, it will not be a case ofretirement but of dissolution as the firm in this case shall have to be dissolved. Thesame will be the situation if Y dies in the above case. Similarly, if a firm is


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succeeded by a company, it will be a case of dissolution, as the firm in this case,shall cease to exist. However, if such succession is as per section 47( xiii ), it will notbe regarded as transfer and thus there will not be any capital gain on suchsuccession.However, the Bombay High Court held that the scope of word 'otherwise' in section45(4) is not ejusdem generies with the expression 'dissolution of a firm or body orassociation of persons'. The expression 'otherwise' has to be read with the wordstransfer of capital assets and section 45(4) would get invoked even in cases ofsubsisting partners of a partnership firm, transferring assets in favour of a retiringpartner in which case the fair market value as on date of transfer should be takenas full value of consideration. The expression 'otherwise' would cover any possiblesituation of transfer of capital asset by the firm to the partner. [ CIT v A.N. Naik

Associates (2004) 265 ITR 346 (Bom)]

It may be noted that the distribution of capital asset in the course of dissolution isnot specifically included in the definition of the term 'transfer'. Instead, a directcharge is sought to be created by introducing a deeming fiction in the form ofsection 45(4) for bringing to tax the deemed capital gains on such distribution. It isthis act of bypassing the provision of section 2(42) by the Legislature that hasbecome the subject matter of an interesting controversy amongst the Courts aswell.One view of the matter is that section 45(4) is a charging section that brings in aneffective charge in the circumstances provided therein, independent of section2(47). This view is supported by the decisions of the Karnataka High Court given

below and the Goa Bench of the Bombay High Court given above. The other viewof the matter holds that without a specific amendment in section 2(47) ( i.e.amending the definition of 'transfer'), section 45(4) has no independent application.This view is supported by a decision of the Madhya Pradesh High Court in the caseof Moped and Machines given below.The facts of the case were as under:The assessee was a firm that consisted of two partners R and P. P expired in April1990. The Assessing Officer held that since the firm stood dissolved after thedeath of one of the partners it was liable to pay tax on capital gains. TheCommissioner (Appeals) and the Tribunal held that there was no transfer. On

appeal the Hon'ble Court, dismissing the appeal, held that in the instant caseunless the capital gain has arisen from the transfer of capital asset within themeaning of section 2(47) of the Act, there was no transfer of assets within themeaning of section 45(4) of the Income-tax Act, 1961. [ CIT v Moped and Machines (2006) 281 ITR 52 (MP)].


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The issue once again came up before the Karnataka High Court recently in thecase of Suvardhan v CIT (2006) 287 ITR 404 (Karn). The assessee in that casewas a registered firm which came into existence by way of partnership deed dated23-7-1986. The partnership consisted of three persons. On July 1, 1988, one of thepartners retired and the other two continued the partnership in terms of thepartnership deed dated 17-10-1988. A survey was conducted in the businesspremises of the assessee. It came to light that the firm had been dissolved and thebusiness had been taken over by one of the partners, Smt. Anuradha MaruthiGokarn. It was also noticed that the partnership was dissolved on 1-4-1992, andthe assets and liabilities had been taken over by the said lady. The AssessingOfficer proposed to apply section 45(4) of the Act. Notice was issued. Theassessee filed a nil return. Thereafter, the Assessing Officer conducted theassessment under section 144 of the Act charging capital gains in the hands of the

firm in respect of the assets transferred by the firm.On behalf of the assessee-firm, attention of the Court was invited to section 45(4)and section 2(47) of the Act to contend that the order of the Tribunal requiredreconsideration. It was contended that both the provisions were required to be readtogether and that on such a combined reading it was clear that the case on handwas a case of 'no transfer'.The revenue pleaded that a reading of the said section 47 of the Act would showthat several transactions were considered as no transfer for the purpose of section45 of the Act. Prior to amendment, section 47( ii ) read as under:"any distribution of capital assets on the dissolution of a firm, BOI or other AOP".

This was omitted by the Finance Act, 1987 w.e.f. 1st April, 1988. Therefore anytransaction resulting in distribution on dissolution of a firm has to be considered as'transfer' in terms of section 47, in the light of omission of clause ( ii ) of section 47.The Court observed that a reading of section 45(4) showed that the profits or gainsarising from the transfer of capital assets by way of distribution of capital assets onthe dissolution of a firm was chargeable to tax as the income of the firm, in the lightof the fact that a transfer had taken place. The Court also took notice of theassessee's contention that the term 'transfer' had been defined under section 2(47)of the Act and that if section 2(47) was read, with section 45(4), there was notransfer at all, and in any case if there was any transfer, it was not by the assessee,

but by the retiring partner.The Karnataka High Court further distinguished the judgement of the MadhyaPradesh High Court in CIT v Moped and Machines 281 ITR 52 relied upon by theassessee by observing that in the said judgement, there was no reference toomission of clause ( ii ) of section 47 as it stood prior to 1-4-1988; that in the said


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judgement, what was considered was the provisions of section 45(4) and section2(47), as it stood then; that therefore, the said judgement would not be applicableto the issue involved in the case on hand; that on the other hand, the decision ofthe Bombay High Court in the case of CIT v A.N. Naik Associates (2004) 265 ITR346 (Bom) was found to be applicable, as in the said decision, the Bombay HighCourt had noticed the effect of the omission of the said clause ( ii ) of section 47 bythe Act of 1987.The Karnataka High Court, in respectful agreement with the judgement of theBombay High Court, noted that when the Parliament in its wisdom had chosen toremove a provision which provided for the cases of 'no transfer', there was no needfor any further amendment to section 2(47), in the light of removal of clause ( ii ) tosection 47, the transaction was liable to capital gains tax at the hands of theauthorities.

The issue remains unresolved as is evident by the conflicting decisions of theCourts on the subject and is sure to haunt the corridors of the Court. However, thebetter view appears that section 45(4) is a charging section, as the same isintroduced for plugging the mischief as is noted by the Bombay High Court.Cases which create real difficulty are the cases of partnership consisting of twopartners only. It is in such cases that a difficulty arises, where one of the partnersdies or is declared insolvent or retires. In such cases, the firm shall standautomatically dissolved on death or insolvency or on retirement by operation of thelaw. In such cases of severe hardships, the recent decision of the Madras HighCourt in the case of CIT v Vijaya Metal Industries (2002) 256 ITR 540 (Mad),

provides a major breakthrough. In that case, the assessee partnership consisted oftwo partners, which was dissolved on death of one of the partners. The business ofthe partnership firm was continued by the surviving partner with the assets of thepartnership firm. The Income-tax Department applied the provisions of section45(4) and brought to tax the deemed capital gain by holding that the transfer tookplace on dissolution of the firm. The Tribunal held that though the dissolution offirm took place by operation of law, it was not followed by transfer of capital assetsby way of distribution of such assets. The Madras High Court confirmed thedecision of the Tribunal.It was held that the relevant date for ascertaining the year in which the tax is to be

levied under section 45 is the year in which the transfer takes place . That year mayor may not be the year in which the dissolution of the firm takes place. The year inwhich the capital gain is to be brought to tax is "the previous year in which the saidtransfer takes place". [ CIT v Vijayalakshmi Metal Industries (2002) 256 ITR 540(Mad)].


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The decision in the case of Vijaya Metal Industries provides a much needed relief.With this one thing is certain that the dissolution by itself will not result indistribution of assets of the firm. The distribution will take place only on taking of apositive action by the parties concerned for distributing the assets. Till such time,the assets may be treated as jointly held by the parties.1. Where depreciable asset is distributed, there will always be short-term capitalgain/loss based upon the particular block of assets. On the other hand, if non-depreciable asset is distributed, it will be long-term capital gain or short-termcapital gain, depending upon the period of holding by the firm.2. Although, for the purpose of computation of capital gains in the hands of firm/

AOP, the sale consideration shall be the market value of the asset as on the dateof its distribution but the cost of acquisition of this asset to the partner/membershall be the value at which it was transferred to partner/member .

Merely because a partner has advanced some money over and above capitalhe has agreed to subscribe does not convert suit for dissolution of partnership andwinding up of affairs of partnership into an action to recover a debt but it remains asuit for declaration to dissolve partnership and winding up of its affairs. In such acase accounts are to be settled as per mode indicated in section 48 aloneconsequent upon dissolution of firm and not independently for recovery of amount.[Delhi Safe Deposits Co . v CIT (2004) 269 ITR 66 (Del)].Judicial decisions1. There cannot be any dispute on the proposition that every dissolution must be inpoint of time anterior to the final winding up of the firm. Generally there will be atime gap between the two events. The firm was dissolved on 5-12-1987 but thesale of the assets as a going concern had taken place only on 20-11-1994. For thecompletion of the process of winding up the Legislature has engrafted section 47 inthe Partnership Act for continuance of the partnership by creating a legal fiction.Therefore, though the firm stood dissolved on 5-12-1987, for the limited purpose ofwinding up of the affairs it continued till its assets and business were sold as agoing concern on 20-11-1994. Therefore the firm continued to hold the propertiesas owner till November 20, 1994. There was no distribution of capital assets of thefirm despite its dissolution and therefore the firm could not have been made liablefor paying capital gains tax in terms of section 45(4). [ CIT v Mangalore Ganesh

Beedi Works (2004) 265 ITR 658 (Karn)].2. It is to be noted that cash settlement to a partner on his retirement from the firmcannot be considered as a distribution of assets to him for the purpose of section45(4) of the Income-tax Act. However, distribution of assets to a partner on hisretirement will definitely come within the purview of section 45(4) as the terms or


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otherwise used in section 45(4) includes retirement of a partner. [ CIT v Naik Associates ( AP ) (2003) 265 ITR 346 (Mum)].3. No capital gain if a firm became limited company under Part IX of Companies

Act, 1956 : Where a partnership firm is treated as company under the provisions ofPart IX of the Companies Act, neither section 45(1) nor section 45(4) shall beattracted even though there was transfer of assets from firm to newly constitutedcompany. [ CIT v Texspin Engineering & Manufacturing Works (2003) 263 ITR 345(Bom)].4. Distribution of stock in trade amongst partners at the time of dissolution : Section45(4) deals with distribution of capital assets at the time of dissolution. Stock intrade is not a capital asset and as such if stock in trade is distributed amongst thepartners, then as per A.L.A. Firm v CIT (1991) 189 ITR 285 (SC) case, in takingaccounts for purposes of dissolution, the firm and the partners, being commercial

men, would value the asset including the stock in trade only at real basis ( i.e. market value) and not at cost or on their value appearing in the books of account.The settlement of accounts of the partners must be not on a notional basis but on areal basis. Thus, once the stock in trade is valued at market price, the surplus, ifany, has to be taxed as business income of the firm. However, the Supreme Courtin the case of Shakti Trading Co. v CIT (2001) 250 ITR 871 (SC), observed that theprinciple that closing stock has to be taken at the market value is applicable onlywhere there was dissolution and also discontinuance of the business of the firm.But, where there is no discontinuance of the business, the closing stock should bevalued at cost or market price whichever is lower.

5. Firm is liable to capital gains tax on firm's assets taken out by partners by book-entries and transferred by them : Where an immovable asset of the firm is, duringits subsistence, taken out by the partners by making mere entries in the books ofthe firm and such asset is sold out by them, the capital gains arising from suchtransfer is exigible to capital gains in the hands of the firm. This is so because suchtransaction amounts to release of a share in specific immovable property of thefirm and, therefore, such a transfer cannot legally be made without a registereddocument. [ CIT v J.M. Mehta & Bros. (1995) 214 ITR 716, 719-20 (Bom)].9. Capital gain where a right to receive the compensation is in disputeThe Supreme Court in the case of CIT v Hindustan Housing and Land

Development Trust (1986) 161 ITR 524 held that where the right to receive thepayment is in dispute as to whether the assessee is entitled to receive the same ornot then such receipt shall not be treated as having accrued to the assessee till thedispute is not settled. Thus, in a case where additional compensation awarded tothe assessee has been made subject matter of appeal by the Government then


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such amount shall be taxable as capital gain only:(a ) in the year in which additional compensation is received, or(b) in the year in which the dispute is finally settled

whichever is later .Further, the Allahabad High Court in the case of CIT v Laxman Das (2000) 246 ITR622 also decided that the same treatment should be given for interest in respect ofsuch disputed compensation.

Amendment made by the Finance Act, 2003 (W.e.f. A.Y. 2004-05): To nullify theabove judgment, the Finance Act, 2003 has inserted a new clause ( c ) in section45(5) to provide that where the amount of the compensation or consideration issubsequently reduced by any court, Tribunal or other authority, the capital gain ofthat year, in which the compensation or consideration received was taxed, shall berecomputed and the rectification shall be made under section 154 read with section155(16) by the Assessing Officer accordingly. Hence, the capital gain shall now betaxable even if the compensation amount is in dispute as the assessee shall beentitled to get the assessment amended if compensation is later on reduced.Taxability of interest awarded on enhanced compensationWhere along with additional compensation interest is also awarded and both theadditional compensation and interest are in dispute then the interest will also notbe taxable till the dispute is settled. But once the dispute is settled, such interestshall not be taxable in lump sum if the assessee is following mercantile system ofaccounting. Such interest shall be, on the other hand, spread over the period on anannual basis right from the date on which the asset was compulsorily acquired bythe Government to the date on which the Court makes an order for enhancedcompensation. [ Rama Bai v CIT (1990) 181 ITR 400 (SC)].10. Capital gain arises on certain self-generated assetsGenerally there is no capital gain on transfer of self-generated assets as the cost ofacquisition of such assets cannot be computed. But certain amendments havebeen made in the Income-tax Act and now capital gain arising on the transfer of thefollowing assets is chargeable to tax:

(i ) goodwill of a business. There will, however, be no capital gain on sale ofgoodwill of a profession;

(ii ) trademark or brand name associated with the business;(iii ) right to manufacture, produce or process any article or thing, for aconsideration e.g. patent, copyright, formula, design;

(iv ) right to carry on any business;(v ) tenancy rights;


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(vi ) route permits;(vii ) loom hours.

The cost of acquisition of the above self-generated assets shall be taken as nil.However, other self-generated assets like goodwill of a profession, etc. are still notsubject to capital gains as for such assets cost cannot be identified or envisagedas per Supreme Court decision in CIT v B.C. Srinivasa Setty (1981) 128 ITR 294(SC). Further, an asset, in the improvement of which it is not possible to envisagea cost, has also been held to be not subject to capital gain by the Bombay HighCourt in Evans Fraser and Co. Ltd. v CIT (1982) 137 ITR 493 (Bom) but the Keralaand Karnataka High Court took the contrary view. [ Parthas Trust v CIT 173 ITR615 (Ker); Emerald Valley Estates Ltd. v CIT (1996) 222 ITR 799 (Kar)]. Where lands sold by assessee was inherited but last previous owner of such assethad acquired it by conquest ( i.e. without paying any price for the acquisition) andthe case of the assessee was that even after applying the Explanation to section49(1), the cost of acquisition in the hands of the last previous owner who acquiredit by a mode of acquisition other than that referred to in clause ( i ) to ( iv ) of sub-section (1) of section 49 could not be ascertained, it was held that as cost ofacquisition of asset was not ascertainable, capital gain could not be computed andas such assessee was not liable to any capital gains tax. [ CIT v Mandharsinhji P.Jadeja (2005) 148 Taxman 110 (Guj)]11. Capital gain on the transfer of land, forming part of building which isdepreciable, can be long-termSection 50 provides for determination of the cost of construction of superstructureand it does not apply to land as land is not a depreciable asset. Hence, if thebuilding comprising of the land is sold, the capital gain on superstructure shall beshort-term capital gain in terms of section 50 and the capital gain on land, if heldfor more than 36 months, shall be long-term capital gain. This is because the landis independent and identifiable capital asset and it continues to remain so evenafter construction of the building thereon. [ CIT v CITI Bank NA (2003) 261 ITR 570(Bom)].12. Exemption of capital gains under various sub-clauses of section 10, section11(1A) and section 13AThe Act has exempted capital gain in the hands of various categories of personsunder sections 10, 11(1A) and 13A. These exemptions are given to the specificcategories of persons. However, the following clauses to section 10 have beeninserted to allow exemption of capital gain to all categories of persons or more thanone person.(A) Long-term capital gain on eligible equity shares exempt if the shares are


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acquired within a certain period: Any income arising from the transfer of a long-term capital asset, being an eligible equity share in a company shall be exemptprovided these are acquired on or after 1-3-2003 but before 1-3-2004 and held fora period of 12 months of more."Eligible equity share" means,

(i ) any equity share in a company being a constituent of BSE-500 Index of theStock Exchange, Mumbai as on the 1-3-2003 and the transactions of purchase andsale of such equity share are entered into on a recognised stock exchange in India;

(ii ) any equity share in a company allotted through a public issue on or after the1-3-2003 and listed in a recognised stock exchange in India before 1-3-2004 andthe transaction of sale of such share is entered into on a recognised stockexchange in India.'.(B) Exemption of capital gains on compensation received on compulsoryacquisition of agricultural land situated within specified urban limits: With a view tomitigate the hardship faced by the farmers whose agricultural land situated inspecified urban limits has been compulsorily acquired, the Finance (No. 2) Act,2004 has inserted a new clause (37) in section 10 so as to exempt the capitalgains (whether short-term or long-term) arising to an individual or a Hinduundivided family from transfer of agricultural land by way of compulsory acquisitionwhere the compensation or the enhanced compensation or consideration, as thecase may be, is received on or after 1-4-2004 . The exemption is available onlywhen such land has been used for agricultural purposes during the preceding twoyears by such individual or a parent of his or by such Hindu undivided family.

Where the compulsory acquisition has taken place before 1-4-2004 but thecompensation is received after 31-3-2004, it shall be exempt. But if part of theoriginal compensation in the above case has already been received before 1-4-2004, then exemption shall not be available even though balance originalcompensation is received after 31-3-2004.However, enhanced compensation received on or after 1-4-2004 againstagricultural land compulsory acquired before 1-4-2004 shall be exempt.(C) Exemption of long-term capital gain arising from sale of shares and units: Anyincome arising on or after 1-10-2004 from the transfer of a long-term capital asset,being an equity share in a company or a unit of an equity oriented fund shall beexempt provided

(a ) such equity shares are sold through recognised stock exchange, whereasunits of an equity oriented fund may either be sold though the recognised stockexchange or may be sold to the mutual fund.

(b) such transaction is chargeable to securities transaction tax.


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"Equity oriented fund" means a fund(i ) 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(ii ) which has been set up under a scheme of a Mutual Fund specified under

clause (23D):The percentage of equity share holding of the fund shall be computed withreference to the annual average of the monthly averages of the opening andclosing figures.13. Exemption of capital gains under sections 54, 54B, 54EC and 54F(A) Profit on transfer of house property used for residence [Section 54] : Benefit ofsection 54 is confined to sale of a residential house after 36 months andreinvestment in a residential house. Reinvestment benefits is available both forpurchase and construction of the house. Purchase has to be either one year beforeor two years later. Construction has to be completed within three years of the saleof the asset in respect of which benefit of reinvestment is claimed. There havebeen many decisions on purchase/construction of the house. Further, certainclarifications have also been issued in this regard. These have been summarizedas under:

(1) House include part of the house : House property does not mean a completeindependent house. It includes independent residential units also, like flats in amulti-storeyed complex. The emphasis is not on the type of the property, but, onthe head under which the rental income is assessed. [ CIT ( Addl .) v Vidya PrakashTalwar (1981) 132 ITR 661 (Del)].

(2) Release deed may also be treated as purchase : Where a property is ownedby more than one person and the other co-owner or co-owners release his or theirrespective share or interest in the property in favour of one of the co-owners, it canbe said that the property has been purchased by the releasee. Such release alsofulfils the condition of section 54 as to purchase so far as releasee-assessee isconcerned [ CIT v T.N. Aravinda Reddy (1979) 120 ITR 46 (SC)].

(3) Addition of floor to the existing house eligible for exemption under section 54 :The assessee sold his residential property and invested the capital gain within thestipulated time in the construction of a new floor on another house owned by himby demolishing the existing floor, it was held that he was entitled to exemptionunder section 54. [ CIT v Narasimhan (PV ) (1990) 181 ITR 101 (Mad)].

(4) No exemption under section 54 if land only is sold : The house propertyconcerned must be building or land appurtenant to building. The basic test waswhether the land appurtenant to building could be used independent of the user ofthe building. If so, it cannot be said to be land appurtenant to building. Further, the


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exemption to investment on purchase only, holding that the exemption undersection 54 was admissible either for purchase or for construction but not for both.[Sarkar (B.B. ) v CIT (1981) 132 ITR 661 (Del)].

(10) Construction can start before the sale of asset : The construction of thenew house may start before the date of transfer, but it should be completed afterthe date of transfer of the original house. [ CIT v J.R. Subramanya Bhat (1987) 165ITR 571 (Karn)]. The very fact that purchase of another house as also theconstruction can take place before the sale means that cost of purchase or newconstruction need not flow from the sale proceeds of the old property. [ CIT v H.K.Kapoor (Decd ) 1998 234 ITR 753 (All) and CIT v M. Vasudevan Chettiar (1998)234 ITR 705 (Mad)].

(11) Allotment of a flat by DDA under the Self-Financing Scheme shall betreated as construction of the house [Circular No. 471, dated 15-10-1986].

Similarly, allotment of a flat or a house by a cooperative society, of which theassessee is the member, is also treated as construction of the house [Circular No.672, dated 16-12-1993]. Further, in these cases, the assessee shall be entitled toclaim exemption in respect of capital gains even though the construction is notcompleted within the statutory time limit. [ Sashi Varma v CIT (1997) 224 ITR 106(MP)]. Delhi High Court has applied the same analogy where the assessee madesubstantial payment within the prescribed time and thus acquired substantialdomain over the property, although the builder failed to hand over the possessionwithin the stipulated period. [ CIT v R.C. Sood (2000) 108 Taxman 227 (Del)].

(12) As per a circular of CBDT, the cost of the land is an integral part of the

cost of the residential house, whether purchased or constructed. [Circular No. 667,dated 18-10-1993].(13) Where an assessee who owned a house property, sold the same and

purchased another property in the name of his wife, exemption under section 54shall be allowable. [ CIT v V. Natarajan (2006) 154 Taxman 399 (Mad)].

(14) Where the assessee utilised the sale consideration for other purposesand borrowed the money for the purpose of purchasing the residential houseproperty to claim exemption under section 54, it was held that the contention thatthe same amount should have been utilised for the acquisition of new asset couldnot be accepted. [ Bombay Housing Corporation v Asst. CIT (2002) 81 ITD 454

(Bom). Also followed in Mrs. Prema P. Shah, Sanjiv P. Shah v ITO (2006) 282 ITR(AT) 211 (Mumbai)].(15) Where non-resident Indian sold property in India and purchased

residential property in U.K. and claimed deduction under section 54, it was heldthat it was not necessary that residential property showed be purchased in India


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itself. [ Mrs. Prema P. Shah, Sanjiv P. Shah v ITO (2006) 282 ITR (AT) 211(Mumbai)].

However, in another case, the Tribunal held that the words purchase/construction of a residential house', in section 54F on plain and simple reading,mean that the purchase/construction of a residential house must be in India andnot outside India.

Therefore, the benefit under section 54F is not allowable for a residentialhouse purchased/constructed outside India. [ Leena J Shah v Asstt. CIT (2006) 6SOT 721 (Ahd)].(B) Capital gain on transfer of land used for agricultural purposes [Section 54B] :

Any capital gain (short-term or long-term), arising to an assessee (only individuals),from the transfer of any agricultural land which has been used by the assessee orhis parents for at least a period of 2 years immediately preceding the date oftransfer, for agricultural purposes, shall be exempt to the extent such capital gain isinvested in the purchase of another agricultural land within a period of 2 years afterthe date of transfer to be used for agricultural purpose, provided the newagricultural land purchased, is not transferred within a period of 3 years from thedate of its acquisition.Section 54B is applicable only to individuals and not to any other assessee this isbecause the section uses the expression used by "his or a parent of his" whichclearly indicate that the "assessee" refers to an individual. [ CIT v Devarajalu (G.K. )(1991) 191 ITR 211 (Mad)].(C) Capital gain on transfer of long-term capital assets not to be charged oninvestment in certain bonds [Section 54EC] : Any long-term capital gain, arising toany assessee, from the transfer of any capital asset on or after 1-4-2000 shall beexempt to the extent such capital gain is invested within a period of 6 months afterthe date of such transfer in the long-term specified asset provided such specifiedasset is not transferred or converted into money within a period of 3 years from thedate of its acquisition.Exemption under section 54EC not available in respect of deemed capital gains onamount received on liquidation of a company : Section 54E (now section 54EC)permits reinvestment benefit, if the sale proceeds/capital gains on sale of long-termcapital assets are invested in the manner required by the section. Where a

shareholder is made liable for deemed capital gains on amount received onliquidation of a company, is he eligible for reinvestment benefit under section 54E(now 54EC)? It was held that section 54E (now 54EC) would have application onlywhere there is an actual transfer and not in a case, where there is only a deemedtransfer. [ CIT v Ruby Trading Co. Pvt. Ltd. (2003) 259 ITR 54 (Raj)].


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Benefit under section 54EC, etc. available even on transfer of depreciable assets : Although as per section 50 the profit arising from the transfer of depreciable assetshall be a gain arising from the transfer of short term capital asset, hence short-term capital gain but section 50 nowhere says that depreciable asset shall betreated as short-term capital asset. Section 54E [or say 54EC or 54F, etc.] is inindependent provision which is not controlled by section 50. If the conditionsnecessary under section 54E are complied with by the assessee, he will be entitledto the benefit envisaged in section 54E, even on transfer of depreciable assetsheld for more than 36 months. [ CIT v Assam Petroleum Industries (P. ) Ltd. (2003)131 Taxman 699 (Gau). See also CIT v ACE Builders Pvt. Ltd. (2005) 144 Taxman855 (Bom)].On the same analogy benefit under section 54EC or 54F shall be available in thecase of depreciate asset if these are held for more than 36 months.

(D) Capital Gain on transfer of asset, other than a residential house [Section 54F] : Any long-term capital gain, arising to an individual or HUF, from the transfer of anycapital asset, other than residential house property , shall be exempt in full, if theentire net sales consideration is invested in purchase of one residential housewithin one year before or two years after the date of transfer of such an asset or inthe construction of one residential house within three years after the date of suchtransfer. Where part of the net sales consideration is invested, it will be exemptproportionately.The above exemption shall be available only when the assessee does not ownmore than one residential house property on the date of transfer of such asset

exclusive of the one which he has bought for claiming exemption under section54F.Perusal of section 54F(4) shows that the assessee has to utilize the amount for thepurchase or construction of the new asset before the date of furnishing the returnof income under section 139. There is no mention of any sub-section of section139. Hence, one cannot interpret the section 139 mentioned should be read assection 139(1). Similar language is appearing in section 54(2). The Gauhati HighCourt, in the case of CIT v Rajesh Kumar Jalan (2006) 286 ITR 274, has held thatsection 139 mentioned in section 54F(4) will not only include section 139(1) but willalso include all sub-section of section 139. In the instant case, it was not disputed

that sale consideration had been utilized before the date of filing of the return undersection 139(4). [Nipun Mehrotra v ACIT (2008) 110 ITD 520 (Bang)] Section 54 and 54F are comparable in many respects. Hence, the law andprecedents relating to section 54 as to whether the house property on whichinvestment is made is residential or not, the law relating to time limits, the


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precedent that construction could start earlier though completed within three yearsare all equally applicable for section 54F. Hence, for judicial decisions for section54F, refer to the judicial decisions given under section 54.

52 Tax Planning for Capital Gains

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