Capital Gains

Capital gains taxation is philosophically distinct from all other heads of income. Under the other four heads, income arises from the productive use of an asset — salary from labour, rent from property, profit from trading, interest from lending. Under capital gains, income arises from the mere appreciation in the value of an asset over time. The assessee has done nothing with the asset — merely held it and then transferred it. This philosophical distinction explains why the law treats capital gains differently in almost every respect: different rates, different computation methods, different set-off rules, and extensive exemptions for reinvestment.

The architecture of Part E: Part E contains 25 sections (S.67-91) that can be functionally grouped into seven blocks: (1) the charging provision and scope (S.67-69); (2) transactions not regarded as transfer (S.70-71); (3) the computation machinery (S.72-80); (4) advance money treatment (S.81); (5) exemptions for reinvestment (S.82-89); (6) cost and improvement definitions (S.90); and (7) valuation reference (S.91). Running parallel to these are the tax rate provisions in S.196-198, which determine the actual tax payable on different categories of capital gains.

The 23 July 2024 watershed: The Union Budget 2024 fundamentally restructured capital gains taxation. The long-standing 20% LTCG rate with indexation was replaced by a flat 12.5% rate WITHOUT indexation for most assets. STCG on listed securities was raised from 15% to 20%. A grandfathering provision was introduced for land and buildings acquired before 23 July 2024. The Rs.1 lakh exemption on listed equity LTCG was raised to Rs.1.25 lakh. These changes, now codified in the 2025 Act, represent the most significant reform of capital gains taxation since 2018.

Key changes in the 2025 Act: (a) Indexation abolished for all assets except the grandfathering relief under S.197(3). (b) Uniform LTCG rate of 12.5% replaces the old 20% (with indexation). (c) STCG on listed equity raised to 20% (from 15%). (d) Rs.1.25 lakh annual exemption on listed equity LTCG under S.198. (e) Holding period for unlisted shares and immovable property reduced to 24 months (from 36 months). (f) Rs.10 crore cap on residential house reinvestment exemptions (S.82(7) and S.86(8)). (g) Buyback proceeds now taxable in shareholder’s hands under S.69 (previously taxed at company level). (h) Grandfathering for land/building acquired before 23.07.2024 — S.197(3) allows the higher of old regime (20% with indexation) or new regime (12.5% without indexation).

4D.3.1 Capital Asset — Section 2(22)

The definition is deliberately wide: ‘property of any kind held by an assessee, whether or not connected with his business or profession.’ This includes land, building, shares, jewellery, patents, goodwill, leasehold rights, and even tenancy rights. But five categories are EXCLUDED: (i) stock-in-trade, consumable stores, and raw materials held for business; (ii) personal effects (movable property held for personal use — wearing apparel, furniture, but NOT jewellery, archaeological collections, drawings, paintings, sculptures, or any work of art); (iii) rural agricultural land (outside municipal/cantonment limits with population <10,000); (iv) specified gold bonds issued under the Gold Monetisation Scheme; and (v) gold deposit bonds under the Gold Deposit Scheme, 1999. Additionally, S.2(22)(b) specifically includes FII securities and investment fund securities, and S.2(22)(c) includes non-exempt ULIPs.

4D.3.2 Transfer — Section 2(109)

The definition of ‘transfer’ is extraordinarily comprehensive. It includes: (a) sale, exchange, or relinquishment; (b) extinguishment of rights; (c) compulsory acquisition under any law; (d) conversion of capital asset into stock-in-trade; (e) maturity/redemption of zero coupon bonds; (f) any transaction which has the effect of enabling enjoyment of immovable property (even without formal transfer); (g) part performance under S.53A of the Transfer of Property Act; and (h) the widest catch-all: disposing of, or parting with, an asset or any interest in it, directly or indirectly, by way of agreement or otherwise, irrespective of characterisation — including indirect transfers through foreign company shares.

The indirect transfer clause (S.2(109)(h)): This is India’s response to the Vodafone controversy. It captures transfers of shares in foreign companies where the value is derived substantially from Indian assets. If a non-resident sells shares of a foreign holding company that owns an Indian subsidiary, the gain attributable to the Indian assets is taxable in India. The scope is sweeping: it applies irrespective of whether the transfer 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.’

4D.3.3 Holding Period and Asset Classification

* Grandfathering for land/building acquired before 23.07.2024: S.197(3) allows resident individuals/HUFs the higher of: 12.5% without indexation OR 20% with indexation. The taxpayer benefits from whichever produces lower tax.

Section 67 is a long and multi-layered charging provision with 18 sub-sections addressing various special situations. The basic rule in S.67(1) is deceptively simple: any profits or gains arising from the transfer of a capital asset effected in a tax year shall be chargeable to tax under the head ‘Capital gains’ and shall be deemed to be the income of the tax year in which the transfer took place.

Special situations carved out of S.67(1): (a) S.67(2)-(4): Insurance proceeds on destruction of capital asset by natural disaster, war, or accidental fire — taxable in the year of receipt, with FMV/money received deemed as full consideration. (b) S.67(5): Non-exempt ULIP receipts treated as capital gains. (c) S.67(6): Conversion of capital asset into stock-in-trade — gains taxable only in the year the stock is SOLD (not the year of conversion), with FMV on conversion date deemed as consideration. (d) S.67(7): Securities held through depository — gains taxable in the hands of the beneficial owner, not the depository; FIFO method for cost and holding period. (e) S.67(9): Asset contributed to a firm/AOP — the value recorded in the firm’s books is deemed consideration (anti-avoidance against under-valuation). (f) S.67(10): Reconstitution of firm/AOP — if a partner receives money or assets exceeding capital account balance, the excess is STCG in the firm’s hands. (g) S.67(12)-(13): Compulsory acquisition with enhanced compensation — original compensation taxable in year of receipt, enhancement taxable in year of receipt of enhanced amount; cost of acquisition for enhancement = nil. (h) S.67(14)-(16): Joint development agreements — capital gains deferred until completion certificate issued; stamp duty value of the developer’s share on that date is deemed consideration.

4D.5.1 Sections 68-69 — Liquidation and Buyback

S.68 — Liquidation: Distribution of assets by a company to shareholders on liquidation is NOT a transfer by the company. But the shareholder is taxable: the money received or market value of assets, reduced by the amount assessed as deemed dividend under S.2(40)(c), is the full value of consideration.

S.69 — Buyback: This is a significant post-2024 change. Previously, buyback was taxed at the company level under S.115QA of the 1961 Act. Now under S.69, consideration received by a shareholder on buyback of shares is treated as capital gains in the shareholder’s hands. Where the consideration is of the nature referred to in S.2(40)(f) (i.e., dividend on buyback), its value is deemed nil for capital gains computation, preventing double taxation. The cost of acquisition to the shareholder is deductible normally.

4D.5.2 Section 70 — Transactions Not Regarded as Transfer

Section 70 is the most detailed provision in Part E. It lists over 40 categories of transfers that are NOT regarded as ‘transfer’ for capital gains purposes. The key categories:

S.71 — Withdrawal of exemption: The exemptions under S.70(c)/(d) (holding-subsidiary transfers) are WITHDRAWN if, within 8 years: (a) the transferee company converts the asset into stock-in-trade, or (b) the parent ceases to hold 100% of the subsidiary. Similarly, exemptions under S.70(zd)/(ze)/(zf) (firm-to-company, company-to-LLP, proprietor-to-company) are withdrawn if any conditions are not complied with. On withdrawal, the gain is taxable in the year of non-compliance.

Non-deductible items (S.72(3)): (a) Interest claimed as deduction under S.22 (house property) or Chapter VIII — you cannot claim interest as a deduction under house property AND also include it in cost of acquisition for capital gains. (b) Securities Transaction Tax (STT) — not deductible from capital gains, even though it is a cost of transfer. The STT regime provides a concessional tax rate in lieu of STT deduction.

Non-resident computation (S.72(6)): For NR transferring shares/debentures of an Indian company (other than listed equity under S.198), cost, transfer expenses, and consideration are first converted into the original foreign currency, gains computed in that currency, and then reconverted to INR. This protects NRs from being taxed on mere exchange rate fluctuations. S.72(7) further provides that for rupee-denominated bonds, any gain arising from rupee appreciation is ignored.

4D.6.1 Indexation and the CII

The old regime (pre-23.07.2024): Cost of acquisition was indexed to the Cost Inflation Index (CII), neutralising the effect of inflation. The formula: Indexed Cost = Actual Cost x (CII of year of transfer / CII of year of acquisition or 2001-02, whichever is later). This effectively reduced the taxable gain by the amount of inflation between acquisition and transfer. The LTCG rate was 20% on indexed gains.

The new regime (from 23.07.2024): Indexation has been ABOLISHED for all assets. LTCG is computed on actual cost (without inflation adjustment) and taxed at 12.5%. This simplifies computation but can increase the effective tax burden on long-held assets with significant inflation.

4D.7.1 Section 73 — Cost for Special Modes of Acquisition

Section 73 provides a detailed Table of 24 categories of assets acquired through special modes (gift, inheritance, amalgamation, demerger, ESOP, conversion, etc.) where the cost of acquisition is deemed to be a specific amount. The key principle: in most cases, the cost to the previous owner ‘carries over’ to the new owner. The most important entries:

Sl.No.1 — Gift, will, inheritance, HUF partition, all S.70 transfers: Cost = cost to the previous owner + cost of improvement by previous owner or assessee. ‘Previous owner’ means the last owner who acquired it by a mode OTHER than those listed in Sl.No.1.

Sl.No.4 — ESOPs and Sweat Equity: Cost = FMV as taken into account for perquisite taxation under S.17(1)(d). This is the two-stage taxation principle: Stage 1 (exercise) = salary perquisite on FMV-exercise price; Stage 2 (sale) = capital gains on sale price minus FMV.

Sl.No.14-15 — Demerger: Cost of shares in resulting company = Cost of shares in demerged company x (Net book value of assets transferred / Net worth of demerged company). Cost of original shares in demerged company is reduced by this amount. This proportionate allocation prevents any gain or loss merely from the demerger itself.

4D.7.2 Section 90 — Cost of Acquisition Definitions

S.90(3) — Self-generated intangibles: For goodwill, trademarks, brand names, rights to manufacture, tenancy rights, stage carriage permits, loom hours, and other intangible assets: if self-generated (not purchased), cost = NIL. If purchased, cost = purchase price. For goodwill acquired by purchase where depreciation was claimed before TY 2020-21, cost is reduced by the total depreciation obtained.

S.90(7)-(8) — Listed equity grandfathering (1 Feb 2018): For listed equity shares, equity MF units, and business trust units acquired before 1 February 2018, cost is the HIGHER of: (a) actual cost of acquisition, or (b) the LOWER of FMV on 31.01.2018 and the full value of consideration on transfer. FMV on 31.01.2018 is determined as: for listed assets — highest trading price on that date; for unlisted MF units — NAV on that date; for unlisted equity which later lists — indexed cost using CII for 2017-18. This grandfathering eliminates all gains that accrued before 1 February 2018.

S.90(9)-(10) — Pre-2001 assets: For any capital asset acquired before 1 April 2001, the assessee may adopt the HIGHER of actual cost or FMV on 1 April 2001. For land or building, this FMV cannot exceed the stamp duty value as on 1 April 2001 (wherever available). This provision replaces the old 1981 base year with the 2001 base year, ensuring that gains accruing before 2001 are permanently exempt from tax.

4D.8.1 Section 74 — Depreciable Assets

For assets forming part of a depreciable block, the regular computation under S.72 does not apply. Instead: if total consideration for all assets transferred from a block in a year exceeds (WDV at start + additions during year – transfer expenses), the excess is deemed STCG — regardless of how long the assets were held. If the entire block ceases to exist (all assets transferred), the gain/loss is STCG/STCL. The rationale: since depreciation has been claimed at the block level (not asset level), individual asset identification is impossible, and the gain is treated as a short-term reversal of over-depreciation.

4D.8.2 Section 76 — Market Linked Debentures and Specified Mutual Funds

Mandatory STCG treatment: Gains on transfer, redemption, or maturity of the following are ALWAYS treated as STCG regardless of holding period: (a) specified mutual funds (>65% in debt/money market instruments) acquired on or after 1 April 2023; (b) Market Linked Debentures; (c) unlisted bonds or unlisted debentures transferred/redeemed on or after 23 July 2024. This eliminates the arbitrage where investors held debt instruments for >36 months to get the old 20% LTCG rate with indexation. No indexation, no concessional rate — gains are taxed at slab rates as STCG.

4D.8.3 Section 77 — Slump Sale

Slump sale — the transfer of an undertaking as a going concern: Gains are generally LTCG if the undertaking was held for more than 36 months (not 24 months), and STCG otherwise. The computation is unique: (a) the ‘net worth’ of the undertaking (total assets minus liabilities, per books, ignoring revaluation) is deemed to be the cost of acquisition and improvement; (b) the FMV of the capital assets on the date of transfer (computed as prescribed) is deemed to be the full value of consideration. For computing net worth: depreciable assets are taken at WDV (not book value); self-generated goodwill and assets fully deducted under S.46 are valued at nil. Mandatory audit: the assessee must furnish a chartered accountant’s report certifying the net worth computation.

4D.8.4 Sections 78-80 — Deemed Full Value of Consideration

S.78 — Stamp duty value for land/building: If consideration for transfer of land or building is less than stamp duty value, the stamp duty value is deemed to be the full value of consideration. A 10% tolerance band applies: if stamp duty value does not exceed 110% of consideration, the actual consideration is accepted. The agreement date’s stamp duty value may be adopted if part consideration is received before that date through banking channels. The assessee can challenge the stamp duty value by reference to the Valuation Officer under S.78(2) if it exceeds FMV.

S.79 — Unquoted shares: If consideration for transfer of unquoted shares is less than FMV (determined as prescribed, typically by the Rule 11UA formula based on net asset value), the FMV is deemed to be the full value of consideration. This prevents under-reporting in private company share transfers.

S.80 — Unascertainable consideration: Where the consideration cannot be ascertained or determined, FMV on the date of transfer is deemed to be the full value of consideration. This ensures that no transfer escapes taxation merely because the consideration is contingent, deferred, or indeterminate.

The exemption provisions are the most utilised and the most litigated part of capital gains law. They share a common structure: if the assessee reinvests the capital gains (or net consideration) in a specified new asset within a specified time frame, the gain (or proportionate gain) is exempt. If the new asset is subsequently transferred within a lock-in period, the previously exempted gain becomes taxable.

Deposit scheme (common to S.82-88): If the capital gains are not utilised before filing the return, the unutilised amount MUST be deposited in a specified bank/institution under the Capital Gains Account Scheme (CGAS), notified by the Central Government. The deposit must be made before the return due date under S.263(1). Proof of deposit must accompany the return. Failure to deposit results in the gain being taxable in the year of transfer. The deposited amount must be utilised within the time limit; any unutilised amount is taxable in the year the time limit expires.

S.82(5)-(6) — Two-house option: If capital gains do not exceed Rs.2 crore, the assessee may purchase or construct TWO residential houses in India instead of one. This option can be exercised only ONCE in a lifetime (for the same or any tax year). This was introduced to accommodate the common practice of purchasing houses for children or aged parents.

S.85 — Specified bonds: Investment limited to Rs.50 lakh in any tax year (or in the year of transfer plus the succeeding year). Only NHAI bonds and REC bonds (5-year, redeemable after 5 years) qualify. The Rs.50 lakh cap applies per assessee, not per transfer. Any loan taken against these bonds is deemed to be a conversion into money, triggering taxability.

S.86 — The most powerful exemption: Unlike S.82 (which applies only to residential house transfers), S.86 applies to the transfer of ANY long-term capital asset (other than a residential house). The reinvestment must be in one residential house in India. The exemption is proportionate: CG x (cost of new asset / net consideration). The assessee must not own more than one residential house (other than the new asset) on the date of transfer, and must not purchase/construct any other residential house within the specified period. Violation triggers reversal of the exempted gain.

S.89 — Extension for compulsory acquisition: If compensation for compulsory acquisition is not received on the date of transfer, the time limits under S.82-86 are reckoned from the date of receipt of compensation, not the date of transfer. This is a necessary relief, as compulsory acquisition often involves delayed payments over several years.

4D.10.1 Section 196 — STCG on Listed Equity (20%)

STCG arising from transfer of listed equity shares, equity-oriented MF units, or business trust units, where STT has been paid, is taxed at a flat 20%. This replaces the pre-2024 rate of 15%. Resident individuals/HUFs can adjust the basic exemption limit (the amount by which other income falls short of the maximum not chargeable to tax is set off against such STCG before applying 20%). Chapter VIII deductions are allowed only from gross total income EXCLUDING such STCG.

4D.10.2 Section 197 — General LTCG (12.5%)

All long-term capital gains NOT covered by S.198 are taxed at a flat 12.5% under S.197. This is the residuary LTCG rate applicable to: unlisted shares, immovable property, gold, jewellery, bonds (other than S.76 deemed STCG instruments), goodwill, and all other long-term capital assets. No indexation is available (except under the S.197(3) grandfathering for pre-23.07.2024 land/building of resident individuals/HUFs). For non-residents transferring unlisted securities or shares of closely-held companies, the foreign currency conversion mechanism under S.72(6) does NOT apply — S.197(4).

4D.10.3 Section 198 — LTCG on Listed Equity (12.5%, Rs.1.25L Exempt)

LTCG from listed equity shares, equity-oriented MF units, and business trust units (where STT is paid) are taxed at 12.5% on the amount exceeding Rs.1,25,000 per year. This Rs.1.25 lakh exemption applies per assessee per year and aggregates gains from all such assets. The exemption limit was raised from Rs.1 lakh (under the old S.112A) to Rs.1.25 lakh.

STT conditions: For equity shares — STT must be paid on BOTH acquisition and transfer. For MF units and business trust units — STT only on transfer. The Central Government may notify acquisitions exempt from the acquisition STT condition (e.g., ESOP exercises, off-market acquisitions prior to listing). For IFSC transactions in foreign currency, the STT condition is relaxed.

Capital losses follow strict compartmentalisation rules that are even more restrictive than those for business losses:

The strict hierarchy: Capital losses cannot be set off against income under any other head (salary, house property, business, other sources). Within capital gains: STCL can be set off against both STCG and LTCG; LTCL can only be set off against LTCG; and losses from S.198 assets (listed equity) can only be set off against gains from S.198 assets. This prevents investors from using listed equity losses to shelter unlisted or immovable property gains. Carry-forward is limited to 8 assessment years, and the loss must be claimed in the return filed by the due date.

[End of Chapter IV-D (Capital Gains). Chapter IV-E: Income from Other Sources follows.]