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Capital Gains Exemption

Last Update Date : April 06, 2018

Profit or gains resulting from the transfer of a capital asset are called Capital Gains. These gains are charged to tax under the head Capital Gains.

Tax Rates on Long-Term and Short-Term Capital Gains

  • The long-term capital gains on listed stocks and equity mutual funds are not taxable. However, the short-term gains are taxable at 15%
  • In case of debt mutual funds, both short and long-term capital gains are taxable
  • The short-term capital gains on other assets including debt mutual fund are included in the total income and considered taxable as per the individual’s Income Tax Slab
  • The long-term capital gains on other assets including debt mutual funds are taxable at 20% with indexation and 10% without indexation (CII)

No deduction under sections 80C to 80U is allowed from long-term capital gains and short-term capital gain taxable under section 111A.

Exemptions under Section 54 and Section 54F

Certain exemptions, to help taxpayers save tax on capital gains, under Section 54 and Section 54F have been laid out by the Income Tax Act.

 

Section 54 Exemption available on long-term Capital Gain on sale of a House Property
Section 54F Exemption available on long-term Capital Gain on sale of any asset other than a House Property

To restate, both the exemptions are available only on long-term capital gains.

These are the common requirements between Section 54 and Section 54F

  1. A new residential house property considered for capital gains exemption must be either purchased or constructed to claim the exemption
  2. Only ONE house property can be purchased or constructed for capital gains exemption.
  3. The new residential property must be purchased
  • either 1 year before the sale or
  • 2 years after the sale of the property or the said asset.
    OR
    The new residential house property must be built/constructed within 3 years of the sale of the original property/asset

In case an assessee is unable to invest the definite amount in the mode stated above prior to the date of tax filing or 1 year before the date of sale, whichever is earlier, he needs to deposit that amount, as specified, in a public sector bank (or other banks as per the Capital Gains Account Scheme, 1988)

Since FY 2014-15, the government has made it mandatory that this new residential property must be situated in India. Properties either purchased or constructed outside India shall not be eligible for capital gains tax exemption.

Differences Between Section 54 and Section 54F

Section 54 Section 54F
To claim full exemption on capital gains tax, the entire amount of capital gains have to be invested. To claim full exemption on capital gains tax, the entire sale receipts have to be invested.
In case of failure of entire capital gains investment, the portion of the amount not invested is charged to tax as long-term capital gains. In case of failure of entire sale receipts investments, the exemption is allowed proportionately as follows:

[Exemption = Cost the new house x Capital Gains/Sale Receipts]

An assessee should not own more than one residential house at the time of sale of the original asset.
If an assessee sells this new property within 3 years of purchase or construction, this exemption will be reversed. Capital gains from the sale of the new property will be taxed as short-term capital gains. If an assessee sells this new property within 3 years of purchase or construction OR buy another residential house within 2 years of the sale of the original asset OR construct a residential house other than the new house within 3 years of the sale of the original asset, this exemption will be reversed. Capital gains from the sale will be taxed as long-term capital gains.

Criteria for Capital Gains Exemption

  1. Ideally, the property must be purchased on the name of the seller but as per the recent ruling of various tribunals and court, even the property purchased in the name of close relatives can qualify for exemption if the consideration for the purchase of new property is paid by the person claiming the exemption.
  2. If the builder of the new residential construction fails to handover the property possession to the taxpayer within 3 years of purchase, the exemption is still allowed.
  3. When the cost of the new residential property is lower than the total sale amount, the capital gains exemption is allowed proportionately.
  4. An assessee (taxpayer) can invest the remaining amount under Section 54EC within 6 months from the date of sale of the original asset.

Exemptions in Respect of Long-Term Capital Gains

Capital Gains on Sale of Residential House (Sec.54):

Capital gains received on sale of a residential house, whether self-occupied or let-out, is fully exempted from capital gains tax subject to the following:

  • The Assessee should be an Individual or HUF.
  • The house is held for more than 3 years (2 years starting 1st April 2017) by the Assessee.
  • The Assessee has :
  1. Purchased a new house 1 year prior to sale / 2 years post the sale of original house OR
  2. Constructed a new house or has purchased a site and constructed a house thereon, within a period of 3 years post the sale of the original house.
  • Cost of the new house is either equal or higher than the Capital Gain received.

In case, prior to the date of filing annual returns, the amount of Capital Gain is not utilized for the above purpose, the same should be deposited in a Bank under “Capital Gains 1988 Account Scheme”.

Key aspects to note regarding long-term gains exemption under Section 54 and its taxability in case of sale of new property within 3 Years:

  1. If the amount of Capital Gain is higher than the cost of the new house, the difference amount is chargeable to tax at 20% considering Long-Term Capital Gain of the Previous Year in which the original house was sold.
  2. If the new house is sold within 3 years from the date of purchase or construction, the cost of the new house will be decreased by the amount of Capital Gain exempted earlier on the original house. Here, the difference between sales proceeds of the new house and such reduced cost will be treated as “Short Term Capital Gains” and considered taxable during the year in which the new house was sold.

Capital Gains on Sale of any Long-term Capital Asset (Section 54EC)

Under Section 54EC, capital gains received on sale of any Long-Term Capital asset is exempted if the amount of capital gain is invested in the purchase of Long-term Specified Assets of NHAI or Rural Electrification Corporation, subject to the following:

  • The capital gains is accrued or earned from the sale of a Long-Term Capital Asset.
  • The Assessee invests the entire amount of capital gains in the specified assets, (i.e. Bonds of NHAI or REC with a lock-in period of 3 years)
  • Amount is invested in the specified assets within 6 months from the date of sale of original asset.
  • The amount of investment is equal or higher than the capital gain. If the entire amount is not invested, exemption will be allowed only on the amount invested. The balance is taxable.
  • The assessee has to preserve the newly invested Specified Asset for a minimum lock-in period of 3 years

Note: The return on bonds (invested in NHAI or Rural Electrification Corporation) is taxable income

Capital Gains on Sale of any Capital Asset (other than a Residential House) (Section 54F):

Such gains are exempted from tax if the investment is made on a Residential House, subject to the following:

  • The Assessee is an Individual / HUF.
  • The Capital Gain has been received from the sale of Long-Term Capital Asset (other than the residential house)
  • The Assessee has
  1. Purchased a new house 1 year before the sale of the Capital Asset or 2 years after the sale of the Capital Asset or construct a house within 3 years or
  2. Purchased a Site and constructs a house thereon within 3 years from the date of sale of the Capital Asset.
    Cost of the new house is either equal or higher than the amount received from sale of original asset. If the entire amount is not invested, the exemption will be allowed only in the proportion which the amount invested bears to the net sale consideration of the original property. The balance is taxable.
  • If the full amount of sale proceeds is not utilized for the above purpose prior to the due date for filing of Returns u/s 139(1), it should be deposited in a Bank under Capital Gains Scheme 1988 A/c and from this account it should be utilised for construction or purchase of house.
  • On the date of sale of the original Capital Asset, the assessee
  1. Does not possess more than 1 residential house other than the new house
  2. Does not buy within 2 years, or construct within 3 years any other residential house from the date of purchase/construction of the new house

Capital Gains on Sale of Agricultural Land (Section 54B)

Under Section 54B, since rural agricultural land does not constitute a capital asset, Capital Gains Tax is not charged on the sale proceeds of Rural Agricultural Land.

Capital gain on the transfer of urban agricultural land:

Any capital gain, arising to an individual or HUF, from the transfer of agricultural land situated in urban area is exempt subject to the following conditions:

  • The agricultural land is owned by an individual or HUF.
  • The agricultural land was being used by an individual or his parents for agricultural purposes for a period of two years immediately preceding the date of transfer.
  • The assessee has purchased within a period of two years from the date of transfer any other land for agriculture purpose.
  • If the entire amount is not invested, exemption will be allowed only on the amount invested. The balance is taxable.
  • If the full amount of sale proceeds is not utilized for the above purpose prior to the due date for filling of Returns u/s 139(1), it should be deposited in a Bank under Capital Gains Scheme 1988 A/c and from this account it should be utilised for purchase of another agricultural land.

Capital Gains on Sale of Industrial Land or Building (Section 54D)

Here, asset means industrial land or building.
Any capital gain resulting from the transfer (land and building used for industrial undertakings) by way of obligatory acquisition under any law is exempt subject to the following conditions:

  • The land or building used by the assessee for the purpose of an industrial undertaking.
  • And it has been used for at least 2 years immediately preceding the date of obligatory acquisition.
  • The assessee has purchased any other land or building or constructed any other building, within a period of 3 years after such transfer, for the purpose of shifting or re-establishing the industrial undertaking or setting up another industrial undertaking.
  • If the entire amount is not invested, the exemption will be allowed only on the amount invested. The balance is taxable.
  • If the full amount of sale proceeds is not utilized for the above purpose prior to the due date for filing of Returns u/s 139(1), it should be deposited in a Bank under Capital Gains Scheme 1988 A/c and from this account it should be utilised for construction or purchase of house.

How Change in Base Year for Indexation from 1981 to 2001 Affects you?

In terms of taxation of long term capital gains, three announcements were made in the budget speech of the Finance Minister.

  • Amendment in holding period (for capital gains to qualify as long term capital gains) for real estate from 3 years to 2 years. Holding period for other capital assets has remained unchanged.
  • More options to be offered under Section 54EC further to NHAI and REC capital gains bond. You can invest up to INR 50 lakhs per financial year in such specified bonds under Section 54EC to avoid paying long term capital gains tax.
  • Base year for indexation changed from 1981 to 2001.

The impact of the first two announcements is reasonably inherent. Let us analyze the impact of change in base year for indexation from 1981 to 2001.

Concept of Indexation

When an asset is purchased, a rise in the value of the asset can be credited to inflation.

For instance, today you can buy one laptop for INR 50,000. After five years, the same laptop can be bought for INR 65,000. The asset is same but the cost of purchase has inflated by 30%. This is the case with capital assets too. The Government, by letting you to index your purchase (acquisition) price, does not penalize you for price appreciation due to inflation.

For example, a piece of land in FY 2006 (July 2005) can be bought for INR 10 lakhs and sold for INR 24 lakhs in FY 2013. Cost inflation index for the years 2005-06 and 2012-13 are 497 and 939 respectively

Here, indexed cost of acquisition (for FY 2013) can be computed as follows:

Cost of acquisition x 939/497
= INR 10 lakhs x 939/497
= INR 18.89 lakhs

Now,
Long-term capital gains = Sales value – Indexed cost of acquisition
= INR 24 lakhs – INR 18.89 lakhs
= INR 5.11 lakhs

Long Term Capital Gain Tax = 20% x INR 5.11 lakhs = INR 10,220 (prior to cess and surcharge)

In absence of allowance for indexation, your capital gain would have been Rs 14 lakhs and your long term capital gains tax liability would have been Rs 2.8 lakhs.

Impact of Change in Base Year

According to Section 55 of the Income Tax Act, ‘Cost of acquisition, where the capital asset became the property of the assessee before the 1st day of April, 1981, means the cost of acquisition of the asset to the assessee or the fair market value of the asset on the 1st day of April, 1981, at the option of the assessee; April 1, 1981 to be replaced with April 1, 2001 (from April 1, 2018 as per the budget announcement)’

Hence, based on this revision, if you acquired a capital asset before 1981, it is your discretion to choose the cost of acquisition. You are allowed to choose either the actual cost or the Fair Market Value (FMV) as on April 1, 1981.

When it is not possible to figure out the actual cost of asset especially for those properties that you have inherited, you have to opt for FMV.

According to Section 48 of the Income Tax Act, “indexed cost of acquisition” means an amount which bears to the cost of acquisition the same proportion as Cost Inflation Index for the year in which the asset is transferred bears to the Cost Inflation Index for the first year in which the asset was held by the assessee or for the year beginning on the 1st day of April, 1981*, whichever is later; April 1, 1981 to be replaced with April 1, 2001 (from April 1, 2018 as per the budget announcement)
Once the cost of acquisition is determined, the Cost of Inflation Index (CII) comes into question.

If you purchase the property in FY1995, CII value for FY1995 is applied to compute indexed cost of acquisition. Now, CII for 1995 will not exist for taxation purposes since the base year has been changed from 1981 to 2001. Now onwards you will have to apply CII value for FY 2001-2002 (from the next year).

Example Showing Calculation of Capital Gains using Indexation

You have bought a property in August 1991 for INR 20 lakhs and sold it in FY2018 for INR 140 lakhs.

Incidentally, CII for FY2018 has not been announced. Let’s assume it as 1165.

Under the old base year of 1981

CII for 1991-92: 199
CII for 2018 (assumed of 2016-17): 1165

Indexed Cost of acquisition: INR 20 lakhs x 1165/199 = INR 117.09 lakhs
Long-Term Capital Gain = INR 140.00 lakhs – INR 117.09 lakhs = INR 22.91 lakhs
Long Term Capital Gain Tax = 20% x INR 22.91 lakhs = INR 4.58 lakhs

Under the new Base year of 2001

Nevertheless, the new CII index has not been announced, it is expected to be in similar ratios i.e. CII value of 426 in 2001 will become 100 and subsequent value will be adjusted accordingly.
Once the change is effected, there is no CII value for FY1992 (or it will be considered at 100, same as for 2001-2002).

Now there are TWO options: (1) Either consider INR 20 lakhs (purchase price) (2) Or consider FMV as on April 2001

Here, you can figure out transaction price of similar properties in 2001 or you can take the assistance of a valuer. You may opt for higher value but in such case IT assessment becomes tough

CII in 1991-1992 was 199. In 2001-2002, it was 426. With CII, property prices would have gone up to INR 42.81 lakhs.

There are two scenarios.

Scenario 1

FMV on April 1, 2001, is INR 50 lakhs (>INR 42.81 lakhs through CII)
Indexed Cost of acquisition= INR 50 lakhs x 1165/426 = INR 136.74 lakhs
Long-Term Capital Gain = INR 140 lakhs – INR 136.74 lakhs = INR 3.26 lakhs
Long-Term Capital Gains Tax = 20% x INR 3.26 lakhs = INR 0.65 lakhs

Under the old regime, capital gains tax was INR 4.58 lakhs; visibly you are profiting from the amendment in tax rule.

Scenario 2

FMV on April 1, 2001, is INR 30 lakhs (<INR 42.81 lakhs through CII)
Indexed Cost of acquisition= INR 30 lakhs x 1165/426 = INR 82.04 lakhs
Long-Term Capital Gain = INR 140 lakhs – INR 82.04 lakhs = INR 57.96 lakhs
Long-Term Capital Gains Tax = 20% x INR 57.96 lakhs = INR 11.59 lakhs

This is much greater than earlier INR 4.58 lakhs; your tax liability has significantly increased.

There isn’t any impact on long-term capital gains tax if you purchase the property after 2001. This change in base year is not only for real estate transactions but also for all the capital assets such as debt, gold, equity and others (wherever indexation is applicable). The analysis and tax computation are same for other investments too. If the appreciation in price has been higher than the increase in CII, you will have to pay lower tax (as compared to that with base year as 1981) and vice-versa.

Capital Gain Account Scheme (CGAS)

The CGAS scheme was introduced in 1988. According to this scheme, the amounts to be claimed as capital gains exemption should be either deposited or reinvested in Capital Gains Account prior to due date of tax filings.

There are two types of capital gains account; Type A and Type B. Type A is advised to utilize for construction of a house and Type B is advised to utilize for the purchase of a house. Under Type B, if account allows the cumulative option, the interest is reinvested and the total amount is paid at the time of withdrawal or completion of term period, whichever is earlier. On the other hand, if account allows the non-cumulative option, the interest amounts gets credited on a timely basis and are not reinvested.

In case of a cumulative option, under Type B, accrued interest would be deemed to have been reinvested. In case of a non-cumulative option, under Type B, due interest would be treated as due/payable at quarterly intervals.

Any unutilized amount should be redeposited in Type A account. The amounts already been utilized by an assessee for the purpose of purchase or construction of a new property together with the amount of deposit will be deemed to by the cost of the new property.

Exemption for Sale of Land under Land Pooling in Andhra Pradesh Section 10 (37A)

The Land Pooling Scheme is an option to the arrangement made by the Government of Andhra Pradesh for development of the new capital city of Amaravati to avoid land-acquisition disputes and lessen the financial burden.

Under the scheme of Land pooling, the compensation is provided to landowners in the form of reconstituted plot or land. Nevertheless, the prevailing provisions do not offer tax exemption on transfer of land on the transfer of Land Pooling Ownership Certificates (LPOCs) or reconstituted plot or land.

In order to provide tax relief to an individual or HUF, who was the owner of such land as on 2nd June, 2014, and has transferred such land under the land pooling scheme notified under the provisions of Andhra Pradesh Capital Region Development Authority Act, 2014, it is proposed to enclose a new clause, section 10(37A).

Capital gains arising from the following transfer shall not be chargeable to tax under the Act:

  • Under land pooling scheme, transfer of capital asset being land or building or both.
  • Sale of LPOCs by the said persons (individual or HUF) received in lieu of land transferred under the scheme.
  • Sale of reconstituted plot or land by said persons (individual or HUF) within 2 years from the end of the financial year in which the ownership of such plot or land was handed over to the said persons.

This amendment will be in effect retrospectively, from 1st April, 2015. It will accordingly, apply in relation to the AY 2015-16 and subsequent years.

In addition, it is proposed to amend section 49 where reconstituted plot or land, received under land pooling scheme is transferred after the expiry of 2 years from the end of the financial year in which the ownership of such plot or land was handed over to the said assessee.

The cost of acquisition of such plot or land shall be deemed to be its stamp duty value on the last day of the second financial year after the end of financial year in which the ownership of such asset was handed over to the assessee.

This amendment is expected to be in effect from 1st April 2018; accordingly, it will apply in relation to the AY 2018-19 and subsequent years.

Exemption on Sale of Agricultural Land u/s 10(37)

Under Section 10(37) of the Income Tax Act, Capital Gains on compensation received on compulsory acquisition of urban agricultural land is exempt from tax. This exemption is available to an individual/HUF.

This tax exemption is available only if the taxpayer has used the said land for the agricultural purpose for a period of 2 years immediately preceding the date of its transfer.

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