Understanding Capital Gains Tax Under the Income Tax Act, 1961

Understanding Capital Gains as per Income Tax Act, 1961

Capital gains, according to Section 45 of the Income Tax Act, 1961, refers to any profit or gain that arises from the transfer of a capital asset in the previous year.

Definition of Capital Assets

Section 2(14) of the Income Tax Act, 1961 defines "capital assets" as:

1. Property of Any Kind: This includes any property held by an assessee, regardless of its connection to their business or profession.
2. Securities Held by Foreign Institutional Investors: These securities must be acquired in accordance with the Securities and Exchange Board of India Act, 1992.
3. Unit Linked Insurance Policies: These are exempt under Section 10(10D), specifically when considering the applicability of the 4th and 5th provisos for assessment years 2021-22 and beyond.

Exceptions to Capital Assets include:

• Stock-in-trade (excluding securities)
• Personal effects of the assessee, excluding diamonds, jewelry, archaeological collections, and artwork
• Agricultural land in rural India
• 61/2% Gold Bonds (1977), 7% Gold Bonds (1980), and National Defense Bonds (1980) issued by the Central Government
• Special Bearer Bonds (1991) issued by the Central Government
• Gold Deposit Bonds from the Gold Deposit Scheme (1999) and deposit certificates from the Gold Monetization Scheme (2015)

Conditions for Recognizing Capital Gains

For a capital gain to exist, there must be:

• A transfer of the capital asset
• A profit or gain or a loss resulting from that transfer

Year of Taxability

Capital gains are typically taxed in the year the transfer occurs.

Modes of Computation

The computation of capital gains varies as follows:

• For Non-Depreciable Assets: Computed under Section 48
• For Depreciable Assets: Computed under Section 50, except as noted below
• For Power Generation Assets: Specifically under Section 50A
• For Slump Sales: Governed by Section 50B

Calculation of Capital Gains under Section 48

The capital gain is calculated as:

• Full Value of Consideration: Amount received from the transfer (a)
• Less: Expenditure incurred in connection with the transfer, including stamp duty, registration fees, legal charges, and brokerage (b)
• Less: Cost of Acquisition and Cost of Improvement (c)

Should any sum, received as an advance during negotiations for the asset transfer, have been included in the total income under Section 56(2)(ix), it cannot be deducted from the cost of acquisition in this calculation (d).

The formula for income/loss chargeable under Section 45, in conjunction with Section 48, is: Income/Loss = [a - b - (c - d)]

Special Provisions from Assessment Year 2021-22 Onwards

Regarding specified persons from specified entities under Section 45(4), the amount attributable to a transferred capital asset will be calculated in a prescribed manner.

Second Proviso to Section 48

For long-term capital assets, cost indexing is performed as follows:

1. Cost of Acquisition:
   [ \text{Cost of Acquisition} \times \left( \frac{\text{Cost Inflation Index in Transfer Year}}{\text{Cost Inflation Index in Acquisition Year or April 1, 2001 (whichever is later)}} \right) ]

2. Cost of Improvement:
   [ \text{Cost of Improvement} \times \text{Cost Inflation Index in Transfer Year} \times \text{Cost Inflation Index in Improvement Year} ]

Exceptions to Section 48

• Non-Residents: Capital gains from the transfer of shares or debentures of an Indian company are calculated by converting costs and considerations into the foreign currency initially utilized, with reconversion back to Indian Rupees. Rule 115A specifies conversion rates.

• Indexation Not Available: This applies to the computation of capital gains on the transfer of bonds, debentures, specified shares, and units.

• Long-Term Gains Calculation: For long-term capital gains (not covered under the above exceptions), costs must be indexed using prescribed indices.

Recent Amendments

• Finance Act 2026: Introduced a proviso to Section 48, effective April 1, 2017, stating that for non-residents redeeming rupee-denominated bonds of Indian companies, capital gains computed shall not include appreciation due to currency fluctuations.

• Subsequent Acquirers: As of April 1, 2018, this benefit extends to individuals who acquire such bonds after the initial subscription.

• Sovereign Gold Bonds: For long-term capital gains from the transfer of Sovereign Gold Bonds issued under the Sovereign Gold Bond Scheme, 2015, the cost of acquisition will be indexed.

Conclusion

Understanding capital gains under the Income Tax Act, 1961 is crucial for accurate tax reporting and compliance. By adhering to the definitions, exceptions, and computation methods outlined in the Act, tax assessments can be effectively managed. Familiarity with relevant sections, including the exceptions and recent changes, will aid taxpayers, accountants, and financial advisors in navigating this complex area of tax law.