Capital Gains - Direct Tax Laws PDF

CHAPTER 4 CAPITAL GAINS LEARNING OUTCOMES After studying this chapter, you would be able to -  appreciate the scope of income chargeable under this head;  examine the provisions of section 2(42A), relating to...

CHAPTER 4 CAPITAL GAINS LEARNING OUTCOMES After studying this chapter, you would be able to -  appreciate the scope of income chargeable under this head;  examine the provisions of section 2(42A), relating to period of holding, for classification of a capital asset as short-term capital asset and long-term capital asset;  analyse and apply the provisions of section 47 to determine whether a particular transaction would be considered/not be considered as transfer for the purpose of capital gains taxation;  determine the cost of acquisition/ improvement and indexed cost of acquisition/ improvement, in case of a short-term capital asset and long-term capital asset, respectively for the purpose of computing the capital gains;  compute capital gains on transfer of depreciable assets;  compute capital gains in case of market linked debenture and units of a specified mutual fund;  compute capital gains in case of slump sale;  determine the quantum of exemption available on investment of capital gains/ net consideration arising on transfer of certain assets and appreciate the conditions to be satisfied to avail such exemption;  compute the capital gains chargeable to tax applying the charging and deeming provisions and giving effect to the exemptions available in respect of capital gains;  identify the cases where an Assessing Officer can make a reference to the Valuation Officer;  appreciate the concessional tax treatment available for short-term capital gains and for long term capital gains on transfer of listed equity shares/ units of an equity oriented fund/ units of a business trust;  compute the tax liability applying the special rates of tax on long-term capital gains and short-term capital gains arising on transfer of listed equity shares/ units of an equity oriented fund and the normal rates of tax on capital gains arising on transfer of other short-term capital assets and other long-term capital assets.  4.2 DIRECT TAX LAWS 4.1 INTRODUCTION Section 45 provides that any profits or gains arising from the transfer of a capital asset effected in the previous year will be chargeable to income-tax under the head ‘Capital Gains’. Such capital gains will be deemed to be the income of the previous year in which the transfer took place. In this charging section, two terms are important. One is “capital asset” and the other is “transfer”. Hence, in this chapter on capital gains, we begin our discussion with the definition of “capital asset” and “transfer”. Thereafter, we will proceed to discuss the various circumstances under which capital gains tax is levied. There are certain transactions which are not to be regarded as transfer for the purposes of capital gains. These transactions have also been discussed in this chapter. For computing long-term capital gains, application of cost inflation index is necessary. Again, there is a separate method of computation of capital gains in respect of depreciable assets. Also, there are exemptions in cases where capital gains/net sales consideration are invested in specified assets. All these aspects are being discussed in this chapter. 4.2 CAPITAL ASSET Definition: According to section 2(14), a capital asset means – (a) property of any kind held by an assessee, whether or not connected with his business or profession; (b) any securities held by a Foreign Institutional Investor which has invested in such securities in accordance with the SEBI regulations. (c) any unit linked insurance policy (ULIP) issued on or after 1.2.2021, to which exemption under section 10(10D) does not apply on account of applicability of the fourth and fifth provisos thereof. A ULIP which is issued on or after 1.2.2021 whose premium payable exceeds ` 2,50,000 for any of the previous years during the term of such policy would be a capital asset [Forth proviso to section 10(10D)]. In a case where premium is payable by a person for more than one ULIP issued on or after 1.2.2021 and the aggregate of premium payable on such ULIPs exceed ` 2,50,000 for any of the previous years during the term of any such ULIP(s), the exemption under section 10(10D) would be available in respect of any of those ULIPs (at the option of the assessee) whose aggregate premium payable does not exceed ` 2,50,000 for any of the previous years during their term. All other ULIPs would be capital assets [Fifth proviso to section 10(10D)].  CAPITAL GAINS 4.3 However, it does not include— (i) Stock-in trade: Any stock-in-trade [other than securities referred to in (b) above], consumable stores or raw materials held for the purpose of the business or profession of the assessee; Whether a particular asset is stock-in-trade or capital asset does not depend upon the nature of the item, but the manner in which the same is held. The item would be stock-in- trade in the hands of the assessee who deals or trades in that item; however, the same item would be capital asset for the assessee who holds it as an investment. Example: A dealer in real estate holds a piece of land as stock-in-trade. But the same will be capital asset for an assessee who holds it as an investment. The exclusion of stock-in-trade from the definition of capital asset is only in respect of sub- clause (a) above and not sub-clause (b). This implies that even if the nature of such security in the hands of the Foreign Portfolio Investor is stock in trade, the same would be treated as a capital asset and the profit on transfer would be taxable as capital gains. Further, the Explanatory Memorandum to the Finance (No.2) Bill, 2014 clarifies that the income arising from transfer of such security by a Foreign Portfolio Investor (FPI) would be in the nature of capital gain, irrespective of the presence or otherwise in India, of the Fund manager managing the investments of the assessee. (ii) Personal effects: Personal effects, that is to say, movable property (including wearing apparel and furniture) held for personal use by the assessee or any member of his family dependent on him. EXCLUSIONS: (a) jewellery; (b) archaeological collections; (c) drawings; (d) paintings; (e) sculptures; or (f) any work of art. Definition of Jewellery - Jewellery is a capital asset and the profits or gains arising from the transfer of jewellery held for personal use are chargeable to tax  4.4 DIRECT TAX LAWS under the head “capital gains”. For this purpose, the expression ‘jewellery’ includes the following: (i) Ornaments made of gold, silver, platinum or any other precious metal or any alloy containing one or more of such precious metals, whether or not containing any precious or semi-precious stones and whether or not worked or sewn into any wearing apparel; (ii) Precious or semi-precious stones, whether or not set in any furniture, utensil or other article or worked or sewn into any wearing apparel. (iii) Rural agricultural land in India i.e., agricultural land in India which is not situated in any specified area. As per the definition that only rural agricultural lands in India are excluded from the purview of the term ‘capital asset’. Hence urban agricultural lands constitute capital assets. Accordingly, the agricultural land described in (a) and (b) below, being land situated within the specified urban limits, would fall within the definition of “capital asset”, and transfer of such land would attract capital gains tax - (a) agricultural land situated in any area within the jurisdiction of a municipality or cantonment board having population of not less than ten thousand, or (b) agricultural land situated in any area within such distance, measured aerially, in relation to the range of population as shown hereunder - Shortest aerial distance from Population according to the last the local limits of a preceding census of which the relevant municipality or cantonment figures have been published before the board referred to in item (a) first day of the previous year. (i) ≤ 2 kms > 10,000 (ii) > 2 kms ≤ 6 kms > 1,00,000 (iii) > 6 kms ≤ 8 kms > 10,00,000 Example Area Shortest aerial Population according to Is the land distance from the the last preceding census situated in this local limits of a of which the relevant area a capital municipality or figures have been asset? cantonment board published before the first referred to in item (a) day of the previous year. (i) A 1 km 9,000 No  CAPITAL GAINS 4.5 (ii) B 1.5 kms 12,000 Yes (iii) C 2 kms 11,00,000 Yes (iv) D 3 kms 80,000 No (v) E 4 kms 3,00,000 Yes (vi) F 5 kms 12,00,000 Yes (vii) G 6 kms 8,000 No (viii) H 7 kms 4,00,000 No (ix) I 8 kms 10,50,000 Yes (x) J 9 kms 15,00,000 No Explanation regarding gains arising on the transfer of urban agricultural land - Explanation 1 to section 2(1A) clarifies that capital gains arising from transfer of any agricultural land situated in any non-rural area (as explained above) will not constitute agricultural revenue within the meaning of section 2(1A). In other words, the capital gains arising from the transfer of such urban agricultural lands would not be treated as agricultural income for the purpose of exemption under section 10(1). Hence, such gains would be exigible to tax under section 45. (iv) Specified Gold Bonds: 6½% Gold Bonds, 1977, or 7% Gold Bonds, 1980, or National Defence Gold Bonds, 1980, issued by the Central Government; (v) Special Bearer Bonds, 1991 issued by the Central Government; (vi) Gold Deposit Bonds issued under the Gold Deposit Scheme, 1999 or deposit certificates issued under the Gold Monetisation Scheme, 2015 and Gold Monetisation Scheme, 2018 notified by the Central Government. Note – ‘Property’ includes and shall be deemed to have always included any rights in or in relation to an Indian company, including rights of management or control or any other rights whatsoever.  4.6 DIRECT TAX LAWS CAPITAL ASSET [Section 2(14)] Property of any kind held Any securities A ULIP which is issued on or after 1.2.2021, to by an assessee, whether held by a FII which exemption u/s 10(10D) does not apply on or not connected with his which has a/c of premium payable exceeding ` 2,50,000 business or profession invested in such for any of the PYs during the term of such securities as policy. per SEBI In a case where premium is payable for more Regulations than one ULIP issued on or after 1.2.2021 and the agg. of premium payable on such ULIPs > ` 2,50,000 for any of the PYs during the term of any such ULIP(s), the exemption u/s 10(10D) would be available in respect of any of those ULIPs (at the option of the assessee) whose agg. premium payable does not exceed ` 2,50,000 for any of the PYs during their term. All other ULIPs would be capital assets. EXCLUSIONS Stock-in- Personal Effects Rural 6½ Gold Bonds, Gold Deposit trade, [i.e., movable Agricultural 1977, 7% Gold Bonds issued consumable property including Land Bonds, 1980, under Gold stores, raw wearing apparel and National Deposit Scheme, materials furniture held for Defence Gold 1999/ Deposit held for personal use by the Bonds, 1980, Certificates issued business or assessee or his Special Bearer under the Gold profession family] Bonds, 1991 Monetisation issued by the Scheme, 2015/ Central Govt. 2018 notified by the Central Govt. EXCLUSIONS FROM PERSONAL EFFECTS Jewellery Archaeological Drawings Paintings & Any work collections Sculptures of art These assets are hence, capital assets u/s 2(14)  CAPITAL GAINS 4.7 4.3 SHORT TERM AND LONG TERM CAPITAL ASSETS Definition – As per section 2(42A), short-term capital asset means a capital asset held by an assessee for not more than 36 months immediately preceding the date of its transfer. As per section 2(29A), long-term capital asset means a capital asset which is not a short- term capital asset. Thus, a capital asset held by an assessee for more than 36 months immediately preceding the date of its transfer is a long-term capital asset. Exception - A security (other than a unit) listed in a recognized stock exchange, or a unit of an equity oriented fund or a unit of the Unit Trust of India or a Zero Coupon Bond will, however, be considered as a long-term capital asset if the same is held for more than 12 months immediately preceding the date of its transfer. Further, a share of a company (not being a share listed in a recognized stock exchange in India) or an immovable property, being land or building or both would be treated as a short- term capital asset if it was held by an assessee for not more than 24 months immediately preceding the date of its transfer. Thus, the period of holding of unlisted shares or an immovable property, being land or building or both, for being treated as a long-term capital asset would be “more than 24 months” instead of “more than 36 months”. However, capital gains arising from transfer of units of a specified mutual fund acquired on or after 1.4.2023 and market linked debentures would always be deemed as arising from transfer of short term capital assets irrespective of the period of holding of such assets. This is provided in section 50AA. Meaning of certain terms: Term Meaning Equity oriented A fund set up under a scheme of a mutual fund specified under fund [Clause section 10(23D) or under a scheme of an insurance company (a) of comprising ULIPs issued on or after 1.2.2021, to which exemption Explanation to under section 10(10D) does not apply on account of applicability of section 112A] the fourth and fifth provisos thereof and (i) in a case where the fund invested in the units of another fund which is traded on a recognised stock exchange –  4.8 DIRECT TAX LAWS I. a minimum of 90% of the total proceeds of such fund is invested in the units of such other fund; and II. such other fund also invests a minimum of 90% of its total proceeds in the equity shares of domestic companies listed on a recognised stock exchange; and (ii) in any other case, a minimum of 65% of the total proceeds of such fund is invested in the equity shares of domestic companies listed on a recognised stock exchange. However, the percentage of equity shareholding or unit held in respect of the fund, as the case may be, shall be computed with reference to the annual average of the monthly averages of the opening and closing figures. In case of a scheme of an insurance company comprising ULIPs issued on or after 1.2.2021, to which exemption u/s 10(10D) does not apply on account of applicability of the fourth and fifth provisos thereof, the minimum requirement of 90% or 65%, as the case may be, mentioned in (i) and (ii) above, is required to be satisfied throughout the term of such insurance policy. Zero Coupon a bond Bond [Section - issued by any infrastructure capital company or infrastructure 2(48)] capital fund or infrastructure debt fund notified by the Central Government under section 10(47) or a public sector company or a scheduled bank on or after 1st June, 2005, - in respect of which no payment and benefit is received or receivable before maturity or redemption from such issuing entity and - which the Central Government may notify in this behalf. Note: The income from transfer of a Zero coupon bond (not being held as stock-in-trade) is to be treated as capital gains. Section 2(47)(iva) provides that maturity or redemption of a Zero coupon bond shall be treated as a transfer for the purposes of capital gains tax. The definitions of the terms “infrastructure capital company” and “infrastructure capital fund” have already been discussed in Chapter 3 – “Profits and gains from business and profession”.  CAPITAL GAINS 4.9 Period of holding: A summary STCA, if held for ≤ 12 month Security (other than unit) listed in a recognized stock exchange Unit of equity oriented fund/ unit of UTI LTCA, if held for > 12 Zero Coupon bond months STCA, if held for ≤ 24 month Unlisted shares LTCA, if held for > Land or building or both 24 months STCA, if held for ≤ 36 month Unlisted securities other than shares LTCA, if held for > 36 Other capital assets months Note – Capital gains arising from transfer of units of a specified mutual fund acquired on or after 1.4.2023 and market linked debentures would always be deemed as arising from transfer of short term capital assets irrespective of the period of holding of such assets. This is provided in section 50AA Applicability of tax on capital gains in the hands of the unit holders where the term of the units of Mutual Funds under the Fixed Maturity Plans has been extended [Circular No. 6/2015, dated 09-04-2015] Fixed Maturity Plans (FMPs) are closed ended funds having a fixed maturity date wherein the duration of investment is decided upfront. Prior to amendment by the Finance (No. 2) Act, 2014, units of a mutual fund under the FMPs held for a period of more than twelve months qualified as long-term capital asset. The amendment in sub-section (42A) of section 2 by the Finance (No. 2) Act, 2014 required the period of holding in case of units of a mutual fund [other than an equity oriented fund] to be more than thirty-six months to qualify as long term capital asset. As a result, gains arising out of any investment in the units of FMPs made earlier and sold/ redeemed after 10.07.2014 would be taxed as short-term capital gains if the unit was held for a period of thirty-six months or less. To enable the FMPs to qualify as a long-term capital asset, some Asset Management Companies (AMCs) administering mutual funds have offered extension of the duration of the FMPs to a date beyond thirty-six months from the date of the original investment by providing to the investor an option of roll-over of FMPs in accordance with the provisions of Regulation 33(4) of the SEBI (Mutual Funds) Regulation, 1996.  4.10 DIRECT TAX LAWS The CBDT has, vide this Circular, clarified that the roll over in accordance with the aforesaid regulation will not amount to transfer as the scheme remains the same. Accordingly, no capital gains will arise at the time of exercise of the option by the investor to continue in the same scheme. The capital gains will, however, arise at the time of redemption of the units or opting out of the scheme, as the case may be. Determination of period of holding [Clause (i) of Explanation 1 to section 2(42A)]: In determining period of holding of any capital asset by the assessee in the circumstances stated in column (1), the period shall be determined by considering the period specified in Column (2). Determination of period of holding S. Circumstances Period to be reckoned/included/excluded, No. (Column 1) as the case may be (Column 2) 1 Where shares held in a The period subsequent to the date of company in liquidation liquidation of company shall be excluded. 2 Where asset becomes the The period for which the capital asset was property of an assessee by held by the previous owner shall be included. virtue of section 49(1) 3 Where inventory of business is Period from the date of conversion or converted into or treated as a treatment as a capital asset shall be capital asset by the assessee considered. 4 Where share(s) in the Indian The period for which the share(s) was held by company (amalgamated the assessee in the amalgamating company company), becomes the property shall be included. of an assessee in lieu of share(s) held by him in the amalgamating company at the time of transfer referred under section 47(vii). 5 Where the share or any other Period from the date of allotment of such security is subscribed by the share or security shall be reckoned. assessee on the basis of right to subscribe to any share or security or by the person in whose favour such right is renounced by the assessee 6 Where the right to subscribe to Period from the date of offer of such right by any share or security, which is the company or institution shall be reckoned. renounced in favour of any other person  CAPITAL GAINS 4.11 7 Where any financial asset is Period from the date of allotment of such allotted without any payment and financial asset shall be reckoned. on the basis of holding of any other financial asset 8 Where share(s) in the Indian The period for which the share(s) were held company being a resulting by the assessee in demerged company shall company becomes the property be included. of an assessee in consideration of demerger 9 Where trading or clearing The period for which the person was a rights of a recognised stock member of the recognised stock exchange exchange in India is acquired by immediately prior to such demutualisation or a person pursuant to corporatisation shall be included. demutualisation or corporation of a recognised stock exchange in India as referred to in section 47(xiii) 10 Where equity share(s) in a The period for which the person was a company allotted pursuant to member of the recognised stock exchange demutualisation or corporation of immediately prior to such demutualisation or a recognised stock exchange in corporatisation shall be included. India as referred to in section 47(xiii) 11 Where unit of a business trust, The holding period for which the share(s) held allotted pursuant to transfer of by the assessee shall be included. share(s) as referred to in section 47(xvii) 12 Where unit(s) becomes the The period for which the unit(s) in the property of the assessee in consolidating scheme of the mutual fund were consideration of transfer of held by the assessee shall be included. unit(s) in the consolidated scheme of the mutual fund referred to in section 47(xviii) 13 Where share(s) of a company is Period from the date on which a request for acquired by the non-resident such redemption was made shall be assessee on redemption of reckoned. Global Depository Receipts referred to in section 115AC(1)(b) held by such assessee 14 Where equity share in a The period for which the preference shares company becomes the property were held by the assessee shall be included. of the assessee by way of  4.12 DIRECT TAX LAWS conversion of preference shares into equity shares referred under section 47(xb) 15 Where unit(s) becomes the The period for which the unit(s) in the property of the assessee in consolidating plan of a mutual fund scheme consideration of transfer of was held by the assessee shall be included. unit(s) in the consolidated plan of a mutual fund scheme as referred to in section 47(xix) 16 In case of a unit or units in a Period for which the original unit or units in segregated portfolio referred the main portfolio were held by the assessee under section 49(2AG) shall also be reckoned. 17 (i) Electronic Gold Receipt The period for which such gold was held [EGR] issued by a Vault by the assessee prior to conversion into Manager in respect of gold the Electronic Gold Receipt deposited as referred to in section 47(viid) [Conversion of gold into EGR not regarded as transfer by virtue of section 47(viid)] (ii) Gold released in respect of The period for which such Electronic Gold an Electronic Gold Receipt Receipt was held by the assessee prior to as referred to in section its conversion into gold. 47(viid) [Conversion of EGR into Gold not regarded as transfer by virtue of section 47(viid)] 18 Where any specified security or Period from the date of allotment or transfer sweat equity shares allotted or of such specified security or sweat equity transferred, directly or indirectly, shares shall be reckoned. by the employer free of cost or at concessional rate to his employees (including former employees) “Specified security” means the securities as defined in section 2(h) of the Securities Contracts (Regulation) Act, 1956 and, where employees’ stock option has been granted under any plan or scheme therefor, includes the securities offered under such plan or scheme. “Sweat equity shares” means equity shares issued by a company to its employees or directors at a discount or for consideration other than cash for providing know-how or making available rights in the nature of intellectual property rights or value additions, by whatever name called.  CAPITAL GAINS 4.13 Period of holding in respect of other capital assets [Clause (ii) of Explanation 1 to section 2(42A)] - The period for which any capital asset is held by the assessee shall be determined in accordance with any rules made by the CBDT in this behalf. Accordingly, the CBDT has inserted Rule 8AA in the Income-tax Rules, 1962 to provide for method of determination of period of holding of capital assets, other than the capital assets mentioned in clause (i) of Explanation 1 to section 2(42A). - In the case of a capital asset, being a share or debenture of a company, which becomes the property of the assessee in the circumstances mentioned in section 47(x), there shall be included the period for which the bond, debenture, debenture- stock or deposit certificate, as the case may be, was held by the assessee prior to the conversion. Note: Section 47(x) provides that any transfer by way of conversion of bonds or debentures, debenture-stock or deposit certificates in any form, of a company into shares or debentures of that company shall not be regarded as transfer for the purposes of levy of capital gains tax. - In case of a capital asset which became the property of the Indian subsidiary company in consequence to conversion of a branch of a foreign company referred to in section 115JG(1), the period for which the asset was held by the said branch of the foreign company and by the previous owner, if any, who has acquired the capital asset by a mode of acquisition referred to in clause (i)/(ii)/(iii)/(iv) of section 49(1) or section 115JG(1) shall be included. Section 115JG has been discussed in detail in Chapter 21: Non-resident Taxation in Module 4. - In case of the amount which is chargeable to tax as income of specified entity under section 45(4) under the head - "Capital gains", the amount or a part of it shall be deemed to be from transfer of short-term capital asset or long term capital asset, as the case may be, mentioned in column (2), if it is attributed to capital asset mentioned in the corresponding row in column (3) – Deemed capital gains Type of capital asset of specified entity from transfer of capital asset (2) (3) 1. Capital gains from (a) capital asset which is short term capital asset transfer of a short term at the time of taxation of amount under capital asset section 45(4); or  4.14 DIRECT TAX LAWS (b) capital asset forming part of block of asset; or (c) capital asset being self-generated asset and self-generated goodwill as defined in section 45(4) 2. Capital gains from Capital asset which is not covered in 1. above and transfer of a long term is long term capital asset at the time of taxation of capital asset(s) amount under section 45(4). 4.4 TRANSFER: WHAT IT MEANS? [SECTION 2(47)] The Act contains an inclusive definition of the term ‘transfer’. Accordingly, transfer in relation to a capital asset includes the following types of transactions:— (i) the sale, exchange or relinquishment of the asset; or (ii) the extinguishment of any rights therein; or (iii) the compulsory acquisition thereof under any law; or Example: Acquisition of industrial undertaking under the Industries (Development and Regulation) Act, 1951. (iv) the owner of a capital asset may convert/treated the same into/as the stock-in-trade of a business carried on by him. Such conversion/treatment is treated as transfer; or Example: Where an investor in shares starts a business of dealing in shares and treats existing investments as stock-in-trade of the newly set up business, such conversion shall be regarded as transfer for the purpose of capital gains. (v) the maturity or redemption of a zero coupon bond; or (vi) possession of an immovable property in consideration of part-performance of a contract referred to in section 53A of the Transfer of Property Act, 1882. Example: A enters into an agreement for the sale of his house. The purchaser gives the entire sale consideration to A. A hands over complete rights of possession to the purchaser since he has received the entire sale consideration though house is not yet registered in the name of the buyer. Under the Income-tax Act, the above transaction is considered as transfer. (vii) transactions which have the effect of transferring or enabling the enjoyment of an immovable property.  CAPITAL GAINS 4.15 Example: A person may become a member of a co-operative society, company or other association of persons which may be building houses/ flats. When he pays an agreed amount, the society etc. hands over possession of the house to the person concerned. No conveyance deed is registered. For the purpose of income-tax, the above transaction is a transfer. Note – Section 2(47) provides an inclusive definition of “transfer”, in relation to a capital asset. Explanation 2 to section 2(47) clarifies that ‘transfer’ includes and shall be deemed to have always included – (1) disposing of or parting with an - directly or indirectly, asset or any interest therein, or - absolutely or conditionally, (2) creating any interest in any asset - voluntarily or involuntarily in any manner whatsoever by way of an agreement (whether entered into in India or outside India) or otherwise. The above transactions would be deemed as a transfer notwithstanding that such transfer of rights has been characterised as being effected or dependent upon or flowing from the transfer of a share or shares of a company registered or incorporated outside India. 4.5 SCOPE AND YEAR OF CHARGEABILITY [SECTION 45] (1) General Provision [Section 45(1)] Any profits or gains arising from the transfer of a capital asset effected in the previous year (other than exemptions covered under this chapter) shall be chargeable to income-tax under this head in the previous year in which the transfer took place. Year of chargeability - Capital gains are chargeable as the income of the previous year in which the sale or transfer takes place. In other words, for determining the year of chargeability, the relevant date of transfer is not the date of the agreement to sell, but the actual date of sale i.e., the date on which the effect of transfer of title to the property as contemplated by the parties has taken place [Alapati Venkataramiah v. CIT 57 ITR 185 (SC)]. However, as already noted, Income-tax Act has recognised certain transactions as transfer in spite of the fact that conveyance deed might not have been executed and registered.  4.16 DIRECT TAX LAWS (2) Insurance receipts [Section 45(1A)] Where any person receives any money or other assets under any insurance from an insurer on account of damage to or destruction of any capital asset, as a result of - ♦ flood, typhoon, hurricane, cyclone, earthquake or other convulsion of nature; or ♦ riot or civil disturbance; or ♦ accidental fire or explosion; or ♦ action by an enemy or action taken in combating an enemy (whether with or without declaration of war), then, any profits or gains arising from receipt of such money or other assets shall be chargeable to income-tax under the head “Capital gains” and shall be deemed to be the income of the such person for the previous year in which such money or other asset was received. Full value of consideration: In order to compute capital gains, the value of any money or the fair market value of other assets on the date of such receipt shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of such capital assets. (3) Unit Linked Insurance Policy Receipts [Section 45(1B)] Where any person receives, at any time during any previous year, any amount, including the amount allocated by way of bonus, on such policy under a unit linked insurance policy (ULIP) issued on or after 1.2.2021, to which exemption under section 10(10D) does not apply on account of the applicability of the fourth and fifth provisos thereof, then, any profits or gains arising from receipt of such amount by such person shall be chargeable to income-tax under the head "Capital gains" and shall be deemed to be the income of such person of the previous year in which such amount was received. Any ULIP which is issued on or after 1.2.2021 whose premium payable exceeds ` 2,50,000 for any of the previous years during the term of such policy would be a capital asset [Forth proviso to section 10(10D)]. In a case where premium is payable by a person for more than one ULIP issued on or after 1.2.2021 and the aggregate of premium payable on such ULIPs exceed ` 2,50,000 for any of the previous years during the term of any such ULIP(s), the exemption under section 10(10D) 1 would be available in respect of any of those ULIPs (at the option of the assessee) whose aggregate 1 Subject to fulfilment of other conditions under section 10(10D).  CAPITAL GAINS 4.17 premium payable does not exceed ` 2,50,000 for any of the previous years during their term [Fifth proviso to section 10(10D)]. Thus, the amount received under any other ULIP(s) issued on or after 1.2.2021 (referred to as specified ULIPs) to which exemption under section 10(10D) does not apply on account of applicability of the fourth and fifth provisos thereof, would be taxable under section 45(1B). The income from such specified ULIPs taxable is to be calculated in such manner as may be prescribed. Accordingly, Rule 8AD prescribes the following manner to compute capital gains on receipt of amount under such specified ULIPs. Where any person receives at any time during any previous year any amount under such specified ULIP, including the amount allocated by way of bonus on such policy, then, — Situation Capital gains arising from receipt of amount during the previous year in which such amount is received (i) Where the amount is A-B, where received for the first A = the amount received for the first time under such specified ULIP time under such during the previous year, including the amount allocated by way of specified ULIP during bonus on such specified policy; and the previous year, B = the aggregate of the premium paid during the term of such specified ULIP till the date of receipt of the amount as referred to in “A” (ii) Where the amount is C-D, where received under such C = the amount received under such specified ULIP during the specified ULIP during previous year, at any time after the receipt of the amount as referred the previous year, at to in (i) above, including the amount allocated by way of bonus on any time after the such policy. receipt of the amount Note - The amount which has already been considered for as referred to in (i) calculation of taxable amount during the earlier previous year(s) would not be included in “C”. D = the aggregate of the premium paid during the term of such specified ULIP till the date of receipt of the amount as referred to in “C” as reduced by “B” i.e., the premium that has already been considered for calculation of taxable amount during the earlier previous year(s). The capital gains as computed in above table would be deemed to be the capital gains arising from the transfer of a unit of an equity-oriented fund set up under a scheme of an insurance company comprising unit linked insurance policies.  4.18 DIRECT TAX LAWS (4) Conversion or treatment of a capital asset as stock-in-trade [Section 45(2)] A person who is the owner of a capital asset may convert the same or treat it as stock-in-trade of the business carried on by him. As noted above, the conversion/treatment is a transfer. As per section 45(2), notwithstanding anything contained in section 45(1), being the charging section, the profits or gains arising from the above conversion or treatment will be chargeable to income-tax as his income of the previous year in which such stock-in-trade is sold or otherwise transferred by him. Full value of consideration: In order to compute the capital gains, the fair market value of the asset on the date of such conversion or treatment shall be deemed to be the full value of the consideration received as a result of the transfer of the capital asset. Components of income arising Manner of computation of on subsequent capital gains and business sale of stock- income in-trade FMV on the date of conversion (-) Cost/ Indexed Cost of acquisition/ Improvement Capital Indexation benefit would Gains be considered in relation Conversio to the year of conversion n of capital of capital asset into asset into stock-in-trade stock-in- trade Sale price of stock-in- Business trade (-) FMV on the Income date of conversion Note – Both Capital Gains and Business income are chargeable to tax in the year in which stock-in-trade is sold or otherwise transferred. ILLUSTRATION 1 X converts his capital asset (acquired on June 10, 2005 for ` 60,000) into stock-in-trade on March 10, 2023. The fair market value on the date of the above conversion was ` 5,50,000. He subsequently sells the stock-in-trade so converted for ` 6,00,000 on June 10, 2023. Examine the tax implication. Cost Inflation Index - F.Y. 2005-06: 117; F.Y. 2022-23: 331; F.Y. 2023-24: 348.  CAPITAL GAINS 4.19 SOLUTION Since the capital asset is converted into stock-in-trade during the previous year relevant to the A.Y. 2023-24, it will be a transfer under section 2(47) during the P.Y.2022-23. However, the profits or gains arising from the above conversion will be chargeable to tax during the A.Y. 2024-25, since the stock-in-trade has been sold only on June 10, 2023. For this purpose, the fair market value on the date of such conversion (i.e. 10 th March, 2023) will be the full value of consideration. The capital gains will be computed after deducting the indexed cost of acquisition from the full value of consideration. The cost inflation index for 2005-06 i.e., the year of acquisition is 117 and the index for the year of transfer i.e., 2022-23 is 331. The indexed cost of acquisition is ` 60,000 × 331/117 = ` 1,69,744. Hence, ` 3,80,256 (i.e., ` 5,50,000 – ` 1,69,744) will be treated as long- term capital gains chargeable to tax during the A.Y.2024-25. During the same assessment year, ` 50,000 (` 6,00,000 - ` 5,50,000) will be chargeable to tax as business profits. (5) Transfer of beneficial interest in securities [Section 45(2A)] As per section 45(2A), where any person has had at any time during the previous year any beneficial interest in any securities, then, any profits or gains arising from the transfer made by the depository or participant of such beneficial interest in respect of securities shall be chargeable to tax as the income of the beneficial owner of the previous year in which such transfer took place and shall not be regarded as income of the depository who is deemed to be the registered owner of the securities by virtue of section 10(1) of the Depositories Act, 1996. Full value of consideration and period of holding: For the purposes of section 48 and proviso to section 2(42A), the cost of acquisition and the period of holding of securities shall be determined on the basis of the first-in-first-out (FIFO) method. When the securities are transacted through stock exchanges, it is the established procedure that the brokers first enter into contracts for purchase/ sale of securities and thereafter, follow it up with delivery of shares, accompanied by transfer deeds duly signed by the registered holders. ♦ The seller is entitled to receive the consideration agreed to as on the date of contract. ♦ Thus, it is the date of broker's note that should be treated as the date of transfer in case of sale transactions of securities provided such transactions are followed up by delivery of shares and also the transfer deeds. ♦ Similarly, in respect of the purchasers of the securities, the holding period shall be reckoned to take place directly between the parties and not through stock exchanges. ♦ The date of contract of sale as declared by the parties shall be treated as the date of transfer provided it is followed up by actual delivery of shares and the transfer deeds.  4.20 DIRECT TAX LAWS Where securities are acquired in several lots at different points of time, the First-In-First-Out (FIFO) method shall be adopted to reckon the period of the holding of the security, in cases where the dates of purchase and sale could not be correlated through specific numbers of the scrips. In other words, the assets acquired last will be taken to be remaining with the assessee while assets acquired first will be treated as sold. Indexation, wherever applicable, for long-term assets will be regulated on the basis of the holding period determined in this manner - CBDT Circular No. 704, dated 28.4.1995. Meaning of certain terms: Term Meaning Beneficial owner A person whose name is recorded as such with a depository. Depository A company formed and registered under the Companies Act, 1956 2 and which has been granted a certificate of registration under section 12(1A) of the Securities and Exchange Board of India Act, 1992. Security Such security as may be specified by SEBI. (6) Introduction of capital asset as capital contribution [Section 45(3)] Where a person transfers a capital asset to a firm, AOP or BOI in which he is already a partner/ member or is to become a partner/ member by way of capital contribution or otherwise, the profits or gains arising from such transfer will be chargeable to tax as income of the previous year in which such transfer takes place. Full value of consideration: For this purpose, the full value of the consideration will be deemed to be the amount recorded in the books of account of the firm, AOP or BOI as the value of the capital asset. (7) Tax implications on receipt of money or capital asset or stock-in trade by a partner or a member on dissolution or reconstitution of firm/AOPs/BOIs [Section 9B and 45(4)] Tax implications on receipt of capital assets or stock in trade or both on dissolution or reconstitution of firm/AOP or BOI [Section 9B] (i) Deemed transfer in the hands of specified entity - Where a specified person (partner of a firm/member of AoP/BoI) receives during the previous year any capital asset or stock in trade or both from a specified entity (firm/AoP/BoI, as the case may be) in connection with the dissolution or reconstruction of such specified entity, then such specified entity would be deemed to have transferred such capital asset or stock in trade or both, as the case may be, to 2 Now Companies Act, 2013  CAPITAL GAINS 4.21 the specified person in the year in which such capital asset or stock in trade or both are received by the specified person. (ii) Year of taxability – Any profits and gains from such deemed transfer of capital asset or stock in trade or both, as the case may be, by the specified entity shall be deemed to be the income of such specified entity of the previous year in which such capital asset or stock in trade or both were received by the specified person (iii) Head of income – Any profit and gains from such deemed transfer of capital asset would be chargeable to income-tax as income of such specified entity under the head “Capital gains”. Any profits and gains from such deemed transfer of stock in trade would be chargeable to tax under the head “Profits and gains from business or profession”, in accordance with the provisions of this Act. (iv) Full value of consideration - In order to compute the capital gains, the fair market value of the capital asset or stock in trade or both on the date of its receipt by the specified person shall be deemed to be the full value of the consideration received or accruing as a result of such deemed transfer of the capital asset or stock in trade or both by the specified entity. Tax implications on receipt of money or capital assets or both on reconstitution of firm/AOP or BOI [Section 45(4)] (i) Deemed income in the hands of specified entity – Where a specified person receives during the previous year any money or capital asset or both from a specified entity in connection with the reconstitution of such specified entity, then any profits or gains arising from such receipt by the specified person shall be chargeable to income-tax as income of such specified entity under the head “Capital gains”. (ii) Year of taxability – Such profits and gains shall be deemed to be the income of specified entity of the previous year in which such money or capital asset or both were received by the specified person. (iii) Computation of such profits and gains from such receipt – Notwithstanding anything to the contrary contained in this Act, such profits or gains shall be determined in accordance with the following formula – A** = B + C – D A = Income chargeable to income-tax u/s 45(4) as income of the specified entity under the head "Capital gains" B = Value of any money received by the specified person from the specified entity on the date of such receipt;  4.22 DIRECT TAX LAWS C = The amount of fair market value of the capital asset received by the specified person from the specified entity on the date of such receipt; and D = The amount of balance in the capital account (represented in any manner) of the specified person in the books of account of the specified entity at the time of its reconstitution. Balance in the capital account of the specified person in the books of account of the specified entity is to be calculated without taking into account the increase in the capital account of the specified person due to the following - revaluation of any asset or - self-generated goodwill or - any other self-generated asset. "self-generated goodwill" and "self-generated asset" mean goodwill or asset, as the case may be, which has been acquired without incurring any cost for purchase or which has been generated during the course of the business or profession. ** If the value of "A" in the above formula is negative, its value shall be deemed to be zero. (iv) Taxability u/s 45(4) is in addition to taxability under section 9B – When a capital asset is received by a specified person from a specified entity in connection with the reconstitution of such specified entity, the provisions of this section shall operate in addition to the provisions of section 9B and the taxation under section 9B shall be worked out independently. (v) Definition of certain terms commonly used under both section 9B and 45(4): Terms Meaning Specified person a person, who is a partner of a firm or member of AOPs or BOIs (not being a company or a co-operative society) in any previous year. Specified entity a firm or other AOPs or BOIs (not being a company or a co-operative society) Reconstitution of Where the specified (a) one or more of its partners or members, as the case may be, of such entity specified entity ceases to be partners or members; or (b) one or more new partners or members, as the case may be, are admitted in such specified entity in such circumstances that one or more of the persons who were partners or members, as the case may be, of the specified entity, before the change, continue as partner or partners or member or members after the change; or  CAPITAL GAINS 4.23 (c) all the partners or members, as the case may be, of such specified entity continue with a change in their respective share or in the shares of some of them Note: The case of dissolution of specified entity which is dealt in section 9B is not covered under section 45(4). The taxability of receipt of money by a partner of a firm/ member of AoP/BoI on reconstitution of firm/AoP/BoI, as the case may be, is dealt with only in section 45(4) and not in section 9B. The taxability of receipt of stock-in-trade by a partner of a firm/member of AoP/BoI on reconstitution is dealt with in section 9B. Therefore, it is only receipt of capital asset by a partner of a firm/member of an AoP/BoI on reconstitution of the firm/AoP/BoI which is taxable under section 9B and under section 45(4). (vi) Type of capital gain from capital asset received by specified person from specified entity in connection with its reconstitution [Section 2(42A) Rule 8AA]: In case of the amount which is chargeable to tax as income of specified entity under section 45(4) under the head - "Capital gains", the amount or a part of it shall be deemed to be from transfer of short-term capital asset or long term capital asset, as the case may be, mentioned in column (2), if it is attributed to capital asset mentioned in the corresponding row in column (3) - Deemed capital gains from Type of capital asset of specified entity transfer of capital asset (2) (3) 1. Capital gains from transfer of (a) capital asset which is short term capital asset at the a short term capital asset time of taxation of amount under section 45(4); or (b) capital asset forming part of block of asset; or (c) capital asset being self-generated asset and self- generated goodwill as defined in section 45(4) 2. Capital gains from transfer of Capital asset which is not covered in 1. above and is long a long term capital asset(s) term capital asset at the time of taxation of amount under section 45(4). (vii) Attribution of capital gains: For the purpose of section 48(iii), where the amount is chargeable to income-tax as income of specified entity under section 45(4), the specified entity shall attribute such amount to capital asset remaining with the specified entity in the prescribed manner: Accordingly, Rule 8AB provides that the specified entity shall attribute such amount to capital asset remaining with the specified entity in the following manner:  4.24 DIRECT TAX LAWS S. No. Particulars Attribution to the capital assets remaining with the specified entity Where the aggregate of the value of money and the fair market value of the capital asset received by the specified person from the specified entity, in excess of the balance in his capital account, chargeable to tax under section 45(4) - (i) relates to revaluation of any capital increase in, or asset or valuation of self-generated recognition of, value of asset or self-generated goodwill, of the that asset because of the specified entity. amount x revaluation or valuation The revaluation should be based on charge aggregate of increase in, a valuation report obtained from a d u/s or recognition of, value registered valuer. 45(4) of all assets because of the revaluation or valuation (ii) does not relate to revaluation of any the amount charged to tax under section capital asset or valuation of self 45(4) shall not be attributed to any capital generated asset or self-generated asset goodwill, of the specified entity (iii) relate only to the capital asset the amount charged to tax under section received by the specified person 45(4) shall not be attributed to any capital from the specified entity asset The specified entity shall furnish the details of amount attributed to capital asset remaining with the specified entity in Form No. 5C. Form No. 5C shall be furnished on or before the due date referred to in the Explanation 2 below section 139(1) for the assessment year in which the amount is chargeable to tax under section 45(4). It is clarified that revaluation of an asset or valuation of self-generated asset or self-generated goodwill does not entitle the specified entity for the depreciation on the increase in value of that asset on account of its revaluation or recognition of the value of self-generated asset or self- generated goodwill due to its valuation. (viii) Power of CBDT to issue guidelines [Section 9B(4) and 9B(5)] - If any difficulty arises in giving effect to the provisions of section 9B and section 45(4), the CBDT may issue guidelines for the purpose of removing the difficulty with the approval of the Central Government.  CAPITAL GAINS 4.25 Every guideline issued by the CBDT shall be laid before each House of Parliament, and shall be binding on the income-tax authorities and on the assessee. Guidelines under section 9B and section 45(4) of the Income-tax Act, 1961 [Circular No. 14/2021 dated 2.7.2021] The amount taxed under section 45(4) is required to be attributed to the remaining capital assets of the specified entity, so that when such capital assets get transferred in the future, the amount attributed to such capital assets gets reduced from the full value of the consideration and to that extent the specified entity does not pay tax again on the same amount. This attribution is given only for the purposes of section 48. Section 48 only applies to capital assets which are not forming block of assets. For capital assets forming block of assets there is section 43(6)(c) to determine written down value of the block of asset and section 50 to determine the capital gains arising on transfer of such assets. However, the Act has not yet provided that amount taxed under section 45(4) can also be attributed to capital assets forming part of block of assets and which are covered by these two provisions. The CBDT has, vide this circular, clarified that Rule 8AB also applies to capital assets forming part of block of assets. Wherever the terms capital asset is appearing in the Rule 8AB, it refers to capital asset whose capital gains is computed under section 48 as well as capital asset forming part of block of assets. Further, wherever reference is made for the purposes of section 48, such reference may be deemed to include reference for the purposes of section 43(6)(c) and section 50. It is further clarified that in case the capital asset remaining with the specified entity is forming part of a block of asset, the amount attributed to such capital asset under rule 8AB shall be reduced from the full value of the consideration received or accruing as a result of subsequent transfer of such asset by the specified entity, and the net value of such consideration shall be considered for reduction from the written down value of such block under section 43(6)(c) or for calculation of capital gains, as the case may be, under section 50. For the purposes of understanding and for removing difficulties, if any, the application of section 9B and section 45(4) is explained with the help of the following examples: Example 1: There are three partners “A”, “B” and "C" in a firm "FR", having one third share each. Each partner has a capital balance of ` 10 lakh in the firm. There are three pieces of lands “S”, “T” and “U” in that firm and there is no other capital asset in that firm. Book value of each of the land is ` 10 lakh. All these three lands were acquired by the firm more than two years ago.  4.26 DIRECT TAX LAWS Partner “A” wishes to exit. The firm revalues its lands based on valuation report from a registered valuer, as defined in rule 11U, and as per that valuation report fair market value of lands “S” and “T” is ` 70 lakh each, while fair market value of land “U” is ` 50 lakh. On the exit of partner “A", the firm decides to give him ` 11 lakh of money and land “U” to settle his capital balance. In accordance with the provisions of section 9B, it would be deemed that the firm “FR" has transferred land “U” to the partner "A" at its fair market value of ` 50 lakh. Let us assume that the indexed cost of acquisition of land “U" is ` 15 Iakh. Now on account of the deeming provisions of section 9B, it is deemed that the firm “FR" has transferred land “U” to partner “A". Thus, an amount of ` 50 lakh less ` 15 lakh would be charged to tax in the hands of firm “FR" under the head “Capital gains”. For partner “A", the cost of acquisition of this land would be ` 50 lakh. Hence, the amount of ` 35 lakh is charged to long term capital gains and let us assume that the tax is ` 7 lakh (assume no surcharge or cess just for ease of calculation and illustration purposes). This, net book profit after tax of ` 33 lakh (capital gains of ` 40 lakh without indexation less tax of ` 7 lakh) is to be credited in the capital account of each of the three partners, i.e. ` 11 lakh each. Thus partner “A" capital account would increase to ` 21 lakh. This exercise is required to be carried out since section 9B mandates that it is to be deemed that the firm “FR" has transferred the land “U" to partner "A" and the long term capital gains of ` 35 lakh is chargeable to tax in the hands of the firm “FR". As against capital balance of ` 21 lakh, partner “A" has received ` 61 lakh (` 11 lakh of money plus land “U" of fair market value of ` 50 lakh). Thus ` 40 lakh is required to be charged to tax under section 45(4). This shall be in addition to an amount of ` 35 lakh charged to tax under section 9B. On account of clause (iii) of section 48, read with rule 8AB, this ` 40 lakh is to be attributed to the remaining assets of the firm “FR" on the basis of increase in their value due to revaluation based on the valuation report of registered valuer. In this case as per revaluation there are only two capital assets remaining; lands “S" and “T". In both cases the value has increased by ` 60 lakh each. Thus, out of ` 40 lakh, ` 20 lakh shall be attributed to land “S" and ` 20 lakh to land “T". When either of these lands gets sold, this amount attributed to them would be reduced from sales consideration under clause (iii) of section 48. The amount of ` 40 lakh which is charged to tax under section 45(4) shall be charged as long term capital gains in view of rule 8AA(5), since the amount of ` 40 lakh is attributed to land “S" and land “T" which are both long term capital assets at the time of taxation of ` 40 lakh under section 45(4).  CAPITAL GAINS 4.27 Example 2: There are three partners “A", “B" and “C" in a firm “FR", having one third share each. Each partner has a capital balance of ` 10 lakh in the firm. There are three pieces of lands “S", “T" and “U" in that firm and there is no other capital asset in that firm. All these three lands were acquired by the firm more than two years ago. Book value of each of the land is ` 10 lakh. Partner “A" wishes to exit. The firm sells land “U" for its fair market value of ` 50 lakh. Let us assume that the indexed cost of acquisition of land “U" is ` 15 lakh. Thus, an amount of ` 50 lakh less ` 15 lakh would be charged to tax in the hands of firm “FR" under the head “Capital gains". Hence, the amount of ` 35 lakh is charged to long term capital gains and let us assume that the tax is ` 7 lakh (assume no surcharge or cess just for ease of calculation and illustration purposes). This, net book profit after tax of ` 33 lakh (capital gains of ` 40 lakh without indexation less tax of ` 7 lakh) is to be credited in the capital account of each of the three partners, i.e. ` 11 lakh each. Thus, partner “A” capital account would increase to ` 21 lakh. Partner “A” decides to exit the firm “FR”. The firm revalues its lands “S” and “T” based on valuation report from a registered valuer, as defined in Rule 11U, and as per that valuation report fair market value of lands “S” and “T” is ` 70 lakh each. On the exit of partner “A”, the firm decides to give him ` 61 lakh of money to settle his capital balance. Thus, as against capital balance of ` 21 lakh, partner “A” has received ` 61 lakh of money. Thus ` 40 lakh is required to be charged to tax section 45(4). This will be in addition to ` 35 lakh already charged to capital gains. On account of section 48(iii), read with rule 8AB, this ` 40 lakh is to be attributed to the remaining assets of the firm “FR” on the basis of increase in their value due to revaluation based on the valuation report of registered valuer. In this case, as per revaluation, there are only two capital assets remaining: lands “S” and “T”. In both cases, the value has increased by ` 60 lakh each. Thus, out of ` 40 lakh, ` 20 lakh shall be attributed to land “S” and ` 20 Lakh to land “’T’’. When either of these lands gets sold, this amount attributed to them would be reduced from sales consideration under section 48(iii). The amount of ` 40 lakh which is charged to tax under section 45(4) shall be charged as long term capital gains in view of rule 8AA(5), since the amount of ` 40 lakh is attributed to land “S” and land “T” which are both long term capital assets at the time of taxation of ` 40 lakh under section 45(4). Note: The final result in both example 1 and 2 is same due to the operation of section 9B. Example 3: There are three partners “A”, “B” and “C” in a firm “FR”, having one third share each. Each partner has a capital balance of ` 100 lakh in the firm. There is a piece of land “S” of book value of ` 30 lakh. There is patent “T” of written down value of ` 45 lakh. And there is cash of  4.28 DIRECT TAX LAWS ` 225 lakh. The land was acquired by the firm more than two years ago. The patent was acquired/ developed/ registered one year back. Partner “A” wishes to exit. The firm revalues its land and patent based on valuation report from a registered valuer, as defined in rule 11U, and as per that valuation report, fair market value of land “S” is ` 45 lakh and fair market value of patent “T” is ` 60 lakh. As per the valuation report, there is also self-generated goodwill of ` 30 lakh. On the exit of partner “A”, the firm decides to give him ` 75 lakh in money and land “S" to settle his capital balance. In accordance with the provisions of section 9B, it would be deemed that the firm “FR" has transferred land “S" to the partner “A" at its fair market value of ` 45 lakh. Let us assume that the indexed cost of acquisition of land “S" is ` 45 lakh. Now, on account of the deeming provisions of section 9B, it is deemed that the firm “FR" has transferred land “S" to partner “A". However, since the sale consideration is equal to indexed cost of acquisition, there will not be any capital gains tax. For partner “A", the cost of acquisition of this land would be ` 45 lakh. The net book profit of ` 15 lakh (capital gains of ` 15 lakh without indexation) is to be credited in the capital account of each of the three partners, i.e., ` 5 lakh each. Thus, partner “A" capital account would increase to ` 105 lakh. This exercise is required to be carried out since section 9B mandates that it is to be deemed that the firm “FR" has transferred the land “S" to partner “A". Thus, any gain in the books is to be apportioned to partners' capital accounts. As against capital balance of ` 105 lakh, partner “A" has received ` 120 lakh (money of ` 75 Lakh plus land “S" of fair market value of ` 45 lakh). Thus, ` 15 lakh is required to be charged to tax under section 45(4). On account of section 48(iii), read with rule 8AB and this guidance note, this ` 15 lakh is to be attributed to the remaining capital assets of the firm “FR" on the basis of increase in the value due to revaluation of existing capital assets, or due to recognition of the value of self-generated goodwill, based on the valuation report of registered valuer. In this case, as per this report, the value of patent “T" has increased by ` 15 lakh and the self-generated goodwill value has been recognised at ` 30 lakh. Thus, one third of ` 15 lakh (i.e. ` 5 lakh) would be attributed to patent “T", while two third of ` 15 lakh (i.e. ` 10 lakh) would be attributed to self-generated goodwill. ` 5 lakh attributed to patent “T" shall not be added to the block of the assets and no depreciation shall be available on the same. When patent “T" gets transferred subsequently, this ` 5 lakh attributed shall be reduced from the full value of the consideration received or accruing as a result of transfer of patent “T" by the firm “FR", and the net value shall be considered for reduction from the written  CAPITAL GAINS 4.29 down value of the intangible block under section 43(6)(c) or for calculation of capital gains, as the case may be, under section 50. (Refer guidance in paragraph 5 of this circular). Let us say that Patent T is sold for ` 25 lakh. ` 5 lakh shall be reduced from ` 25 lakh and only net amount of ` 20 lakh shall be considered for reduction from the written down value of the intangible block under section 43(6)(c) or for calculation of capital gains, as the case may be, under section 50. Similarly, when goodwill gets sold subsequently, ` 10 lakh would be reduced from its sales consideration under section 48(iii). The amount ` 15 lakh which is charged to tax under section 45(4) shall be charged as short term capital gains, as ` 5 lakh is attributed to the Patent “T" which is part of block of assets and ` 10 lakh is attributed to self-generated goodwill. In accordance with rule 8AA(5), both of these are to be characterised as short term capital gains. Note: For the purpose of calculation of depreciation under section 32, the written down value of the block of asset “intangible" of which Patent “T" is part, would remain ` 45 lakh and would not be increased to ` 60 lakh due to revaluation during the year. In this regard it may be highlighted that the following provisions are relevant in determining the amount on which depreciation is allowable under the Act: Explanation 2 of section 32(1) provides that the term "written down value of the block of assets" shall have the same meaning as in section 43(6)(c). Section 43(6)(c), with respect to block of assets, inter alia, provides that the aggregate of the written down values of all the assets falling within that block of assets at the beginning of the previous year is to be increased by the actual cost of any asset falling within that block, acquired during the previous year. This clause does not allow any increase on account of revaluation. Section 43(1) which defines “Actual cost" as actual cost of the assets to the assessee. In revaluation, there is no actual cost to the assessee. Further, section 32 does not allow depreciation on goodwill. If in the given example “self-generated goodwill" is replaced by “self-generated asset", even then, the depreciation will not be admissible on the amount of ` 30 lakh recognised in valuation. In this regard it may be highlighted that the above mentioned provisions, in the immediate preceding paragraph, are also applicable to “self- generated asset" and since there is no actual cost to assessee in case of “self-generated asset", depreciation is not allowable under section 32 on an asset whose actual cost is nil.  4.30 DIRECT TAX LAWS (8) Compensation on compulsory acquisition [Section 45(5)] Sometimes, a building or some other capital asset belonging to a person is taken over by the Central Government by way of compulsory acquisition. In that case, the consideration for the transfer is determined by the Central Government or RBI. When the Central Government pays the above compensation, capital gains may arise. Such capital gains are chargeable as income of the previous year in which such compensation or part thereof, was first received. Enhanced Compensation- Many times, persons whose capital assets have been taken over by the Central Government and who get compensation from the government go to the court of law for enhancement of compensation. If the court awards a compensation which is higher than the original compensation, the difference thereof will be chargeable to capital gains in the year in which the same is received from the government. Cost of acquisition in case of enhanced compensation - For this purpose, the cost of acquisition and cost of improvement shall be taken to be nil. Compensation received in pursuance of an interim order deemed as income chargeable to tax in the year of final order - In order to remove the uncertainty regarding the year in which the amount of compensation received in pursuance of an interim order of the court is to be charged to tax, a proviso has been inserted after clause (b) to provide that such compensation shall be deemed to be income chargeable under the head ‘Capital gains’ in the previous year in which the final order of such court, Tribunal or other authority is made. Reduction of enhanced compensation - Where capital gain has been charged on the compensation received by the assessee for the compulsory acquisition of any capital asset or enhanced compensation received by the assessee and subsequently such compensation is reduced by any court, tribunal or any authority, the assessed capital gain of that year shall be recomputed by taking into consideration the reduced amount. This re-computation shall be done by way of rectification under section 155. Death of the transferor- It is possible that the transferor may die before he receives the enhanced compensation. In that case, the enhanced compensation or consideration will be chargeable to tax in the hands of the person who receives the same. (9) Taxability of capital gains in case of Specified Agreement [Section 45(5A)] Genuine hardship on account of taxability of capital gains in the year of transfer of property to developer: The definition of 'transfer', inter alia, includes any arrangement or transaction where any rights are handed over in execution of part performance of contract, even though the legal title has not been transferred.  CAPITAL GAINS 4.31 Applying the definition of transfer, under these development agreements, the transfer took place in the year in which the owner of the immovable property, being land or building or both handed over the immovable property to the developer. Consequently, the capital gains tax liability in the hands of the owner would arise in the year in which the possession of immovable property is handed over to the developer for development of a project, in spite of the fact that the consideration thereof (i.e. the actual constructed property) will be received only after a couple of years. Deferment of taxability of capital gains: With a view to minimise the genuine hardship which the owner of land or building may face in paying capital gains tax in the year of transfer, section 45(5A) provides that - in case of an assessee being individual or Hindu undivided family, - who enters into a specified agreement for development of a project, - the capital gain arises from such transfer shall be chargeable to income-tax as income of the previous year in which the certificate of completion for the whole or part of the project is issued by the competent authority. Meaning of Specified Agreement: Specified agreement means the registered agreement in which a person owing land or building or both, agrees to allow another person to develop a real estate project on such land or building or both, in consideration of a share, being land or building or both in such project, whether with or without payment of part of the consideration in cash. Full value of consideration: For the purpose of section 48, the stamp duty value of his share, being land or building or both, in the project on the date of issuing of said certificate of completion as increased by any consideration received in cash or by a cheque or draft or by any other mode, if any, shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of the capital asset. Non-applicability of the beneficial provision: It may, however, be noted these beneficial provisions would not apply, where the assessee transfers his share in the project on or before the date of issue of said completion certificate and the capital gain tax liability would be deemed to arise in the previous year in which such transfer took place. In such a case, full value of consideration received or accruing shall be determined by the general provisions of the Act. [Proviso to section 45(5A)]  4.32 DIRECT TAX LAWS Meaning of certain terms: Term Meaning Competent authority The authority empowered to approve the building plan by or under any law for the time being in force Stamp duty value The value adopted or assessed or reassessable by any authority of Government for the purpose of payment of stamp duty in respect of an immovable property being land or building or both. Taxability of capital gains in case of Specified Agreement: At a Glance Individual/ HUF entering into specified agreement for development of project Is the individual/ HUF transferring his share No Is the individual/ HUF in the project after the date of issue of transferring his share in the completion certificate? project on or before the date of issue of completion certificate? Yes Yes Capital gains tax liability would arise in the Capital gains tax liability would P.Y. in which Certificate of Completion arise in the P.Y. in which the for whole or part of project is issued by the property is handed over to Competent Authority the developer Stamp duty value of his share, on the date of issue of certificate of completion (+) Consideration in cash or cheque or draft or any other mode = Full Value of Consideration as per section 45(5A) Full value of consideration deemed to be the cost of acquisition for determining capital gains on subsequent sale of share of developed property [Section 49(7)]  CAPITAL GAINS 4.33 4.6 CAPITAL GAINS ON DISTRIBUTION OF ASSETS BY COMPANIES IN LIQUIDATION [SECTION 46] (1) In the hands of liquidated company: Where the assets of a company are distributed to its shareholders on its liquidation, such distribution shall not be regarded as a transfer by the company for the purposes of section 45 [Section 46(1)]. The above section is restricted in its application to the circumstances mentioned therein i.e., the assets of the company must be distributed to shareholders on the liquidation of the company. If, however, the liquidator sells the assets of the company resulting in a capital gain and distributes the funds so collected, the company will be liable to pay tax on such gains. (2) In the hands of shareholders: Shareholders receive money or other assets from the company on its liquidation. They will be chargeable to income-tax under the head ‘capital gains’ in respect of the market value of the assets received on the date of distribution, or the moneys so received by them. The portion of the distribution which is attributable to the accumulated profits of the company is to be treated as dividend income of the shareholder under section 2(22)(c), which would be taxable in the hands of shareholders under the head “Income from other sources”. The same will be deducted from the amount received/ fair market value for the purpose of determining the full value of consideration for computation of capital gains. (3) Capital gains tax on subsequent sale by the shareholders: If the shareholder, after receipt of any such asset on liquidation of the company, transfers it, then Fair Market Value on the date of distribution would be treated as cost of acquisition of such asset.  4.34 DIRECT TAX LAWS Capital Gains on distribution of assets by companies in liquidation [Section 46] In the hands of the In the hands of the company [Section shareholders 46(1)] [Section 46(2)] Distribution is not a transfer Distribution attributable to Money received (+) FMV of accumulated profits of the assets distributed (-) company deemed dividend u/s 2(22)(c) No capital gains tax liability Deemed dividend u/s Full value of 2(22)(c) consideration for the purpose of section 48 Taxable in the hands of To be considered for shareholders as “Income computing Capital from Other Sources” Gains in the hands of shareholders 4.7 CAPITAL GAINS ON BUYBACK OF SHARES OR OTHER SECURITIES [SECTION 46A] (1) In case of specified securities other than shares: Any consideration received by a holder of specified securities (other than shares) from any company on purchase of its specified securities is chargeable to tax in the hands of the holder of specified securities. The difference between the cost of acquisition and the value of consideration received by the holder of securities is chargeable to tax as capital gains in his hands. The computation of capital gains shall be made in accordance with the provisions of section 48.  CAPITAL GAINS 4.35 Such capital gains shall be chargeable in the year in which such securities were purchased by the company. For this purpose, “specified securities” shall have the same meaning as given in Explanation to section 77A of the Companies Act, 1956 3. As per Section 68 of the Companies Act, 2013, "specified securities" includes employees' stock option or other securities as may be notified by the Central Government from time to time. Note – As far as shares are concerned, this provision would be attracted in the hands of the shareholder only if the shares are bought back by a company, other than a domestic company. (2) In case of shares (whether listed or unlisted): In case of buyback of shares (whether listed or unlisted) by domestic companies, additional income-tax @20% (plus surcharge@12% and cess@4%) is leviable in the hands of the company under section 115QA. Consequently, the income arising to the shareholders in respect of such buyback of shares by the domestic company would be exempt under section 10(34A), since the domestic company is liable to pay additional income-tax on the buyback of shares. Taxation provisions in respect of buyback (1) (2) (3) (4) Taxability Buyback of shares Buyback of shares by Buyback of specified in the by domestic a company, other than securities by any hands of companies a domestic company company Company Subject to additional Not subject to tax in the Not subject to tax in the [email protected]%. hands of the company. hands of the company. Shareholder/ Income arising to Income arising to Income arising to holder holder of shareholders exempt shareholder taxable as of specified securities specified under section 10(34A) capital gains u/s 46A. taxable as capital gains securities u/s 46A. 4.8 IMPORTANT DEFINITIONS (a) Amalgamation [Section 2(1B)] - “Amalgamation”, in relation to companies, means - the merger of one or more companies with another company or - the merger of two or more companies to form one company 3 Now section 68 of the Companies Act, 2013  4.36 DIRECT TAX LAWS (the company or companies which so merge being referred to as the amalgamating company or companies and the company with which they merge or which is formed as a result of the merger, as the amalgamated company) in such a manner that - (i) all the property of the amalgamating company or companies immediately before the amalgamation becomes the property of the amalgamated company by virtue of the amalgamation; (ii) all the liabilities of the amalgamating company or companies immediately before the amalgamation become the liabilities of the amalgamated company by virtue of the amalgamation; (iii) shareholders holding not less than three-fourth in value of the shares in the amalgamating company or companies (other than shares already held therein immediately before the amalgamation by, or by a nominee for, the amalgamated company or its subsidiary) become shareholders of the amalgamated company by virtue of the amalgamation, otherwise than as a result of the acquisition of the property of one company by another company pursuant to the purchase of such property by the other company or as a result of the distribution of such property to the other company after the winding up of the first mentioned company. (b) Demerger [Section 2(19AA)] - “Demerger”, in relation to companies, means the transfer, pursuant to a scheme of arrangement under sections 230 to 232 of the Companies Act, 2013, by a demerged company of its one or more undertaking to any resulting company in such a manner that - (i) all the property of the undertaking, being transferred by the demerged company, immediately before the demerger, becomes the property of the resulting company by virtue of the demerger; (ii) all the liabilities relatable to the undertaking, being transferred by the demerged company, immediately before the demerger, become the liabilities of the resulting company by virtue of the demerger; (iii) the property and the liabilities of the undertaking or undertakings being transferred by the demerged company are transferred at values appearing in its books of account immediately before the demerger;  CAPITAL GAINS 4.37 However, this provision does not apply where, in compliance to the Indian Accounting Standards specified in Annexure to the Companies (Indian Accounting Standards) Rules, 2015, the resulting company records the value of the property and the liabilities of the undertaking or undertakings at a value different from the value appearing in the books of account of the demerged company, immediately before the demerger. (iv) the resulting company issues, in consideration of the demerger, its shares to the shareholders of the demerged company on a proportionate basis except where the resulting company itself is a shareholder of the demerged company; Note - If the resulting company is a shareholder of the demerged company, it cannot issue shares to itself. However, the resulting company has to issue shares to the other shareholders of the demerged company. (v) the shareholders holding not less than three-fourths in value of the shares in the demerged company (other than shares already held therein immediately before the demerger, or by a nominee for, the resulting company or, its subsidiary) become shareholders of the resulting company or companies by virtue of the demerger, otherwise than as a result of the acquisition of the property or assets of the demerged company or any undertaking thereof by the resulting company; (vi) the transfer of the undertaking is on a going concern basis; (vii) the demerger is in accordance with the conditions, if any, notified under section 72A(5) by the Central Government in this behalf. Explanation in respect of Certain Terms: Explanation Term Particulars 1 Undertaking Includes - any part of an undertaking or a unit or division of an undertaking or - a business activity taken as a whole, However, it does not include individual assets or liabilities or any combination thereof not constituting a business activity. 2 Liabilities Includes (a) the liabilities which arise out of the activities or operations of the undertaking; (b) the specific loans or borrowings (including  4.38 DIRECT TAX LAWS debentures) raised, incurred and utilised solely for the activities or operations of the undertaking; and (c) in cases, other than those referred to in clause (a) or clause (b), so much of the amounts of general or multipurpose borrowings, if any, of the demerged company as stand in the same proportion which the value of the assets transferred in a demerger bears to the total value of the assets of such demerged company immediately before the demerger. 3 Property For the purpose of determining the value of the property, any change in the value of assets conse- quent to their revaluation shall be ignored. 4&5 Splitting up or (i) Splitting up or the reconstruction of reconstruction - any authority or - a body constituted or established under a Central, State or Provincial Act, or - a local authority or - a public sector company, into separate authorities or bodies or local authorities or companies, as the case may be, shall be deemed to be a demerger if such split up or reconstruction fulfils such conditions as may be notified by the Central Government in the Official Gazette. (ii) The reconstructi