B.A. LL.B. (Five Years) Sem 7 Law of Taxation 2018 Dec Question Paper with Solutions

The power to tax capital gains

Capital gains were first taxed in India by section 12-B of the 1922 Act, inserted in 1947. It was argued that "income" in the legislative entry could not include gains on capital. In Navinchandra Mafatlal v. Commissioner of Income-tax, Bombay City, AIR 1955 SC 58, the Supreme Court rejected that argument. The entry is read in its widest sense and covers capital gains. Today the power rests on Union List entry 82, "taxes on income other than agricultural income".

The charge: section 45(1)

Section 45(1) makes "any profits or gains arising from the transfer of a capital asset effected in the previous year" chargeable under the head "Capital gains". They are deemed the income of the previous year in which the transfer took place. The charge is subject to the reinvestment exemptions in sections 54 to 54H. Four conditions must all be met.

1. A capital asset (section 2(14)). This means property of any kind held by the assessee, whether or not connected with his business. Some things are excluded:

• stock-in-trade, consumable stores and raw materials held for business;

The courts read this widely. Kartikeya V. Sarabhai v. Commissioner of Income Tax, (1997) 7 SCC 524, decided on 4 September 1997. The assessee held preference shares of a company, bought at Rs 420 each. On a reduction of capital in 1966, the company paid Rs 450 a share and cut the face value. The assessee said there was no transfer, since he still held the shares. The Supreme Court held otherwise. Sale is only one mode of transfer. On the reduction, his rights to dividend and to a share of the net assets were extinguished in part. That was a transfer, and the gain was taxable under section 45.

3. In the previous year. The transfer must take place in the previous year, which fixes the year of charge.

4. A gain arises. There must be a profit or gain, computed as below. If the computation shows a loss, the loss rules apply instead.

Transfers that are not taxed (section 47)

Section 47 lists transactions that are not regarded as transfers. Examples are a gift, a will, an irrevocable trust and the partition of a Hindu undivided family. Another is an exchange of shares in an amalgamation for shares of the new company. No gain is charged at that stage. The new holder usually takes over the earlier owner's cost (section 49).

Deemed consideration for land and buildings (section 50C). Where the stated price is below the stamp duty value, that value is taken as the full consideration. This does not apply where the stamp duty value is not more than 110 per cent of the price.

Indexation. For a long-term asset transferred before 23 July 2024, cost was raised by the cost inflation index. For transfers on or after that date, indexation is generally withdrawn. One exception remains. It concerns a resident individual or Hindu undivided family selling land or a building acquired before 23 July 2024. He pays the lower of 12.5 per cent without indexation and 20 per cent with it (proviso to section 112).

At what rate

Short-term or long-term (section 2(42A)). An asset is short-term if held for not more than twenty-four months before transfer. For listed securities, units of equity oriented funds and zero coupon bonds, the period is twelve months. An asset held longer is long-term.

Rates for transfers on or after 23 July 2024:

1. Section 54. An individual or Hindu undivided family sells a long-term residential house. He buys another house in India within one year before or two years after the sale, or builds one within three years. The gain is exempt up to the cost of the new house. The cost counted is capped at Rs 10 crore.
2. Section 54EC. Long-term gains on land or buildings are exempt if invested within six months in specified bonds. The investment allowed is up to Rs 50 lakh in a year.
3. Section 54F. Long-term gains on any asset other than a house are exempt if the net consideration is invested in a residential house, on similar conditions.

Losses

1. A short-term capital loss may be set off against any capital gain. A long-term loss only against long-term gains (section 70).
2. A capital loss cannot be set off against income under any other head (section 71(3)).
3. Unabsorbed capital losses are carried forward for eight assessment years, on the same matching rule (section 74).

• section 197: 12.5 per cent on long-term gains, with the land and building comparison; and
• section 198: 12.5 per cent on long-term equity gains above Rs 1,25,000.

The reinvestment exemptions sit in sections 82 to 89.

Conclusion. Capital gains are taxed as income, a power upheld in Navinchandra Mafatlal. Section 45(1) charges the gain from the transfer of a capital asset in the year of transfer. A capital asset is property of any kind, except stock-in-trade, personal effects, rural agricultural land and a few bonds. "Transfer" is read widely, to include extinguishment of rights, as Kartikeya V. Sarabhai holds. The gain is the full consideration, including the stamp duty value for land, less transfer costs and cost. Indexation is withdrawn for transfers from 23 July 2024, save for an option on older land and buildings. Short-term equity gains bear 20 per cent and long-term gains 12.5 per cent, with reinvestment reliefs under sections 54 to 54F. The 2025 Act keeps the scheme in sections 67 and 196 to 198.