CHANAKYA NATIONAL LAW UNIVERSITY,

NYAYA NAGAR, MITHAPUR, PATNA – 800001

The final draft submitted in the course of Taxation Laws for the requirement of
the degree B.A., LL.B. (Hons.), For the 8th Sem, Academic Session 2022-23

TAX ON TRANSFER OF CAPITAL ASSETS

TAXATION LAWS

SUBMITTED TO: DR G. P. PANDEY SUBMITTED BY: RUDRAKSH PANDEY

ASSISTANT PROFESSOR OF LAW B.A.,LL.B.(HONS.), 8TH SEMESTER

ROLL- 2144
 DECLARATION

I hereby declare that the work reported in the B.A.,LL.B. (Hons.) entitled “TAX ON

TRANSFER OF CAPITAL ASSETS” submitted at Chanakya National Law University, Patna is

an authentic record of my work carried under the supervision of Dr G P Pandey. I have not
submitted this work elsewhere for any other degree. I am fully responsible for the contents of
my project report.

Rudraksh Pandey
Chanakya National Law University, Patna
 ACKNOWLEDGEMENT

The researcher takes this opportunity to express his profound gratitude and deep regards to
his guide Dr. G. P. Pandey for his exemplary guidance and constant encouragement
throughout the course of this thesis. The blessing, help and guidance given by him from time
to time shall carry the researcher a long way in the journey of life on which the researcher is
about to embark.

The researcher is obliged to staff members of Chanakya National Law University, for the
valuable information provided by them in their respective fields. The researcher is grateful
for their cooperation during the period of his assignment.

Thank you,
Rudraksh Pandey
 TABLE OF CONTENT

DECLARATION----------------------------------------------------------------------------------------1

ACKNOWLEDGEMENT-----------------------------------------------------------------------------2

TABLE OF CONTENT--------------------------------------------------------------------------------3

CHAPTER I: INTRODUCTION--------------------------------------------------------------------4

RESEARCH METHODOLOGY--------------------------------------------------------------------5

CHAPTER II: CAPITAL GAINS-------------------------------------------------------------------6

CHAPTER III: CAPITAL ASSET------------------------------------------------------------------7

CHAPTER IV: SHORT-TERM & LONG-TERM ASSETS-----------------------------------9

CHAPTER V: TRANSFER--------------------------------------------------------------------------10

CHAPTER VI: MODE OF COMPUTATION---------------------------------------------------13

CHAPTER VII: EXEMPTIONS-------------------------------------------------------------------16

CONCLUSION-----------------------------------------------------------------------------------------19

BIBILIOGRAPHY------------------------------------------------------------------------------------20
 CHAPTER I: INTRODUCTION

The purpose of defining a “capital asset” is to determine clear boundaries of what will qualify
as capital and what will not, so as to avoid any confusion or give rise to any dispute. Capital
needs to be defined as capital gains are taxed in India, as is the common practice in many
other countries.

Capital gains refers to the difference calculated between the cost of acquisition of some asset
along with the cost of any improvements made upon that asset, as well as any cost incurred in
connection with the transfer and the value of sale consideration upon such transfer of
property.

Capital gains can be classified into long-term capital gains (LTCG) and short-term capital
gains (STCG) depending on the period for which the capital asset has been held by the
transferor before any transfer of property is made. The rate of taxation as well as any
corresponding tax benefits, e.g. in cases of re-investment, are determined on the basis of
which category any capital asset falls within, which is why it is important to determine which
category any asset should be a part of.
 CHAPTER II: CAPITAL GAINS

Section 45 of the Income Tax Act, 1961 provides that any profits or gains arising from the
transfer of a capital asset effected in the previous year shall, save as otherwise provided in
various sections of Sec. 54, be chargeable to income-tax under the head “Capital Gains” and
shall be deemed to be the income of the previous year in which the transfer took place.

Doubts may arise as to whether “Capital Gains” being a capital receipt can be brought to tax
as income. It may be noted that the ordinary accounting canons of distinctions between a
capital receipt and a revenue receipt are not always followed under the Income-tax Act.
Section 2(24)(vi) of the Income-tax Act specifically provides that “Income” includes “any
capital gains chargeable under Section 45(1)”. It may not be out of place to mention here that
in the absence of a specific provision in Section 2(24) capital gains have no logic to be taxed
as income.

The constitutional validity of the provisions of the Act relating to capital gains was
challenged in Navin Chandra Mafatlal v. C.I.T.1. The Supreme Court while upholding the
competence of parliament in legislating with regard to capital gains as part of income,
observed that the term income should be given the widest connotation so as to include capital
gains within its scope. However, all capital profits do not necessarily constitute capital gains.
For instance, profits on re-issue of forfeited shares, profits on redemption of debentures,
premium on issue of shares, are capital profits and not capital gains, hence, not liable to tax.

The requisites of a charge to income-tax, of capital gains under Section 45(1) are:

(i) There must be a capital asset.

(ii) The capital asset must have been transferred.
(iii) The transfer must have been effected in the previous year.
(iv) There must be a gain arising on such transfer of a capital asset.
(v) Such capital gain should not be exempt under Sections 54, 54B, 54D, 54EC,
54EE, 54ED, 54F, 54G, or 54GA

1
(1955) 27 ITR 245
 CHAPTER III: CAPITAL ASSET

Section 2(14) of the Income Tax Act, 1961 provides that Capital asset means property of any
kind held by an assessee whether or not connected with his business or profession. The asset
may be movable, immovable, tangible or intangible. It also includes any securities held by a
Foreign Institutional Investor which has invested in such securities in accordance with the
regulations made under the SEBI Act, 1992.

The Supreme Court in the case of Vodafone International Holdings B.V vs. Union of
India2 held that influence/persuasion of a parent company over its subsidiary could not be
construed as a right in the legal sense. To supersede this ruling with retrospective effect from
1st April 1962, an Explanation has been inserted to clarify that “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.

Capital Gains does not include:

(i) any stock-in-trade(other than securities held by FII mentioned in clause (b)
above), consumable stores or raw-materials held for the purposes of his business
or profession; 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.
(ii) 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 but excludes
a. jewellery;
b. archaeological collections;
c. drawings;
d. paintings;
e. sculptures; or
f. any work of art

2
[2012] 204 Taxman 408
 For this purpose, the expression ‘jewellery’ includes the following:

(1) 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;

(2) 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 agriculture land excludes : a) any area within the jurisdiction of a
municipality or a cantonment board and which has a population of not less than
ten thousand; or b) any area within the distance, measured aerially from the
jurisdiction of a municipality or a cantonment board – I. not being more than two
kilometres, from the local limits of any municipality or cantonment board and
which has a population of more than ten thousand but not exceeding one lakh II.
not being more than six kilometres, from the local limits of any municipality or
cantonment board and which has a population of more than one lakh but not
exceeding ten lakh III. not being more than eight kilometres, from the local limits
of any municipality or cantonment board and which has a population of more than
ten lakh.
(iv) 6 per cent Gold Bonds, 1977 or 7 per cent Gold Bonds, 1980 or National Defence
Gold Bonds, 1980 issued by the Central Government;
(v) Special Bearer Bonds 1991 issued by the Central Govt.
(vi) Gold Deposit Bonds issued under the Gold Deposit Scheme, 1999 or deposit
certificates issued under the Gold Monetisation Scheme, 2015 notified by the
Central Government
 CHAPTER IV: SHORT-TERM & LONG-TERM ASSETS

Section 2(42A) defines short term capital asset as a capital asset held by the assessee for not
more than 36 months immediately preceding the date of transfer. Therefore, an asset which is
held by the assessee for period of > 36 months immediately preceding the date of transfer is a
long-term capital asset.

However, a security (other than a unit) listed in a recognised stock exchange or a unit of an
equity oriented fund, or of UTI or a Zero-Coupon Bond, will be considered as a long-term
asset if it is held for period of > 12 months immediately preceding the date of transfer.

A share of a company not being a share which is listed on a recognised 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”.

Assets other than short-term capital assets are known as ‘long-term capital assets’ and the
gains arising therefrom are known as ‘long-term capital gains’. In the case of other long- term
capital assets, the period of holding is determinable subject to any rules made by CBDT. An
asset should be held for more than 36 months immediately prior to the date of its transfer to
become a long term capital asset. However, where a capital asset, being Immoveable property
(land or building or both) is transferred on or after April 1, 2017, then it will be treated as
Long Term Capital Asset if it is held for more than 24 months immediately prior to the date
of its transfer
 CHAPTER V: TRANSFER

The essential requirement for the incidence of tax on capital gains is the transfer of a “capital
asset”. The Act contains an inclusive definition of “transfer”, and hence, it includes:

(i) Sale exchange / relinquishment of assets

(ii) Extinguishment of any of the rights therein
(iii) Compulsory acquisition thereof under law in a case where the asset is converted
by the owner thereof into, or is treated by him as, stock in trade of business carried
on by him, such conversion or treatment maturity / redemption of zero coupon
bond
(iv) Any transaction involving the allowing of the possession of any immovable
property to be taken or retained in part performance of a contract of the nature
referred to in section 53 of Transfer of Property Act,1882 (4 of 1882)
(v) Any transactions which have the effect of transferring or enabling the enjoyment
of an immovable property

The Supreme court in the case of Vodafone International Holdings B.V. vs. Union of
India3 gave the following ruling –

a. the transfer of shares in the foreign holding company does not result in an
extinguishment of the foreign company’s control of the Indian company.
b. It does not constitute an extinguishment and transfer of an asset situated in India.
c. Transfer of foreign holding company shares offshore, cannot result in an
extinguishment of the holding companies right of control of the Indian company and
the same does not constitute extinguishment and transfer of an asset/management and
control of property situated in India.

To supersede this ruling with retrospective effect from 1st April 1962, Explanation 2 to
section 2(47) has been inserted which defines transfer as follows:

“Transfer” includes and shall be deemed to have always included disposing of or parting with
an asset or any interest therein, or creating any interest in any asset in any manner
whatsoever, directly or indirectly, absolutely or conditionally, voluntarily or involuntarily by

3
[2012] 204 Taxman 408
way of an agreement (whether entered into in India or outside India) or otherwise,
notwithstanding that such transfer of rights has been characterized as being effected or
dependent upon or flowing from the transfer of a share or shares of a company registered or
incorporated outside India.

The above transactions would be deemed as a transfer notwithstanding that such transfer of
rights has been characterized as being effected or dependent upon or flowing from the
transfer of a share or shares of a company registered or incorporated outside India.

The distribution of capital assets on the dissolution of a firm, body of individuals or other
association of persons, is also regarded as transfer liable to capital gains tax. For the purposes
of computing capital gain in such cases, the fair-market value of the capital asset on the date
of such distribution will be deemed to be the full value of consideration received or accruing
as a result of transfer of the capital asset.

What doesn’t constitute Transfer?

Section 47 specifies certain transactions which will not be regarded as a transfer, as below:

Any distribution of capital assets on total / partial partition of HUF

Any transfer of a capital asset under a gift / irrevocable trust (doesn’t include ESOP’s)

Transfer of asset from Holding Company to its wholly owned Indian Subsidiary andvice-
versa

Transfer of capital asset from amalgamating company to amalgamated company, in a scheme

of amalgamation, as long as the resultant company is an Indian Company

Transfer of capital asset from demerged company to resulting company, in a scheme of

demerger, as long as the resultant company is an Indian Company

Transfer / issue of shares by the resulting company to the shareholders of the demerged
company, if such transfer was made in consideration of such demerger

Transfer of shares by a shareholder, held in the amalgamating company, in a scheme of

amalgamation, if such transfer is made as a consideration, by way of allotment of shares in
the amalgamated Indian company
Transfer of rupee denominated bonds / any government security, outside India, by a non-
resident to another non-resident Redemption of sovereign gold bonds, issued by RBI, by an
individual

Transfer of any capital asset to the Government / University / National Museum / National
Art Gallery, any work of art, book, manuscript, drawing, painting, print

Transfer made outside India of Rupee Denominated Bond (RDB’s) of an Indian Company,
issued outside India by a non-resident to another non-resident.

Transfer by way of conversion of bonds / debentures / preference shares into equity shares
of that Company Transfer of capital asset under reverse mortgage

Transfer by a unit holder under consolidation plans / schemes of Mutual Fund

 CHAPTER VI: MODE OF COMPUTATION

Section 48 of the Act provides that the income chargeable under the head “capital gains”
shall be computed by deducting from the full value of consideration received or accruing as a
result of the transfer of the capital asset the following amounts –

(i) the expenditure [No deduction will be allowed in respect of Securities Transaction
Tax (STT paid)] incurred wholly and exclusively in connection with such transfer;
(ii) the cost of acquisition of the capital asset and the cost of any improvement thereto

However, in the case of an assessee who is a non-resident, capital gains arising from the
transfer of a capital asset, being shares in, or debentures of, an Indian company shall be
computed by converting the cost of acquisition, expenditure incurred wholly and exclusively
in connection with such transfer and the full value of the consideration received or accruing
as a result of the transfer of the capital asset into the same foreign currency as was initially
utilised in the purchase of the shares or debentures, and the capital gains so computed in such
foreign currency shall be reconverted into Indian currency.

The Finance Act, 1997 has with effect from 1.4.1998 denied the benefit of indexation of cost
of bonds and debentures other than indexed bonds issued by the government.

Provided also that where shares, debentures or warrants referred to in the proviso to Clause
(iii) of Section 47 are transferred under a gift or an irrevocable trust, the market value on the
date of such transfer shall be deemed to be the full value of consideration received or
accruing as a result of transfer for the purposes of this section.

The RBI has recently permitted Indian corporate to issue rupee denominated bonds outside
India as a measure to enable Indian corporate to raise funds from outside India. For providing
relief to non-residents who bear risk of currency fluctuation, w.e.f. AY 2017-18, section 48
has been amended to provide that capital gain, arising in case of appreciation of rupee
between the date of issue and the date of redemption against the foreign currency in which
investment is made, shall be exempt from tax on capital gains.

Benefit of Indexation shall be available in the case of long term capital gain arising on
transfer of sovereign Gold Bonds.
For this purpose:

(i) “foreign currency” and “Indian currency” have the meanings respectively
assigned thereto in Section 2 of the Foreign Exchange Management Act, 1999,
and
(ii) the conversion of Indian currency into foreign currency and the re-conversion of
foreign currency into Indian currency shall be at the rate of exchange prescribed in
that behalf;
(iii) “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
2001 whichever is later;
(iv) “indexed cost of improvement” means an amount which bears to the cost of
improvement the same proportion as Cost Inflation Index for the year in which the
asset is transferred bears to the Cost Inflation Index for the year in which the
improvement to the asset took place; and

COMPUTATION OF LONG-TERM CAPITAL GAINS

In the case of long-term capital gains, the value of profit made in each transfer is calculated
by taking into consideration not just the profit made through the sale, but a multitude of other
factors as well, such as the year in which the transferred property was purchased and the year
in which the subsequent sale was made. In order to determine the value of long term capital
gains, firstly one takes into consideration the full value of the sales consideration of the asset.
To this amount, certain costs are deducted, these include- expenditure incurred wholly and
exclusively in connection with transfer of capital asset (E.g., brokerage, commission,
advertisement expenses, etc.), indexed cost of acquisition and indexed cost of improvement,
if any.

Indexation is the process by which one accounts for the rise in the value of the asset
concerned owing to inflation, on the basis of this the cost is adjusted. This benefit can be
availed only for assets that fall in the category of long-term capital assets. The central
government has also notified a “cost inflation index” which is a table of yearly rates to be
taken into consideration when the relevant calculations are being made. Indexation takes into
consideration, during computation, the year of acquisition, the year of transfer, the cost
inflation index from the year of acquisition and the cost inflation index from the year of
transfer.

Therefore, the formula is as follows:

=(Cost of acquisition × Cost inflation index of the year of transfer of capital asset) / Cost
inflation index of the year of acquisition

 Similarly, the indexed cost of improvement on any long term capital asset is also calculated.

COMPUTATION OF SHORT-TERM CAPITAL GAINS

Short-term capital gains are calculated by deducting from the full value of consideration
received upon transfer, the cost of acquisition, the cost of improvement and also by
subtracting the expenditure incurred wholly in connection with the relevant transfer. Short-
term capital gains are of two kinds; those that fall within the purview of S. 111A and those
that do not.

Section 111A is applicable in case of gains arising on transfer of equity shares or units of
equity oriented mutual-funds or units of business trust, from 1.10.2004 through a recognised
stock exchange. This transaction is liable to securities transaction tax (STT). An equity
oriented mutual fund is specified under section 10(23D) wherein it qualified that 65% of the
invested funds, out of total proceeds are invested in equity shares of domestic companies.
Such gain is charged to tax at 15% (plus surcharge and cess as applicable).

Short-term gains that are not covered by s. 111A include gains from sale of equity shares
other than through a recognised stock exchange, sale of shares other than equity shares, gains
on debentures, bonds and Government securities, capital gain from sale of assets other than
shares/units like immovable property, gold, silver, etc. In such cases, amount of tax levied is
calculated at normal rate of tax, which is determined on the basis of the total taxable income
of the taxpayer.
 CHAPTER VII: EXEMPTIONS

The exemptions available on long-term capital gains are:

Profit on sale of the residential house (Section 54):

If the residential house property, whether it is self-occupied or rented out is sold, you can
avail full exemption, provided:

 The assessee must be an individual or Hindu Undivided Family.

 The assessee has held the house for more than 24 months.

 The assessee has purchased a new house one year before the date of sale or two years
after the date of sale of the original house or if he is constructing a new house, within
3 years from the date of sale of the original house.

 If the amount is deposited in a bank under the Capital Gains Account Scheme, 1988.

 If the cost of the new house is equal to or more than the capital gain earned.

 If the cost of the new house is less than the capital gain, then the difference amount is
taxed at 20%.

 If the new house is sold within 3 years from the date of purchase or construction, then
the cost of the new house is deducted by the amount of capital gain exempted on the
original house and the difference in the sale price of the new house will be treated as a
short-term capital gain.

If the long-term capital gain is invested in long-term specified assets of NHAI or Rural
Electrification Corporation or Other bonds notified by Central Govt. (Section 54EC):

It is available subject to the following:

 The profit earned is from the sale of a long-term capital asset I.e. land or building or
both.
  The assessee must invest a part of the capital gain or the whole of the gain in specified
assets like bonds of NHAI or REC or Other bonds notified by Central Govt. within 6
months from the date of sale of the original asset.

 Assessee can invest a maximum of Rs. 50 lakh in specified bonds in a financial year.

 The assessee must retain the new asset for a minimum of 3 years (5 years if the bond
is issued on or after 1st April 2018).

Profits from the sale of an asset other than a residential house are used to buy a residential
house (Section 54F):

This is available subject to the following conditions:

 The assessee must be an individual or a Hindu Undivided Family.

 The long-term capital gain should be from the sale of an asset that is not a residential
house.

 The assessee has purchased a new house one year prior to the date of sale or two years
after the date of sale of the original house or if he is constructing a new house, within
a period of 3 years from the date of sale of the original house.

 If the cost of the new house is not less than the value of the asset sold, the full amount
of capital gain is exempt from income tax. But If a part of the capital gain is invested,
then only that part will be exempted proportionately (I.e. cost of the new house *
capital gain amount /Net consideration) and the balance amount will be taxable @
20%.

 If the full amount is not invested to buy a house or construct a house then it should be
kept in the bank under Capital Gains Account Scheme, 1988. The deposit amount in
that account should be utilized for the construction of a house or to buy a new house.

 On the date of sale of the original asset, the assessee should not own more than one
residential house apart from the new house. He should also not buy another house in 2
years or construct a new house in 3 years after such date (apart from the new house).
Other Exemptions:

The following are the other exemptions allowed on capital gains (short-term or long-term):

 Section 54B: The capital gain earned on the sale of agricultural land will have to be
reinvested in the purchase of agricultural land. The land must be used for agricultural
purposes for at least 2 years immediately before the transfer. If the capital gain is
higher than the amount of purchase cost of the new agricultural land then the
remaining balance will be taxed. If the capital gain is less than the purchase cost of
the new agricultural land then no tax will be charged.

 Section 54D: Exemption is allowed for capital gain arising from industrial land or
building that has been compulsorily acquired by the Government. The asset should
have been used for the industrial purpose for 2 years immediately before the transfer.
The exemption is allowed only if the capital gain will be reinvested to acquire land or
building for the industrial purpose.

 Section 54G: Exemption is allowed on the capital gain arising from the transfer of
land, building, plant or machinery to shift an industrial undertaking from the urban
area to the rural area. The exemption is allowed provided the capital gain is reinvested
to acquire land, building, plant or machinery in a rural area.

 Section 54GA: Exemption is allowed on the capital gain arising from the transfer of
land, building, plant or machinery to shift an industrial undertaking from the urban
area to Special Economic Zone provided the gain is reinvested to acquire land,
building, plant or machinery in the Special Economic Zone.
 CONCLUSION

The law is clear and unambiguous when it comes to taxation. The various exemptions take
into consideration exceptional cases wherein taxation may not be feasible or desirable. The
legislative intent is clear, to provide a clear and systematic method whereby one can
determine which category each asset will fall into and compute how much tax will be paid
upon the sale of each of these assets. With the present law, that objective can be achieved, as
it leaves little room for speculation.

Section 45 to 55A of the Income Tax Act deals with capital gains. Understanding about
capital gains can be helpful for both an assessee and businessman as they can claim necessary
exemptions as per the Act.
BIBILIOGRAPHY