TAX PLANNING FOR CAPITAL GAINS

Dr. Girish Ahuja

M.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 precious
metal may be a personal effect
In the definition of jewellery, only ornaments made of precious metal are included.
Thus, items other than ornaments, made of precious metals can be treated as
personal effects provided they are commonly and ordinarily used or intended to be
used for personal or household use.
Silver utensils of the type which were used in the kitchen or in the dining room of
the 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 effects
meant for personal use even if they are placed before Goddess Lakshmi at the
time 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, jugs
were 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 articles
cannot be treated as having been held for personal use and the assessing
authority 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 ITR
493 (Mad)].
Gold caskets, gold tray, gold cups, saucers, spoons and photo frames were not
regarded as personal effects intended for personal or household use. [Poddar (G
S) v CWT (1965) 57 ITR 207 (Bom)].
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The expression intended for personal or household use did not mean capable of
being intended for personal use or household use. It meant normally commonly
and ordinarily intended for personal or household use. It was further observed that
merely because the gold caskets were kept in the showcase, they could not be
treated as part of furniture. In order to be a personal effect, it is not essential that
the person himself should use it every day, it is enough if it is used on ceremonial
occasions or as and when desired by the assessee.
2. Capital gain v Business income
Whether a particular asset is stock-in-trade or capital asset does not depend upon
the nature of the article, but the manner in which it is held. The same item may be
stock-in-trade in the hands of the assessee who deals in that item. But it will be
capital asset in the case of an assessee who uses it for earning income or holds as
an 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 person
who holds it as an investment and derives income from leasing or renting of the
property.
Even stock-in-trade may become capital asset in certain circumstances and vice
versa. If an assessee who deals in certain goods or commodities as trader, on
closure of the business, retains the existing stocks as investment, the stocks will
become capital asset in his hands from the time of closure, not withstanding that
they were stock-in-trade earlier in his hands. Even in the course of a business, an
assessee may try to transfer some of the stock-in-trade from his trading activity
and 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 happen
in the case of dealer in shares and real estate. But in all these cases, the finding
will be one of fact depending upon the intention and conduct of the assessee
supported by direct and circumstantial evidence. Similarly, when a capital asset is
converted 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 or
capital gain: Normally, the purchase of land represents investment of money in
land. [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 of
selling it at a profit is not conclusive on the question whether an isolated
transaction of purchase and resale is an adventure in the nature of trade. If there
are 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 a
single unit as he purchased, goes to establish that he was carrying on business in
real 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 after
developing 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 the
transaction of purchase, the nature of the property, the length of its ownership and
holding, the conduct and subsequent dealings of the assessee in respect of the
property, the manner of its disposal and the frequency and multiplicity of
transactions afforded valuable guides in determining whether the assessee was
carrying on a trading activity and whether a particular transaction should be
stamped with the character of a trading adventure. [CIT v Trivedi (V.A.) (1988) 172
ITR 95 (Bom)].
In order to hold that an activity is in the nature of an adventure in the nature of
trade there must be positive material to prove that the assessee intended to trade
in such an activity and in the absence of evidence the sale of immovable property
consisting land could give rise only capital accretion. If the land owner developed
the land, expended the money, laid roads convert the land into house sites and
with 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 (Ceiling
and Regulation) Act, 1976, she applied for construction of group housing on the
excess land and sold the land to a developer and builder. The Assessing Officer
held that the instalments received from the builder is business income. The
Tribunal held that it is not business income as there was no adventure in the
nature of trade. On reference, the Delhi High Court upheld the decision of the
Tribunal 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 the
assessee to retain the land. It was very clear that on the assessee's part there was
only an intention to transfer the land and not the portion that may be constructed by
the builder on a future date. Clause 3 of the agreement merely provided the mode
of 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 thereby
deleting 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 brick
field and later given for development, upholding the finding of the Tribunal, it was
held that the firm did not acquire the land, with a view to sell it at a profit. It was
treated in the accounts as a fixed asset given to other for outright development
without the assessee itself plotting it out, so that it had continued to be a capital
asset. There was no scope, it was found, for holding it either as business or even
an 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 the
purchase 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 the
same in parcels because the huge area could not be sold in one transaction. Such
an 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, a
share broker purchased certain shares as personal assets and had been showing
the same in his wealth-tax returns, it was held that the profit on such shares should
be taxable as capital gains and not as business income as these shares were
capital 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 of
buying and sale of such shares, while at the same time it can also hold other
shares as its capital for the purpose of earning dividend income. Thus, where the
finding was that the shares in question were never treated by the assessee as
stock-in-trade and they were held for earning dividend only, it was held that the
Tribunal was right in law in holding that the profit on sale of such shares was to be
treated 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 noticed
that the assessee had relinquished the land in lieu of forest department allowing
use of their land for laying down the drainage and the question was as to whether
loss arising on such transfer could be allowed as a business loss, it was held that
the 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 loss
and 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 agreement
Development agreement is not an agreement for sale simpliciter. It is an executory
agreement, whereby the developer undertakes to put up a superstructure on that
part or portion of land retained by the owner in consideration of transfer of
remaining part. Development agreement is not a sale simpliciter, because there is
an element of builder's contract with the only difference that the consideration is
not cash, but in kind i.e. constructed portion on the retained land. An agreement for
sale 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 the
obligations 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 has
suffered the breach. There cannot be specific performance in the sense ordinarily
understood 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). A
similar 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 ITR
793 (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 development
agreement 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 for
sale cannot possibly mean that in every case, the development agreement can be
taken as an agreement for sale simpliciter, though this was the inference drawn by
the 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 of
transfer on mere signing of the agreement. A development agreement may be
silent 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 that
development agreement specifically stipulates possession with owner till
obligations undertaken by the developer is discharged with only right of entry for
developer or his nominees to discharge the obligations undertaken in the
agreements.
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If the development agreement had granted an unqualified, uninterrupted and
irrevocable right of possession to the developer, it will be difficult to avoid liability in
the year in which development agreement was executed, though there is a
possible argument that the possession is not in the capacity of a buyer, but only as
a builder, the property itself is not for enjoyment by the developer but by the
prospective flat owners. Such an argument can be taken and defended,
notwithstanding the possible hassles with the Income-tax Department. Even if such
a stand is taken, liability cannot be postponed till completion of the agreement, if
there are registered sales prior to completion. Proportionate profit therefrom will
have to be accounted.
If on a bare reading of a contract in its entirety, an Assessing Officer comes to the
conclusion that in the guise of the agreement for sale, a development agreement is
contemplated under which the developer applies for permissions from various
authorities either under power of attorney or otherwise and in the name of the
assessee, then the Assessing Officer is entitled to take the date of the contract as
the date of the transfer in view of section 2(47)(v). In this very case, the date on
which developer obtained a commencement certificate is not within the accounting
year ending 31-3-1996. At the same time, if one reads the contract as a whole it is
clear that a dichotomy is contemplated between the limited power of attorney
authorizing the developer to deal with the property as an irrevocable license to
enter upon the property after the developer obtains the requisite approvals of
various authorities. In fact the limited power of attorney may not be given but once
under 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 relevant
date to decide the date of transfer under section 2(47)(v) and in which event the
question of substantial performance of the contract thereafter does not arise. This
point has not been considered by any of the authorities below. No judgment has
been shown to exist on this point. Therefore, although there is concurrent finding of
fact there is no merit in the argument of the assessee that the court should go only
by the date of actual possession and not by the date on which the irrevocable
license was given. If the contract read as a whole indicates passing of or
transferring of complete control over the property in favour of the developer then
the 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 taken
instantaneously, but it may spell out a transaction by which the possession will
pass at the future point of time. Under the terms of a contract, normally, a series of
acts or transactions that would at one point of time or the other take place in
furtherance 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 the
possession to be taken in part performance of the contract of transfer. It is at that
point of time that the deemed transfer takes place. True, entering into the
agreement/contract is a transaction in a broad sense but, when the agreement
envisages an event or act on the happening or doing of which alone the
possession is allowed to be taken in part performance of the contract, the
transaction of the nature contemplated by sub-clause (v) cannot be said to have
occurred before that date. The date of entering into the agreement cannot be the
determining factor in such a case, even though the agreement envisages a future
transaction pursuant to which possession will be allowed to be taken. However, it
needs to be clarified that it is not possible to lay down a rigid proposition that an
agreement, as such, can never be construed as a transaction allowing possession
to 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 gain
Capital gain arises only when there is a transfer of capital asset. If the capital asset
is 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 2000-2001
section 45(1A) has been inserted to provide that in case of profits or gains from
insurance claim due to damage or destruction of property, there will be capital gain
on such deemed transfer although no asset has been actually transferred in such
case.
Judicial decisions Whether a transaction constitute transfer or not
(1) Redemption of bonds constitutes transfer as there is extinguishment of right by
operation of contract and also a relinquishment of right in the asset in lieu of which
the assessee received cash from the competent authority. Thus, in either of the
situations, the case was covered by the definition of section 2(47). [Pervij Wang
Chuk 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 of
motor vehicles, mere delivery of the physical possession is sufficient to constitute
transfer, the entries in the R.C. book will be made only after the transferee
becomes 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 the
conversion of debentures into equity shares is not regarded as transfer but if the
preference shares are converted into equity shares, it will be regarded as a transfer
and 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 case
shall be fair market value of equity shares on the date of its allotment. [CIT v
Trustees of HEH the Nizams Second Supplementary Family Trust (1976) 102 ITR
248 (AP)]. Conversion of preference share into ordinary shares amounts to transfer
in hands of the shareholders. [CIT v Motors and General Stores P. Ltd. (1967) 66
ITR 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 thus
transfer: The assessee had entered into an agreement to purchase certain
property. Both parties reserved the right to specific performance of the agreement.
Nearly four years thereafter, again another agreement was entered into in the
nature of deed of cancellation, by which the assessee agreed for termination of the
earlier 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 assessee
was 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 of
Rs. 6,00,000 received by the assessee from the vendor could be treated as capital
gains 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 of
shareholders and they will be liable to capital gain for the same. [Anarkali Sarabai v
CIT (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 company
as a result of succession of the firm by a company in the business carried on by the
firm 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 and
liabilities of the company;
(b) all the partners of the firm immediately before the succession become the
shareholders of the company in the same proportion in which their capital accounts
stood 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 the
company;
(d) the aggregate of the shareholding in the company of the partners of the firm
is not less than 50% of the total voting power in the company and their
shareholding 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 is
approved by the SEBI;
(7) Succession of the sole proprietary concern by a company is not a transfer if
following conditions are satisfied: Where a sole proprietary concern is succeeded
by a company in the business carried on by it as a result of which the sole
proprietary concern sells or otherwise transfers any capital asset or intangible
asset to the company, it will not be regarded as transfer provided the following
conditions are satisfied:
(a) all the assets and liabilities of the sole proprietory concern relating to the
business immediately before the succession become the assets and liabilities of
the 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 remain
as 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 or
indirectly, in any form or manner, other than by way of allotment of shares in the
company [Section 47(xiv)];
(1) Transfer can be made to the existing company but the partners/ proprietor
should hold at least 50% of the equity capital of the company and their/his share
holding should continue to remain as such.
(2) The exemption in case of succession by the company is allowed to a proprietary
firm 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 will
be taxable as business income in the hands of a firm or sole proprietary firm as the
case 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 maintain
peace among the family members, the family arrangement is governed by the
principles which are not applicable to dealing between strangers. So, such bona
fide realignment of interest, by way of effecting family arrangements among the
family members would not amount to transfer. [CIT v A.L. Ramanathan (2000) 245
ITR 494 (Mad)]. In this case the court followed the decision of the Supreme Court
in 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 only
when the capital asset is transferred. There cannot be a capital loss if the capital
asset 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 no
capital 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 to
transfer of a capital asset: Where the assessee had paid the earnest money and
acquired right to obtain conveyance of immovable property, such earnest money
paid shall be cost of acquisition of such right and if such right is given up, there is a
transfer of a capital asset and the compensation received for giving up such right is
the 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 of
Companies Act, 1956: Where a partnership firm is incorporated as a company
under the provisions of Part IX of the Companies Act, Neither section 45(1) nor
section 45(4) shall be attracted even though there was transfer of assets from firm
to newly constituted company. [CIT v Texsprin Engg. & Mfg. Works (2003) 263 ITR
345 (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 than
36 months immediately preceding the date of its transfer is known as a short term
capital asset.
However, the following assets shall be treated as short-term capital assets if they
are 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-term
capital asset. In other words, if the asset is held by the assessee for more than 36
months 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 capital
asset 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 a
company in liquidation
Exclude the period
subsequent to the date of
liquidation
(ii) Property acquired in any
mode given under section
49(1) (e.g. by way of gift
will, etc.)
Include the holding period
of previous owner also.
(iii) Shares in an Indian
Amalgamated Company
acquired in a scheme of
Amalgamation
Include the holding period
of shares in the
Amalgamating Company
by the Assessee.
(iv) Shares in Indian
Resulting company
acquired in case of
demerger
Include the holding period
of shares in the Demerged
Company by the Assessee
(v) (a) Trading or clearing
rights of recognised stock
exchange pursuant to its
demutualisation or
corporatisation
Include the period for which
the person was a member
of the recognised stock
exchange in India
(b) equity shares in a
company acquired by a
person pursuant to the
demutualisation or
corporatisation of
recognised stock exchange
do
Holding period in case of share or any other security
The period of holding, in the following circumstances will be computed as under:
1. Right to subscribe to shares
or any other securities (may be
called as financial assets
subscribed to by the assessee
on the basis of right to subscribe
to such financial assets.
The period shall be
reckoned from the
date of allotment of
such
financial asset.
2. Right to subscribe to share or
any other securities acquired by
do
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a person in whose favour the
right has been renounced by the
existing holder.
3. Period of holding of the right
by a person who has renounced
the right.
The period shall be
reckoned from the
date of offer of such
right by the company
or institution to the
date of
renouncement, which
in normal
circumstances will be
short-term.
4. Period of holding of a
financial asset allotted without
any payment and on the basis of
holding of any other financial
asset e.g. bonus shares.
The period will be
reckoned from the
date of allotment of
such financial asset
(not from the date of
allotment of the
original shares).
(C) Judicial decisions for determining period of holding
(i) Property constructed on a land purchased earlier: In case of property is
constructed on a site purchased much earlier, the question arises whether the
period of holding the asset i.e., the property, should be reckoned from the date of
completion of the construction of the property or from the date of acquisition of the
land. The correct position is that the asset consists of two components: (1) Land
and (2) Building. When the property is sold, the period of holding has to be
reckoned separately for the land and the building. The consideration received can
also be split into two parts relating to each component.
In CIT v Vimal Chand Golecha (1993) 201 ITR 442 (Raj), the land was purchased
in 1962 and building was constructed thereon in the accounting years relevant to
assessment 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 ITR
76 (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 can
be considered a separate capital asset even if a building is constructed thereon.
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Thus, where the land is held for more than a prescribed period, the gains arising
from the sale of the land can be considered as long-term capital gains even though
the building thereon, being a new construction, is held for a period less than the
prescribed one [CIT v Dr. D.L. Ramachandra Rao (1999) 236 ITR 51 (Mad). Also
see CIT v Citibank N.A. (2004) 260 ITR 570 (Bom)].
In the above cases, the burden will be on the assessee to satisfy how much of the
sale proceeds should be apportioned for the land and how much of the sale
proceeds pertained to the structure. [CIT v Estate of Omprakash Jhunjhunwala
(2002) 254 ITR 152 (Cal)].
It may be noted that split between land and superstructure was also to be made for
the purpose of depreciation as held by the Supreme Court in CIT v Alps Theatre
(1967) 65 ITR 377 (SC). Hence, the decisions of the above High Courts fall in line
with the views of the other precedents.
(ii) Period of holding of share in the co-operative housing society: While computing
the capital gain tax in case of transfer of his shares by a person who is a member
of cooperative housing society, the relevant date would be date on which the
member acquires the shares in the cooperative housing society and the date on
which member had sold his shares therein. Thus, where the assessee acquired
shares in the society on
6-9-1979 and was allotted flat on 15-11-1979. He was given possession of flat in
October 1981, and sold the shares of the society along with the flat, on 4-12-1982,
the capital gains arising from the sale were long term capital gains, shares having
been held for more than 36 months. [CIT v Anilben Upendra Shah (2003) 262 ITR
657 (Guj)].
Similarly, the assessee became a member in Venus Apartments (Galaxy Co-
operative Housing Society). He was allotted a flat in the building of the society by
resolution dated 4-11-1980, passed by the managing committee of the society. On
the date of allotment, i.e., 4-11-1980, the property was under construction and
came to be completed on 12-9-1983. Physical possession was handed over to the
assessee on 12-9-1983. On 30-4-1984, the flat was sold by the assessee for a
consideration of Rs. 3,75,000. The assessee worked out long-term capital gains at
Rs. 1,59,395. The Assessing Officer did not accept the stand of the assessee that
the assessee had become the owner of the property as per resolution dated 4-11-
1980. According to the Assessing Officer the assessee had held the property for a
period of less than 36 months and as such was liable to short-term capital gains
tax, it was held that the assessee in the present case was allotted a share by the
co-operative housing society on 4-11-1980, and the sale of the same took place on
30-4-1984, i.e., after a period of 36 months. The Tribunal was therefore justified in
holding that the capital gains arising were long-term capital gains and the
14

assessee was entitled to deduction from such gains as per law. [CIT v Jindas
Panchand Gandhi (2005) 279 ITR 552 (Guj)]
(iii) Period of holding of shares where call money is paid after allotment: Where the
shares are acquired by the assessee from a company and the payment is made to
the company even after allotment of shares as and when the call is made by the
company, the period of holding of such shares shall be considered from the date of
allotment of shares even though the call money has been paid after allotment of
such shares.
(iv) Right to acquire any house property: Where a flat is booked with a builder
under a letter of allotment or an agreement for sale, this would represent only a
right to acquire a flat and if such right is acquired more than 36 months back, it
becomes a long-term asset. However, when the possession of the flat is taken, the
period 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 right
upon a merger would loose its existence.
(v) Holding need not be as capital asset: The entire period of holding i.e., from the
date of initial acquisition upto the date of transfer has to be taken into account in
order to decide whether it is a long-term capital asset although it may not have
been held as capital asset initially. [Keshavji Karsondas v CIT (1994) 207 ITR 737
(Bom)].
6. Computation of capital gain
The income chargeable under the head 'Capital gains' shall be computed, by
deducting from the full value of the consideration received or accruing as a result
of the transfer of the capital asset, the following amounts, namely:
(i) expenditure incurred wholly and exclusively in connection with such a
transfer;
(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 of
improvement mentioned above will be substituted by the words 'indexed cost of
acquisition' and 'indexed cost of improvement' respectively.
(A) Judicial decision on consideration price
(1) Receipt of consideration in instalments: Even if the full value of consideration
agreed upon is received in instalments in different years, the entire value of
consideration has to be taken into account for computing the capital gains which
become chargeable in the year of transfer.
(2) Capital gains arise on accrual basis: Capital gain is attracted, the moment the
assessee has acquired the right to receive the price. It is not necessary that the
consideration should have been actually received. What the parties did
15

subsequently will not have any bearing on the liability of the assessee to tax of the
year 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 of
asset: Interest on loan taken for acquiring a capital asset will become part of the
cost of acquisition. [CIT v Mithlesh Kumari (1973) 92 ITR 9 (Del)]. However,
interest payable on provident fund loan (interest so payable is credited to the
provident fund account of the assessee) is not deductible interest on expenditure
[Vashisht Bhargava v ITO (1975) 99 ITR 148 (Del)]. As regards interest on the
asset acquired by the assessee carrying on business or profession, interest before
the asset is put to use shall form part of cost of the asset but any interest due or
paid 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 mortgaged
by the previous owner during his lifetime and the assessee, after inheriting the
same, has discharged the mortgage debt, the amount paid by him for the purpose
of clearing off the mortgage shall be regarded as cost of acquisition under section
48 read with section 55(2) of the Act. [Arunachalam (RM) v CIT (1997) 227 ITR
222 (SC)] The position is, however, different where the mortgage is created by the
owner after he has acquired the property. The clearing off of the mortgage debt by
him prior to transfer of the property would not entitle him to claim deduction under
section 48 of the Act because in such a case he did not acquire any interest in the
property 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 any
other security) allotted to the assessee on or after 1-4-1981 without any payment
and 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 entire
sale consideration received on the transfer of the bonus shares/security shall be
treated as capital gains. However, in case bonus shares have been allotted to the
assessee before 1-4-1981, although the cost of such bonus shares is nil but the
assessee 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 to
acquire the original shares.
(4) Cost of acquisition of an asset acquired from the previous owner in any mode
given u/s 49(1): In this case, the cost of acquisition is taken as the cost to the
16

previous owner and it is this cost which will have to be indexed. For the purpose of
indexation the year in which the asset was first held by the assessee (not the
previous 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), the
indexation of cost was allowed from the date of acquisition of the asset by the
previous owner and not the date when the asset was acquired by the assessee
from 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 the
indexation of cost will be allowed with reference to the year in which the previous
owner acquired the asset.
7. Treatment of advance money received
Where any capital asset, was on any previous occasion, the subject of negotiations
for 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 asset
was acquired or the written down value or the fair market value, as the case may
be, 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 be
deducted from the cost of the asset. If such an advance was received and retained
by 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 and
the assessee has assumed the F.M.V. of the asset as on 1-4-1981 as the cost of
acquisition, such advance money received (though before 1-4-1981) shall also be
deducted as in the section it is written that it will be deducted from the fair market
value.
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 the
cost of 'acquisition' of such asset shall be a capital receipt not taxable [Travancore
Rubber & Tea Co. Ltd. v CIT (2000) 243 ITR 158 (SC)].
For purposes of section 51, no distinction is made between moneys received and
retained by way of 'advance' and 'other money'. The phrase 'other money' would
cover, for example, deposits made by the purchaser for guaranteeing due
performance of the contracts and not forming part of the consideration. The monies
received on the previous occasions and retained by the vendor/assessee cannot,
therefore, be treated as a revenue receipt. [Travancore Rubber & Tea Co. Ltd. v
17

CIT (2000) 243 ITR 158 (SC)].
The provisions of section 51 seems to be illogical after the introduction of the
concept of indexed cost of acquisition as in this case the cost of acquisition will be
first reduced by the amount of advance money received and thereafter it will be
indexed.
Treatment in the hands of vendee: Forfeiture of earnest money by the vendor, if
due to default on the part of the vendee, will not amount to relinquishment of a right
in that asset. Therefore the amount forfeited will not be allowed as a capital loss
under head capital gains. [CIT v Sterling Investment Corporation Ltd. (1980) 123
ITR 441 (Bom)].
On the other hand, if the vendor commits a default and the vendee receives some
compensation besides the refund of the earnest money paid by him, such
compensation shall be subject to capital gains as it will amount to relinquishment
of a right by the vendee.
Where the assessee had paid the earnest money and acquired right to obtain
conveyance of immovable property, such earnest money paid shall be cost of
acquisition of such right and if such right is given up, there is a transfer of a capital
asset and the compensation received for giving up such right is the consideration
price. [CIT v Vijay Flexible Container (1990) 186 ITR 693 (Bom)].
8. Capital gain on transfer of a capital asset by way of distribution on the
dissolution of a firm, AOP/BOI
The profits or gains arising from the transfer of a capital asset in specie to the
partners/members thereof by way of distribution on the dissolution of a firm or other
association of persons or body of individuals (not being a company or a
cooperative society) or otherwise, shall be chargeable to tax as the income of the
firm, association or body, of the previous year in which the said transfer takes
place. In such a case, there will be a capital gain to the firm/AOP, etc. For the
purposes of computation of capital gain, the fair market value of the asset on the
date of such transfer shall be deemed to be the full value of the consideration
received or accruing as a result of transfer, instead of the value at which it is given
to 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 above
should take colour from the preceding word i.e. dissolution. In other words, the
word "otherwise" should mean something like dissolution. For example, if a firm
consists of two partners X & Y, and Y retires from the firm, it will not be a case of
retirement but of dissolution as the firm in this case shall have to be dissolved. The
same will be the situation if Y dies in the above case. Similarly, if a firm is
18

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 not
be regarded as transfer and thus there will not be any capital gain on such
succession.
However, the Bombay High Court held that the scope of word 'otherwise' in section
45(4) is not ejusdem generies with the expression 'dissolution of a firm or body or
association of persons'. The expression 'otherwise' has to be read with the words
transfer of capital assets and section 45(4) would get invoked even in cases of
subsisting partners of a partnership firm, transferring assets in favour of a retiring
partner in which case the fair market value as on date of transfer should be taken
as full value of consideration. The expression 'otherwise' would cover any possible
situation 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 is
not specifically included in the definition of the term 'transfer'. Instead, a direct
charge is sought to be created by introducing a deeming fiction in the form of
section 45(4) for bringing to tax the deemed capital gains on such distribution. It is
this act of bypassing the provision of section 2(42) by the Legislature that has
become the subject matter of an interesting controversy amongst the Courts as
well.
One view of the matter is that section 45(4) is a charging section that brings in an
effective charge in the circumstances provided therein, independent of section
2(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 view
of 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 case
of 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 April
1990. The Assessing Officer held that since the firm stood dissolved after the
death of one of the partners it was liable to pay tax on capital gains. The
Commissioner (Appeals) and the Tribunal held that there was no transfer. On
appeal the Hon'ble Court, dismissing the appeal, held that in the instant case
unless the capital gain has arisen from the transfer of capital asset within the
meaning of section 2(47) of the Act, there was no transfer of assets within the
meaning of section 45(4) of the Income-tax Act, 1961. [CIT v Moped and Machines
(2006) 281 ITR 52 (MP)].
19

The issue once again came up before the Karnataka High Court recently in the
case of Suvardhan v CIT (2006) 287 ITR 404 (Karn). The assessee in that case
was a registered firm which came into existence by way of partnership deed dated
23-7-1986. The partnership consisted of three persons. On July 1, 1988, one of the
partners retired and the other two continued the partnership in terms of the
partnership deed dated 17-10-1988. A survey was conducted in the business
premises of the assessee. It came to light that the firm had been dissolved and the
business had been taken over by one of the partners, Smt. Anuradha Maruthi
Gokarn. It was also noticed that the partnership was dissolved on 1-4-1992, and
the assets and liabilities had been taken over by the said lady. The Assessing
Officer proposed to apply section 45(4) of the Act. Notice was issued. The
assessee filed a nil return. Thereafter, the Assessing Officer conducted the
assessment 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 required
reconsideration. It was contended that both the provisions were required to be read
together and that on such a combined reading it was clear that the case on hand
was a case of 'no transfer'.
The revenue pleaded that a reading of the said section 47 of the Act would show
that several transactions were considered as no transfer for the purpose of section
45 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 any
transaction 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 gains
arising from the transfer of capital assets by way of distribution of capital assets on
the dissolution of a firm was chargeable to tax as the income of the firm, in the light
of the fact that a transfer had taken place. The Court also took notice of the
assessee'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 no
transfer 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 Madhya
Pradesh High Court in CIT v Moped and Machines 281 ITR 52 relied upon by the
assessee by observing that in the said judgement, there was no reference to
omission of clause (ii) of section 47 as it stood prior to 1-4-1988; that in the said
20

judgement, what was considered was the provisions of section 45(4) and section
2(47), as it stood then; that therefore, the said judgement would not be applicable
to the issue involved in the case on hand; that on the other hand, the decision of
the Bombay High Court in the case of CIT v A.N. Naik Associates (2004) 265 ITR
346 (Bom) was found to be applicable, as in the said decision, the Bombay High
Court had noticed the effect of the omission of the said clause (ii) of section 47 by
the Act of 1987.
The Karnataka High Court, in respectful agreement with the judgement of the
Bombay High Court, noted that when the Parliament in its wisdom had chosen to
remove a provision which provided for the cases of 'no transfer', there was no need
for any further amendment to section 2(47), in the light of removal of clause (ii) to
section 47, the transaction was liable to capital gains tax at the hands of the
authorities.
The issue remains unresolved as is evident by the conflicting decisions of the
Courts on the subject and is sure to haunt the corridors of the Court. However, the
better view appears that section 45(4) is a charging section, as the same is
introduced for plugging the mischief as is noted by the Bombay High Court.
Cases which create real difficulty are the cases of partnership consisting of two
partners only. It is in such cases that a difficulty arises, where one of the partners
dies or is declared insolvent or retires. In such cases, the firm shall stand
automatically dissolved on death or insolvency or on retirement by operation of the
law. In such cases of severe hardships, the recent decision of the Madras High
Court 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 of
two partners, which was dissolved on death of one of the partners. The business of
the partnership firm was continued by the surviving partner with the assets of the
partnership firm. The Income-tax Department applied the provisions of section
45(4) and brought to tax the deemed capital gain by holding that the transfer took
place on dissolution of the firm. The Tribunal held that though the dissolution of
firm took place by operation of law, it was not followed by transfer of capital assets
by way of distribution of such assets. The Madras High Court confirmed the
decision 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 may
or may not be the year in which the dissolution of the firm takes place. The year in
which the capital gain is to be brought to tax is "the previous year in which the said
transfer takes place". [CIT v Vijayalakshmi Metal Industries (2002) 256 ITR 540
(Mad)].
21

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 in
distribution of assets of the firm. The distribution will take place only on taking of a
positive 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 capital
gain/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-term
capital 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 date
of its distribution but the cost of acquisition of this asset to the partner/member
shall be the value at which it was transferred to partner/member.
Merely because a partner has advanced some money over and above capital
he has agreed to subscribe does not convert suit for dissolution of partnership and
winding up of affairs of partnership into an action to recover a debt but it remains a
suit for declaration to dissolve partnership and winding up of its affairs. In such a
case accounts are to be settled as per mode indicated in section 48 alone
consequent upon dissolution of firm and not independently for recovery of amount.
[Delhi Safe Deposits Co. v CIT (2004) 269 ITR 66 (Del)].
Judicial decisions
1. There cannot be any dispute on the proposition that every dissolution must be in
point of time anterior to the final winding up of the firm. Generally there will be a
time gap between the two events. The firm was dissolved on 5-12-1987 but the
sale of the assets as a going concern had taken place only on 20-11-1994. For the
completion of the process of winding up the Legislature has engrafted section 47 in
the 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 of
winding up of the affairs it continued till its assets and business were sold as a
going concern on 20-11-1994. Therefore the firm continued to hold the properties
as owner till November 20, 1994. There was no distribution of capital assets of the
firm despite its dissolution and therefore the firm could not have been made liable
for 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 firm
cannot be considered as a distribution of assets to him for the purpose of section
45(4) of the Income-tax Act. However, distribution of assets to a partner on his
retirement will definitely come within the purview of section 45(4) as the terms or
22

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 of
Part IX of the Companies Act, neither section 45(1) nor section 45(4) shall be
attracted even though there was transfer of assets from firm to newly constituted
company. [CIT v Texspin Engineering & Manufacturing Works (2003) 263 ITR 345
(Bom)].
4. Distribution of stock in trade amongst partners at the time of dissolution: Section
45(4) deals with distribution of capital assets at the time of dissolution. Stock in
trade is not a capital asset and as such if stock in trade is distributed amongst the
partners, then as per A.L.A. Firm v CIT (1991) 189 ITR 285 (SC) case, in taking
accounts 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 a
real basis. Thus, once the stock in trade is valued at market price, the surplus, if
any, has to be taxed as business income of the firm. However, the Supreme Court
in the case of Shakti Trading Co. v CIT (2001) 250 ITR 871 (SC), observed that the
principle that closing stock has to be taken at the market value is applicable only
where 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 be
valued 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, during
its subsistence, taken out by the partners by making mere entries in the books of
the firm and such asset is sold out by them, the capital gains arising from such
transfer is exigible to capital gains in the hands of the firm. This is so because such
transaction amounts to release of a share in specific immovable property of the
firm and, therefore, such a transfer cannot legally be made without a registered
document. [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 dispute
The 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 the
payment is in dispute as to whether the assessee is entitled to receive the same or
not then such receipt shall not be treated as having accrued to the assessee till the
dispute is not settled. Thus, in a case where additional compensation awarded to
the assessee has been made subject matter of appeal by the Government then
23

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 ITR
622 also decided that the same treatment should be given for interest in respect of
such disputed compensation.
Amendment made by the Finance Act, 2003 (W.e.f. A.Y. 2004-05): To nullify the
above judgment, the Finance Act, 2003 has inserted a new clause (c) in section
45(5) to provide that where the amount of the compensation or consideration is
subsequently reduced by any court, Tribunal or other authority, the capital gain of
that year, in which the compensation or consideration received was taxed, shall be
recomputed and the rectification shall be made under section 154 read with section
155(16) by the Assessing Officer accordingly. Hence, the capital gain shall now be
taxable even if the compensation amount is in dispute as the assessee shall be
entitled to get the assessment amended if compensation is later on reduced.
Taxability of interest awarded on enhanced compensation
Where along with additional compensation interest is also awarded and both the
additional compensation and interest are in dispute then the interest will also not
be taxable till the dispute is settled. But once the dispute is settled, such interest
shall not be taxable in lump sum if the assessee is following mercantile system of
accounting. Such interest shall be, on the other hand, spread over the period on an
annual basis right from the date on which the asset was compulsorily acquired by
the Government to the date on which the Court makes an order for enhanced
compensation. [Rama Bai v CIT (1990) 181 ITR 400 (SC)].
10. Capital gain arises on certain self-generated assets
Generally there is no capital gain on transfer of self-generated assets as the cost of
acquisition of such assets cannot be computed. But certain amendments have
been made in the Income-tax Act and now capital gain arising on the transfer of the
following assets is chargeable to tax:
(i) goodwill of a business. There will, however, be no capital gain on sale of
goodwill of a profession;
(ii) trademark or brand name associated with the business;
(iii) right to manufacture, produce or process any article or thing, for a
consideration e.g. patent, copyright, formula, design;
(iv) right to carry on any business;
(v) tenancy rights;
24

(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 not
subject to capital gains as for such assets cost cannot be identified or envisaged
as 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 envisage
a cost, has also been held to be not subject to capital gain by the Bombay High
Court in Evans Fraser and Co. Ltd. v CIT (1982) 137 ITR 493 (Bom) but the Kerala
and Karnataka High Court took the contrary view. [Parthas Trust v CIT 173 ITR
615 (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 asset
had acquired it by conquest (i.e. without paying any price for the acquisition) and
the case of the assessee was that even after applying the Explanation to section
49(1), the cost of acquisition in the hands of the last previous owner who acquired
it 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 of
acquisition of asset was not ascertainable, capital gain could not be computed and
as 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 is
depreciable, can be long-term
Section 50 provides for determination of the cost of construction of superstructure
and it does not apply to land as land is not a depreciable asset. Hence, if the
building comprising of the land is sold, the capital gain on superstructure shall be
short-term capital gain in terms of section 50 and the capital gain on land, if held
for more than 36 months, shall be long-term capital gain. This is because the land
is independent and identifiable capital asset and it continues to remain so even
after 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, section
11(1A) and section 13A
The Act has exempted capital gain in the hands of various categories of persons
under sections 10, 11(1A) and 13A. These exemptions are given to the specific
categories of persons. However, the following clauses to section 10 have been
inserted to allow exemption of capital gain to all categories of persons or more than
one person.
(A) Long-term capital gain on eligible equity shares exempt if the shares are
25

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 exempt
provided these are acquired on or after 1-3-2003 but before 1-3-2004 and held for
a 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 the
Stock Exchange, Mumbai as on the 1-3-2003 and the transactions of purchase and
sale 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 the
1-3-2003 and listed in a recognised stock exchange in India before 1-3-2004 and
the transaction of sale of such share is entered into on a recognised stock
exchange in India.'.
(B) Exemption of capital gains on compensation received on compulsory
acquisition of agricultural land situated within specified urban limits: With a view to
mitigate the hardship faced by the farmers whose agricultural land situated in
specified 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 capital
gains (whether short-term or long-term) arising to an individual or a Hindu
undivided family from transfer of agricultural land by way of compulsory acquisition
where the compensation or the enhanced compensation or consideration, as the
case may be, is received on or after 1-4-2004. The exemption is available only
when such land has been used for agricultural purposes during the preceding two
years 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 the
compensation is received after 31-3-2004, it shall be exempt. But if part of the
original compensation in the above case has already been received before 1-4-
2004, then exemption shall not be available even though balance original
compensation is received after 31-3-2004.
However, enhanced compensation received on or after 1-4-2004 against
agricultural land compulsory acquired before 1-4-2004 shall be exempt.
(C) Exemption of long-term capital gain arising from sale of shares and units: Any
income 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 be
exempt provided
(a) such equity shares are sold through recognised stock exchange, whereas
units of an equity oriented fund may either be sold though the recognised stock
exchange 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 with
reference to the annual average of the monthly averages of the opening and
closing 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 of
section 54 is confined to sale of a residential house after 36 months and
reinvestment in a residential house. Reinvestment benefits is available both for
purchase and construction of the house. Purchase has to be either one year before
or two years later. Construction has to be completed within three years of the sale
of the asset in respect of which benefit of reinvestment is claimed. There have
been many decisions on purchase/construction of the house. Further, certain
clarifications have also been issued in this regard. These have been summarized
as under:
(1) House include part of the house: House property does not mean a complete
independent house. It includes independent residential units also, like flats in a
multi-storeyed complex. The emphasis is not on the type of the property, but, on
the head under which the rental income is assessed. [CIT (Addl.) v Vidya Prakash
Talwar (1981) 132 ITR 661 (Del)].
(2) Release deed may also be treated as purchase: Where a property is owned
by more than one person and the other co-owner or co-owners release his or their
respective share or interest in the property in favour of one of the co-owners, it can
be said that the property has been purchased by the releasee. Such release also
fulfils the condition of section 54 as to purchase so far as releasee-assessee is
concerned [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 the
stipulated time in the construction of a new floor on another house owned by him
by demolishing the existing floor, it was held that he was entitled to exemption
under section 54. [CIT v Narasimhan (PV) (1990) 181 ITR 101 (Mad)].
(4) No exemption under section 54 if land only is sold: The house property
concerned must be building or land appurtenant to building. The basic test was
whether the land appurtenant to building could be used independent of the user of
the building. If so, it cannot be said to be land appurtenant to building. Further, the
27

basic requirement is that the capital gain should arise from the transfer of building
or land, the income of which is chargeable under the head Income from house
property. If the land alone is sold, the provisions of section 54 will have no
application inasmuch as the income from land is not chargeable under the head
Income from house property. [CIT v Zaibunnisa Begum (1985) 151 ITR 320 (AP)].
(5) Successor is entitled to benefit of exemption in case of death of the
assessee: In case of assessee's death during the stipulated period, benefit of
exemption under section 54(1) is available to legal representative if the required
conditions are satisfied by the legal representative. [Ramanathan (CV) v CIT
(1980) 155 ITR 191 (Mad)].
(6) Purchase of limited interest in the house eligible for exemption under section
54: Where an assessee had sold the residential house and acquired only 15%
interest in another house and such other house was already used for residence
prior to purchase, it was held that the benefit should be available to the assessee.
[CIT v Chandaben Maganlal (2000) 245 ITR 182 (Guj)]. In coming to the
conclusion, the High Court followed its own earlier decision in CIT v Tikyomal
Jasanmal (1971) 82 ITR 95 (Guj). In that case, what was purchased was a unit of
house property, while in the present case before the High Court, it was a limited
interest in the property.
(7) Construction in another property not eligible for exemption: An assessee
gifted some land to his wife. He, thereafter constructed a building on the said land.
The Government acquired the land and building and paid compensation for land to
the wife and for the building to the assessee (husband). It was held that capital
gain on land was assessable in the hands of the husband by virtue of section 64
but he was not entitled to exemption under section 54 in respect of capital gain on
the acquisition of the land of the wife as the capital gain to the wife did not arise on
transfer of a residential house. [T.N. Vasavan v CIT (1992) 197 ITR 163 (Ker)].
(8) House of the firm used by partners: Where a firms property is used for
residence of partners and thereafter distributed to the partners upon dissolution of
the firm and the partner sells the same, exemption can be claimed by the partner
under section 54. For this purpose, period for which this property was held by the
firm shall also be taken into account for determining the question whether the
house property in exemption was a long-term capital asset or not. [CIT v M.K.
Chandrakanth (2002) 258 ITR 14 (Mad)].
(9) There can be both purchase and construction: Where the assessee had
partly invested the capital gains on the purchase of another house and partly on
the construction of additional floor to the house so purchased within the prescribed
time limit, it was held that the Income-tax Officer was not justified in restricting
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exemption to investment on purchase only, holding that the exemption under
section 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 the
new house may start before the date of transfer, but it should be completed after
the date of transfer of the original house. [CIT v J.R. Subramanya Bhat (1987) 165
ITR 571 (Karn)]. The very fact that purchase of another house as also the
construction can take place before the sale means that cost of purchase or new
construction 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 be
treated 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 the
assessee 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 to
claim exemption in respect of capital gains even though the construction is not
completed 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 made
substantial payment within the prescribed time and thus acquired substantial
domain over the property, although the builder failed to hand over the possession
within 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 54
shall be allowable. [CIT v V. Natarajan (2006) 154 Taxman 399 (Mad)].
(14) Where the assessee utilised the sale consideration for other purposes
and borrowed the money for the purpose of purchasing the residential house
property to claim exemption under section 54, it was held that the contention that
the same amount should have been utilised for the acquisition of new asset could
not 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 held
that it was not necessary that residential property showed be purchased in India
29

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 and
not outside India.
Therefore, the benefit under section 54F is not allowable for a residential
house purchased/constructed outside India. [Leena J Shah v Asstt. CIT (2006) 6
SOT 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 or
his parents for at least a period of 2 years immediately preceding the date of
transfer, for agricultural purposes, shall be exempt to the extent such capital gain is
invested in the purchase of another agricultural land within a period of 2 years after
the date of transfer to be used for agricultural purpose, provided the new
agricultural land purchased, is not transferred within a period of 3 years from the
date of its acquisition.
Section 54B is applicable only to individuals and not to any other assessee this is
because the section uses the expression used by "his or a parent of his" which
clearly 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 on
investment in certain bonds [Section 54EC]: Any long-term capital gain, arising to
any assessee, from the transfer of any capital asset on or after 1-4-2000 shall be
exempt to the extent such capital gain is invested within a period of 6 months after
the date of such transfer in the long-term specified asset provided such specified
asset is not transferred or converted into money within a period of 3 years from the
date of its acquisition.
Exemption under section 54EC not available in respect of deemed capital gains on
amount received on liquidation of a company: Section 54E (now section 54EC)
permits reinvestment benefit, if the sale proceeds/capital gains on sale of long-term
capital assets are invested in the manner required by the section. Where a
shareholder is made liable for deemed capital gains on amount received on
liquidation 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 only
where there is an actual transfer and not in a case, where there is only a deemed
transfer. [CIT v Ruby Trading Co. Pvt. Ltd. (2003) 259 ITR 54 (Raj)].
30

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 asset
shall 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 be
treated as short-term capital asset. Section 54E [or say 54EC or 54F, etc.] is in
independent provision which is not controlled by section 50. If the conditions
necessary under section 54E are complied with by the assessee, he will be entitled
to the benefit envisaged in section 54E, even on transfer of depreciable assets
held 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 Taxman
855 (Bom)].
On the same analogy benefit under section 54EC or 54F shall be available in the
case 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 any
capital asset, other than residential house property, shall be exempt in full, if the
entire net sales consideration is invested in purchase of one residential house
within one year before or two years after the date of transfer of such an asset or in
the construction of one residential house within three years after the date of such
transfer. Where part of the net sales consideration is invested, it will be exempt
proportionately.
The above exemption shall be available only when the assessee does not own
more 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 section
54F.
Perusal of section 54F(4) shows that the assessee has to utilize the amount for the
purchase or construction of the new asset before the date of furnishing the return
of income under section 139. There is no mention of any sub-section of section
139. Hence, one cannot interpret the section 139 mentioned should be read as
section 139(1). Similar language is appearing in section 54(2). The Gauhati High
Court, in the case of CIT v Rajesh Kumar Jalan (2006) 286 ITR 274, has held that
section 139 mentioned in section 54F(4) will not only include section 139(1) but will
also 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 under
section 139(4). [Nipun Mehrotra v ACIT (2008) 110 ITD 520 (Bang)]
Section 54 and 54F are comparable in many respects. Hence, the law and
precedents relating to section 54 as to whether the house property on which
investment is made is residential or not, the law relating to time limits, the
31

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