Capital Gains - 2 | Commerce & Accountancy Optional Notes for UPSC PDF Download

Cost of Acquisition

The cost of acquisition is the amount the taxpayer has paid or incurred to acquire the asset. It includes expenses related to acquiring the asset or completing the title. The cost of acquisition is determined based on the date of acquisition and not the date when it became a taxable capital asset. Interest on loans for acquiring a capital asset, litigation expenses incurred by the taxpayer to amend articles, and expenses for compelling a company to register shares in the taxpayer's name are part of the cost of acquisition.

Cost of acquisition for assets acquired before April 1, 2001 (Section 55(2)(b)):

• In the following scenarios, the taxpayer must take either the actual cost of acquisition or the fair market value of the asset as of April 1, 2001, as the cost of acquisition for computing capital gains. The higher figure should be used.
• When the taxpayer acquired the asset themselves before April 1, 2001.
• When the taxpayer acquired the asset through a mode that makes them a deemed assessee, and the previous owner acquired the asset before April 1, 2001.
• For both cases above, the following formula is used to compute the indexed cost:
• Indexed Cost = Actual cost to the previous owner or actual price of assets on April 1, 2001 (whichever is higher) × Cost Index of the transfer year 100

Fair market value (Section 2(22B)):

• The price the capital asset would typically fetch in the open market on the relevant date.
• When the above price is not ascertainable, the price determined according to the rules under the Income Tax Act.

According to Section 55A, in cases other than those covered in (i) above, the assessing officer can refer the valuation officer if:

• The value claimed by the taxpayer and the fair market value differ by more than 15% of the value of the asset or more than Rs. 25,000, whichever is higher.
• If, considering the nature of the asset and relevant circumstances, it is necessary.

Deemed Cost of Acquisition:

These are circumstances when the cost incurred by the previous owner is considered the cost of acquisition for the current owner.

• Acquisition of an asset under a gift or will.
• Acquisition of an asset during the partition of a Hindu Undivided Family (HUF).
• Acquisition of an asset during the liquidation of a company.
• Acquisition of an asset under a transfer to a revocable or irrevocable trust.
• Acquisition of an asset by inheritance or succession.
• Acquisition of an asset on the transfer of capital asset by the amalgamating company to the amalgamated company if the latter is an Indian company.
• Acquisition on a transfer by a wholly owned Indian subsidiary company to its holding company or vice versa.
• Acquisition on any transfer in a demerger of a capital asset by the demerged company to the resulting company under Section 47(vib).
• On conversion of self-acquired property of a member of HUF to the joint family property.
• On the transfer of an asset by a sole proprietary concern to a company as a result of succession under Section 47(xiv), subject to certain conditions.
• Acquisition on any transfer by a private company or unlisted public company to a limited liability partnership firm as a result of the conversion of the company into a limited liability partnership.

Cost of Acquisition of Bonus Shares

The cost of acquisition of bonus shares is as follows:

• If bonus shares are received before April 1, 2001, the fair market value on April 1, 2001, will be considered as the cost of acquisition.
• If bonus shares are received after April 1, 2001, the cost of acquisition shall be considered as nil.

Note: If bonus shares are issued to preference shareholders, the amount equal to the deemed dividend on which they were liable to pay tax would be the cost of bonus shares.

Cost of Acquisition of Goodwill, etc.

The cost of acquisition of goodwill, a trademark or brand name associated with a business, the right to manufacture, produce, or process any article or things, the right to carry on any business or profession, tenancy rights, stage carriage permit, or loom hours shall be determined as follows:

• If the asset is purchased from a previous owner, the purchase price shall be the cost of acquisition.
• In any other case, the cost of acquisition shall be nil.
• If it is acquired in any mode under clauses (i) to (iv) of Section 49(i), the cost of the previous owner, if paid by them, shall be the cost of acquisition. But if it was self-generated by the previous owner, the cost of acquisition shall be nil.

Cost of Acquisition of Right Shares (Section 55(2)(aa))

Where an assessee, by virtue of holding certain shares, becomes entitled to subscribe to any additional shares, then:

• The cost of acquisition of the original shares shall remain unchanged, i.e., it shall be the amount actually paid for acquiring the original shares.
• The cost of acquisition of the right shares, when the assessee subscribes to the shares on the basis of the said entitlement, shall be the amount actually paid for acquiring the right shares.
• The cost of acquisition of the right to acquire such shares, when such a right is renounced in favor of any other person, shall be taken to be nil.
• As regards the person in whose favor the right to subscribe to the shares has been renounced, the cost of acquisition of such right share shall be the amount paid by them to the company for acquiring the shares plus the amount paid to the person renouncing the right.

Cost of Acquisition for Computing Long-Term Capital Gain under Section 112A:

The cost of acquisition for the purposes of computing capital gains in relation to a long-term capital asset, being:

• An equity share in a company,
• A unit of an equity-oriented fund, or
• A unit of a business trust,

Referred to in Section 112A, as per Section 55(2)(ac), the cost of acquisition for the assets acquired by the assessee before February 1, 2018, shall be the higher of:

• The actual cost of acquisition of such asset, or

The lower of:

• The fair market value of such asset on January 31, 2018, and
• The full value of consideration received or accruing as a result of the transfer of the capital asset.

Cost of Acquisition of Depreciable Assets (Section 50)

As discussed under the unit 'Profits and gains of business and profession,' all depreciable assets except in the case of electricity companies are part of a block of assets. If the full value of the consideration as a result of the transfer of any part or entire block of the asset exceeds the cost of acquisition of that block of depreciable assets, there will be capital gain, which will always be a short-term capital gain. The cost of acquisition of a block of depreciable assets is the written-down value of the block at the beginning of the year plus the actual cost of any asset falling within the same block acquired during the year. In other words, the excess of the sale consideration over the aggregate of the following amounts shall be a short-term capital gain:

• Expenditure in connection with the transfer;
• Cost of acquisition; and
• Cost of improvement, thereto.

In the case of depreciable assets, the cost of acquisition and the cost of improvement are taken as the aggregate of the following:

• The written-down value of the block of assets at the beginning of the year; and
• The actual cost of any asset falling within the block of assets acquired during the previous year.
• Such an excess shall be deemed to be the capital gain arising from the transfer of short-term capital assets.

Cost of Improvement 

As per Section 55(1)(b), the provisions for cost of improvement are as follows:

• For a capital asset like goodwill of a business or a right to manufacture, produce, or process any article or thing, or a right to carry on any business, the cost of improvement is considered nil. This applies regardless of whether the goodwill or right was self-generated or acquired for a price.

For any other asset:

• If the capital asset became the property of the previous owner or the assessee before April 1, 2001, the cost of improvement is all capital expenditure incurred up to April 1, 2001, by the previous owner or the assessee. Any expenditure incurred before April 1, 2001, by the assessee or previous owner is disregarded, regardless of whether the assessee opts for the market value as of April 1, 2001, or not.
• In other cases, where assets were acquired after April 1, 2001, the cost of improvement includes all capital expenditure incurred by the assessee in making any additions or alterations to the capital asset after it became their property. Additionally, where the capital asset became the property of the assessee through any method given in Section 49(i), capital expenditure incurred by the previous owner is also treated as the cost of improvement.

Note: Any expenditure deductible in computing the income chargeable under the heads of income from house property, income from other sources, and profits and gains of business or profession is not included in the cost of improvement.

Indexed Cost of Acquisition and Improvement 

For the computation of capital gain, in the case of short-term capital gain, the cost of acquisition and cost of improvement are deducted from the full value of consideration. In the case of long-term capital gain, indexed cost of improvement and indexed cost of acquisition are deducted. The indexed cost of acquisition is the amount that bears the same proportion to the cost of acquisition as the cost inflation index for the year in which the asset is transferred bears to the cost inflation index for the first year in which the asset was held by the assessee, or for the year beginning on April 1, 2001, whichever is later. The indexed cost of acquisition is calculated with the following formula:

• Indexed Cost of Acquisition = Cost of Acquisition × (Cost inflation Index of the year in which the asset is to be transferred or sold) / (Cost Inflation Index of the year of acquisition of the asset by the assessee or the year of acquisition of the asset by the previous owner or the year beginning on April 1, 2001, whichever is later)
• Cost Inflation Index: An index specified by the Central Government through notification in the official Gazette.

Capital Gains Exempt From Tax

Capital gains, which are profits or gains arising from the transfer of certain capital assets, are generally taxable. However, there are exemptions provided under the Income Tax Act, 1961 for specific types of capital gains. These exemptions can be broadly categorized into two types:

• Exemption of capital gains under specific sections of the Income Tax Act, such as Section 54, 54B, 54D, 54EC, 54EE, 54F, 54G, 54GA, and 54GB.
• Exemption of capital gains under various sub-clauses of Section 10.

Some examples of the types of capital gains that are exempt from tax include:

• Capital gains arising from the transfer or distribution of assets of a company to its registered shareholders during liquidation.
• Capital gains arising from the transfer of property used for residence, subject to certain conditions laid down in Section 54.
• Capital gains arising from the transfer of agricultural land situated in an urban area, subject to the provisions of Section 54B.
• Capital gains arising from the compulsory acquisition of land and buildings of industrial enterprises, as per Section 54D.
• Capital gains arising from the transfer of long-term capital assets invested in long-term specified assets (Section 54EC).
• Capital gains arising from the transfer of long-term listed securities invested in specified equity shares (Section 54ED).
• Capital gains on the transfer of other long-term assets, except residential houses, if the consideration received is invested in a new residential house (Section 54F).
• Capital gains on the shifting of industrial undertakings from urban areas (Section 54G).
• Capital gains on the transfer of assets or the shifting of industrial undertakings from urban areas to special economic zones (Section 54GA).
• Exemption of long-term capital gains on the transfer of residential property on investment in equity shares of an approved company under certain conditions (Section 54GB).
• Extension of the time limit for purchasing new assets or investing the amount of capital gains in case of compulsory acquisition of assets (Section 54H).

The Capital Gains Account Scheme, 1988, introduced by the Central Government, allows taxpayers to park their funds in specified banks until they are invested for the prescribed purpose. Under this scheme, two types of deposits can be made: Savings deposit and Term deposit. The interest rates for both types of deposits are fixed by the RBI from time to time. The scheme is applicable for exemption of tax on capital gain under Sections 54, 54B, 54D, 54F, 54G, and 54GA of the Income Tax Act.

Tax on Short-Term Capital Gain on Transfer of Equity Shares in a Company or Units of an Equity-Oriented Fund

Under Section 111(A) of the Income Tax Act, if short-term capital gains arise from the transfer of equity shares in a company or units of an equity-oriented fund, the tax on such gains will be charged at 15% plus any applicable surcharge and 4% on the amount of income tax and surcharge as health and education cess, provided the following conditions are met:

• The equity shares in a company or units of an equity-oriented fund are short-term capital assets.
• The sale transaction of such assets is entered into on or after October 1, 2004.
• The transaction is subject to Securities Transaction Tax (STT).

Tax on Long-Term Capital Gain on Transfer of Listed Securities or Units of Unit Trust of India (UTI) or a Mutual Fund

Tax on long-term capital gains (LTCG) on the transfer of listed securities or units of UTI or a mutual fund specified in Section 10(23D) or Zero-Coupon Bonds shall be charged as follows:

• At 10% of LTCG computed without indexing the cost of acquisition, or
• At 20% of LTCG computed after indexing the cost of acquisition; whichever is less.

Surcharge on Income Tax:

In the case of individuals, Hindu Undivided Families (HUFs), Associations of Persons (AOPs), or Bodies of Individuals (BOIs), if the total income exceeds:

• Rs. 50 Lakhs and up to 1 Crore – 10%
• Exceeds Rs. 1 crore and up to Rs. 2 crore – 15%
• Exceeds Rs. 2 crore and up to Rs. 5 crore – 25%
• Exceeds Rs. 5 crore – 37%

In the case of firms (if the total income exceeds one crore rupees), a 12% surcharge is payable.  In the case of domestic companies, a 7% surcharge shall be charged if the total income exceeds one crore rupees but is less than 10 crores. If the income exceeds Rs. 10 crores, the surcharge rate will be 12%. In the case of foreign companies, a 2% surcharge shall be charged if the total income exceeds one crore rupees but is less than 10 crores. If the income exceeds 10 crores, the surcharge shall be charged at 5%.

Note: If the income exceeds one crore rupees, the rule of marginal relief will be applied.

Health and Education Cess:

• On the amount of income tax and surcharge, a health and education cess shall be levied at 4%.