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Introduction to capital gains exemption

You may be able to claim a capital gains exemption on gains earned on sale of capital assets. The capital gains exemption is available based on type of capital asset sold, type of gains, conditions for subsequent investment, time allowed and other criteria. The law confers different type of exemptions for safeguarding your capital where you sell a capital asset and invest in another capital asset.

Basic terms used:

Sale consideration is the amount for which you sell the capital asset as reduced by the expenses incurred on transfer.

Capital gains are the indexed gains in case of long-term capital asset and the ordinary gains on sale in case of a short-term capital asset.

Cost of asset should be indexed in case of long-term capital assets. The indexation factor is the cost inflation index notified for each financial year. In case of short-term capital asset, the cost is the amount paid for acquiring the asset.

1) Capital gains exemption on sale of immovable property (land and building) – Section 54:

You can claim a capital gains exemption on long-term capital gains arising from sale of a residential house property. This exemption is available only to an individual and HUF. For the purpose of claiming the exemption, you should purchase a new residential house property or construct a new residential house. The purchase can be within one year before the sale or within two years after the sale. However, in the case of construction, the construction of new house should be within three years of the sale.

The amount eligible for exemption is the lower of the long-term capital gain or the cost of the new residential house. In a case where the amount invested in the new house is lesser than the capital gain, the difference is taxable in the year of sale.

In case where the capital gain does not exceed Rs 2 crore, there is an option to invest in two residential houses and claim the capital gains exemption. This is only a one-time benefit available to the individual or HUF.

Once you choose to claim the exemption, you need to invest in the new residential house before filing your income tax return or deposit the unutilized capital gains in capital gains accounts scheme (CGAS). It is mandatory to deposit in the CGAS scheme in order to claim the capital gains exemption. You can later withdraw from the CGAS account and use the capital gain for purchasing or constructing the new residential house. The period allowed for using the CGAS withdrawals is the same as allowed for purchasing a new house or constructing a new house.

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2)  Capital gains exemption on agricultural land – Section 54B:

You can claim a capital gains exemption on sale of an agricultural land. The exemption is available for both long-term capital gains and short-term capital gain arising from agricultural land. This exemption is available only to an individual and HUF. The exemption is subject to the condition that the land must be used for agricultural purposes in the two years for agricultural purposes. For the purpose of claiming the exemption, you should purchase a new agricultural land within two years after the sale.

The amount eligible for exemption is the lower of the capital gain or the cost of the new agricultural land. In a case where the amount invested in the agricultural land is lesser than the capital gain, the difference is taxable in the year of sale.

Once you choose to claim the exemption, you need to invest in the new agricultural land before filing your income tax return or deposit the unutilized capital gains in capital gains accounts scheme (CGAS). It is mandatory to deposit in the CGAS scheme in order to claim the capital gains exemption. You can later withdraw from the CGAS account and use the capital gain for purchasing the new agricultural land. The period allowed for using the CGAS withdrawals is the same as allowed for purchasing a new agricultural land.

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3) Capital gains on compulsory acquisition of land and building – Section 54D:

In the case of a compulsory acquisition of an industrial undertaking, the entity can claim capital gains exemption on the capital gain arising on the compulsory acquisition of land and building as part of the industrial undertaking. The exemption is subject to the condition that the land and/or building must be used for the business of the said industrial undertaking. For the purpose of claiming the exemption, you should purchase a new land and/ building within three years for the purpose of shifting or re-establishing the said industrial undertaking or setting up another industrial undertaking.

The amount eligible for exemption is the lower of the capital gain or the cost of the new land and/ building. In a case where the amount invested in the new land and/ building is lesser than the capital gain, the difference is taxable in the year of sale.

Once you choose to claim the exemption, you need to invest in the new land and/ building before filing your income tax return or deposit the unutilized capital gains in capital gains accounts scheme (CGAS). It is mandatory to deposit in the CGAS scheme in order to claim the capital gains exemption. You can later withdraw from the CGAS account and use the capital gain for purchasing the new land and/ building. The period allowed for using the CGAS withdrawals is the same as allowed for purchasing a new land and/ building.

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4) Capital gains exemption by investing in Section 54EC bonds

The long-term capital gains arising on sale of land and/ building can also be invested in long-term bonds up to Rs 50 lakh. The land and/ building may or may not be residential in nature. For the purpose of claiming the exemption, you should make the investment in the bonds within six months of the sale.

The amount eligible for exemption is the lower of the capital gain or the amount invested in the bonds. In a case where the amount invested in the bonds is lesser than the capital gain, the difference is taxable in the year of sale.

You can claim capital gains exemption under section 54EC for capital gains arising from more than one capital asset. However, the amount of exemption cannot exceed Rs 50 lakh. Also, the investment in section 54EC bonds should remain locked-in for five years. The eligible bonds are bonds issued by Rural Electrification Corporation Limited and also by National Highway Authority of India.

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5) Capital gains exemption on long-term capital gains other than residential house – Section 54F

The long-term capital gains arising on sale of any long-term capital asset other than residential house is eligible for exemption under section 54F. This exemption is available only to an individual and HUF. For the purpose of claiming the exemption, you should purchase a new residential house property or construct a new residential house. The purchase can be within one year before the sale or within two years after the sale. However, in the case of construction, the construction of new house should be within three years of the sale.

For example, you can sell a long-term capital asset such as gold or stocks and invest in a residential house and claim exemption under section 54F.

The amount capital gain eligible for exemption is in the proportion of the amount invested to the sale consideration. The difference is taxable in the year of sale.

The investment in the new residential house should be locked-in for three years. Also, the individual or HUF should not own more than one residential house other than the new house.

Once you choose to claim the exemption, you need to invest in the new land and/ building before filing your income tax return or deposit the unutilized capital gains in capital gains accounts scheme (CGAS). It is mandatory to deposit in the CGAS scheme in order to claim the capital gains exemption. You can later withdraw from the CGAS account and use the capital gain for purchasing the new land and/ building. The period allowed for using the CGAS withdrawals is the same as allowed for purchasing a new land and/ building.

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6) Capital gains exemption on sale in the course of shifting of industrial undertaking – Section 54G

An entity can claim capital gains exemption from sale of capital assets in the course of shifting of an industrial undertaking. The eligible capital assets are machinery or plant or building or land or any rights in building or land used for the purposes of the business of an industrial undertaking. Such undertaking should be situated in an urban area. The exemption is available if the undertaking is shifted to another area other than an urban area within one year before the sale or three years after the sale.

For the purpose of claiming the exemption, the entity should comply with below conditions:

a)       purchase new machinery or plant for the purposes of business of the industrial undertaking in the area to which the said undertaking is shifted;

b)      acquired building or land or constructed building for the purposes of his business in the said area;

c)       shifted the original asset and transferred the establishment of such undertaking to such area; and

d)      incurred expenses on such other purpose as may be specified in a scheme framed by the Central Government for the purposes of this section.

The amount eligible for exemption is the lower of the capital gain or the amount incurred for the purpose of point (a) to (d) above. In a case where the amount incurred for the purpose of point (a) to (d) above is lesser than the capital gain, the difference is taxable in the year of sale.

Once you choose to claim the exemption, the entity should invest in the shifting to the new area before filing your income tax return or deposit the unutilized capital gains in capital gains accounts scheme (CGAS). It is mandatory to deposit in the CGAS scheme in order to claim the capital gains exemption. You can later withdraw from the CGAS account and use the capital gain for the purpose of shifting the undertaking as per point (a) to (d) above. The period allowed for using the CGAS withdrawals is the same as allowed for shifting the undertaking.

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7) Capital gains exemption on sale of assets upon shifting of industrial undertaking to special economic zone – Section 54GA

An entity can claim capital gains exemption from sale of capital assets in the course of shifting of an industrial undertaking from urban area to special economic zone. The eligible capital assets are machinery or plant or building or land or any rights in building or land used for the purposes of the business of an industrial undertaking situate. The special economic zone may be in an urban area or any other area. The exemption is available if the undertaking is shifted to special economic zone other than an urban area within one year before the sale or three years after the sale.

For the purpose of claiming the exemption, the entity should comply with below conditions:

a)       purchased new machinery or plant for the purposes of business of the industrial undertaking in special economic zone;

b)      acquired building or land or constructed building for the purposes of his business in the Special Economic Zone;

c)        shifted the original asset and transferred the establishment of such undertaking to the Special Economic Zone; and

d)      incurred expenses on such other purposes as may be specified in a scheme framed by the Central Government for the purposes of this section.

The amount eligible for exemption is the lower of the capital gain or the amount incurred for the purpose of point (a) to (d) above. In a case where the amount incurred for the purpose of point (a) to (d) above is lesser than the capital gain, the difference is taxable in the year of sale.

Once you choose to claim the exemption, the entity should invest in the shifting to the special economic zone before filing your income tax return or deposit the unutilized capital gains in capital gains accounts scheme (CGAS). It is mandatory to deposit in the CGAS scheme in order to claim the capital gains exemption. You can later withdraw from the CGAS account and use the capital gain for the purpose of shifting the undertaking as per point (a) to (d) above. The period allowed for using the CGAS withdrawals is the same as allowed for shifting the undertaking.

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8) Capital gains exemption on sale of residential property invested in a Start-up – Section 54GB

You can claim a capital gains exemption on long-term capital gains arising from sale of a residential house property or a plot of land. This exemption is available only to an individual and HUF. For the purpose of claiming the exemption, the sale consideration should be invested in the equity shares of an eligible company. The investment should be made before filing the income tax return from the due date. Also, the company should use the subscription amount received to purchase a new asset within one year from the date of subscription.

The amount capital gain eligible for exemption is in the proportion of the amount invested in the new asset to the sale consideration. In a case where the amount invested in the new asset is lesser than the sale consideration, the difference is taxable in the year of sale.

Once you choose to claim the exemption, the company should invest the subscription received in the new asset before filing your income tax return or deposit the unutilized capital gains in a scheme notified by the Central Government. It is mandatory to deposit in the notified scheme in order to claim the capital gains exemption. You can later withdraw from the scheme account and use the capital gain for the purpose of shifting the undertaking as per point (a) to (d) above. The period allowed for using the withdrawals is the same as allowed for purchasing a new asset.

The investment in the equity shares of the eligible start-up or the asset should remain locked-in for a period of five years from their date of investment or purchase.

Eligible start-up is a company or a Limited Liability Partnership engaged in innovation, development or improvement of products or processes or services or a scalable business model with a high potential of employment generation or wealth creation. Such start-up should be incorporated between 1 April 2016 and 31 March 2022, turnover not greater than Rs 100 crore and holds certificate of eligible business.

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