Capital Gains and Income from Other Sources
Weightage: Unit 4 of Chapter 3 (Capital Gains) and Chapter 3's final unit (Other Sources) of ICAI's Paper 3 Section A, together roughly 10 marks. Capital Gains is computationally the densest of the five heads; Other Sources is short and largely definitional once the residual principle is understood.
Capital Gains
What is a capital asset
Section 2(14) defines capital asset widely — property of any kind held by the assessee, whether connected with business or not — and then excludes specific categories: stock-in-trade (which generates business income, not capital gains, when sold); personal effects — movable property held for personal use, with jewellery, archaeological collections, drawings, paintings, sculptures and any work of art expressly carved out of the exclusion and therefore still capital assets even though personally used; agricultural land in rural areas (defined by distance from municipal limits and population thresholds); and specified gold bonds and deposit certificates.
The jewellery/art carve-out is worth committing to memory precisely because it inverts the ordinary intuition: personal effects are generally excluded, but this specific list of personally-used items is not excluded and remains a capital asset.
What is a transfer
Section 2(47) defines transfer inclusively: sale, exchange, relinquishment of the asset; the extinguishment of any rights in the asset; compulsory acquisition; conversion of a capital asset into stock-in-trade; and, notably, a transaction involving allowing possession of an immovable property in part performance of a contract (section 53A of the Transfer of Property Act) — this last limb is what taxes a builder's or seller's gain the moment possession is handed over under an agreement to sell, even before a registered sale deed is executed.
Short-term versus long-term
The dividing line depends on the asset:
- Listed securities, units of equity-oriented funds, and zero-coupon bonds: long-term if held for more than 12 months.
- Unlisted shares and immovable property (land or building): long-term if held for more than 24 months.
- All other capital assets: long-term if held for more than 36 months.
Computation
Short-term capital gain = Full value of consideration − (cost of acquisition + cost of improvement + expenditure wholly and exclusively in connection with the transfer).
Long-term capital gain = Full value of consideration − (indexed cost of acquisition + indexed cost of improvement + expenditure in connection with the transfer).
Indexation is not available for bonds and debentures (other than capital-indexed bonds and sovereign gold bonds issued by the RBI), and, following recent amendment, indexation benefit for certain long-term capital assets has been made optional or removed in specified cases with a corresponding rate adjustment — a candidate should confirm the current position for the applicable assessment year rather than assume a fixed universal rule, since this is an area of frequent legislative change.
Full value of consideration in the case of transfer of land or building is deemed to be the higher of actual consideration and the stamp duty value, subject to a tolerance band (a specified percentage variance is ignored) — this is section 50C's safeguard against understating consideration to reduce tax, and the tolerance band exists to avoid penalising genuine, modest, arm's-length variance from stamp valuation.
Cost of acquisition where the asset was acquired otherwise than by purchase
Where a capital asset became the property of the assessee by way of gift, will, inheritance, succession, or specified modes (not a purchase for consideration), the cost to the previous owner is deemed to be the cost of acquisition, and the period of holding of the previous owner is included in computing the assessee's own holding period — this is what allows an inherited asset to be long-term even where the current holder has held it only briefly.
Fair market value as on 1 April 2001 may be substituted for actual cost, at the assessee's option, for any asset acquired before that date (subject to specified restrictions for land and buildings, where fair market value cannot exceed stamp duty value as on that date).
Exemptions
Section 54 — capital gain on the transfer of a long-term residential house property, where the assessee purchases another residential house within 1 year before or 2 years after the transfer, or constructs one within 3 years after, is exempt to the extent of the capital gain invested in the new house, subject to a monetary cap on the exemption amount and a restriction (subject to a one-time relaxation for gains up to a specified limit) generally allowing exemption for investment in only one residential house.
Section 54B — capital gain on transfer of agricultural land used for agricultural purposes by the assessee or his parents for 2 years preceding transfer, where the assessee purchases another agricultural land within 2 years, is exempt to the extent invested.
Section 54EC — capital gain on transfer of land or building (long-term) invested in specified bonds (NHAI, REC and similar notified bonds) within 6 months of transfer, exempt up to a monetary ceiling (₹50 lakh in a financial year), with a lock-in period of 5 years on the bonds.
Section 54F — capital gain on transfer of any long-term capital asset other than a residential house, where the net consideration (not merely the gain) is invested in purchasing a residential house within 1 year before or 2 years after, or constructing one within 3 years, subject to the condition that the assessee does not own more than one other residential house on the date of transfer (subject to specified exceptions), with the exemption computed proportionately where the full net consideration is not invested:
Capital Gains Account Scheme. Where the assessee has not completed the purchase or construction by the date of filing the return, the unutilised amount must be deposited in a specified bank account under the Capital Gains Account Scheme before that due date, to preserve the exemption; if not utilised within the prescribed period thereafter, the unutilised amount is taxed as capital gain of the year the prescribed period expires.
Set-off restrictions specific to capital gains
Long-term capital loss can be set off only against long-term capital gain, never against short-term gain. Short-term capital loss can be set off against both short-term and long-term capital gain. This asymmetry is examined constantly and is the single most frequent error in set-off problems within this head.
Income from Other Sources
The residual principle
Section 56 charges income of every kind not chargeable under Salaries, House Property, Business/Profession or Capital Gains, and not exempt, under this head — it is the residual, catch-all head, and its scope is defined by exclusion from the other four rather than by any positive description of its own content.
Specifically included
Dividend income (subject to specified exemptions for certain categories); interest on securities; winnings from lotteries, crossword puzzles, races, card games, and other games of any sort, or from gambling or betting of any form or nature, taxed at a flat 30% rate (plus applicable surcharge and cess) with no deduction for any expenditure and no basic exemption limit benefit against this specific income; income from letting of machinery, plant or furniture, and, where a building is let along with such assets and the two lettings are inseparable, the composite income from both.
Family pension received by a legal heir after the death of the employee is taxable under this head (not Salaries, since there is no longer an employer-employee relationship with the recipient), with a standard deduction of the lower of a specified sum or one-third of the family pension.
Gifts. Where any sum of money is received without consideration and the aggregate exceeds ₹50,000 in the year, the whole aggregate amount is taxable (not merely the excess over ₹50,000). Where immovable property is received without consideration and its stamp duty value exceeds ₹50,000, the stamp duty value is taxable; where received for inadequate consideration and the shortfall between stamp duty value and consideration exceeds the higher of ₹50,000 or 10% of consideration, the shortfall is taxable. Similar rules apply to movable property (shares, jewellery, and specified categories) received without or for inadequate consideration, measured against fair market value.
Exceptions to the gift taxation rules — money or property received from a relative, on the occasion of marriage, under a will or by way of inheritance, in contemplation of death of the payer, from a local authority, from any fund, foundation, university or other educational or medical institution or trust registered under specified charitable provisions, and certain other specified categories, are not taxable regardless of amount.
Deductions under section 57
Reasonable expenditure incurred wholly and exclusively for earning the income under this head is deductible — for interest on securities and dividend, a reasonable sum for collection charges; for income from letting of machinery, plant or furniture, current repairs, insurance premium, and depreciation as though it were a business asset; no standard deduction is available against most items under this head, except family pension as noted above.
