Exemption of Capital Gains under Sections 10 and 54

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Certain assets are not ‘Capital Assets’ for purposes of capital gain and hence there is no gain on transfer of such assets. Similarly, there are certain transactions which are not regarded as ‘transfer’ for capital gain purposes, and hence there is no capital gain on such transactions.

We will now discuss cases where although there is a transfer and such transfer is of capital asset but still the capital gain arising on account of such transaction is exempt from income-tax.

These exemptions are of two types: —

(A) Exemption of capital gains under various sub-clauses of Section 10;

(B) Exemption of capital gains under sections 54, 54B, 54D, 54EC, 54EE, 54F, 54G, 54GA and 54GB.

Exemption of Capital Gains
Exemption of Capital Gains

Table of Contents

1. [Section 10(37)] : Exemption of Capital Gains on Compensation received on Compulsory Acquisition of Urban Agricultural Land

Section 10(37) is applicable if the following conditions are satisfied—

  1. The assessee is an individual or a Hindu undivided family.
  2. He or it owns an agriculture land situated in urban area mentioned in section 2(14)(iii)(a)/(b).
  3. There is transfer of the agriculture land by way of compulsory acquisition or the consideration for transfer is approved or determined by the Central Government (not by a State Government) or RBI.
  4. The agriculture land was used by the assessee (and/or his parents if the land was owned by an individual) for agricultural purposes during 2 years immediately prior to the date of transfer.
  5. The asset may be long-term capital asset or short-term capital asset.
  6.  Capital gain arises from compensation (and/or additional compensation) or consideration which is received by the assessee after March 31, 2004.

If the above conditions are satisfied, capital gain (short-term or long-term) is exempt from tax.

Where the compulsory acquisition has taken place before 1.4.2004 but the compensation is received after 31.3.2004, it shall be exempt. But if part of the original compensation in the above case has already been received before 1.4.2004, then exemption shall not be available even though balance original compensation is received after 31.3.2004.

However, enhanced compensation received on or after 1.4.2004 against agricultural land compulsory acquired before 1.4.2004 shall be exempt.

2. (Section 54) : Exemption of Capital Gains from the Transfer of Residential House Property:

Capital gain arising on the transfer of a residential house is exempt u/s 54 in the following circumstances:

  1. the asset transferred is a residential house, the income of which is chargeable under the head “income from house property”;
  2. the asset transferred is a long-term capital asset and hence there is a long-term capital gain;
  3. the asset has been transferred by an individual or a Hindu Undivided Family;
  4. the assessee has purchased one residential house in India within 1 year before or 2 years after the date on which the transfer took place, or constructed one residential house in India within a period of 3 years after the date on which the transfer took place.

If all these four conditions are satisfied then the assessee can claim the exemption under section 54.

Quantum of Deduction

(1) Amount of long-term capital gain; or

(2) Amount invested in the purchase or construction of the residential house

whichever is less.

Consequences where the new house purchased and/or constructed is transferred within a period of 3 years of its purchase or construction:

In this case, for the purpose of computing capital gain on such transfer, cost of acquisition of the new house property shall be reduced by the amount of capital gain exempt under this Section i.e. Section 54 earlier, and such capital gain will be:

  1. Short-term Capital Gain if the new house is transferred within 2 years.
  2. Long-term Capital Gain if the house property is transferred after 2 years but before 3 years from the date of its acquisition. Benefit of Indexation of the net cost of acquisition (i.e. Cost of Acquisition – Capital Gain exempt U/s 54) will also be allowed.

The Finance Act, 2019 [W.e.f. A.Y. 2020-21] has inserted a proviso under section 54(1) to provide as under: 

Where the amount of the capital gain does not exceed ₹2 crore, the assessee, may at his option, purchase or construct two residential houses in India, and where such an option has been exercised, — 

  • the provisions of this sub-section shall have effect as if for the words “one residential house in India”, the words “two residential houses in India” had been substituted; 
  • any reference in this sub-section and sub-section (2) to “new asset” shall be construed as a reference to the two residential houses in India.

Therefore, now the exemption can be claimed for purchase / construction of 2 Residential Houses instead of 1. This benefit is available only when the Capital Gain does not exceed Rs. 2 Crore . Further, this benefit is available only once in a life time.

3. (Section 54B) : Exemption of Capital Gain on Transfer of Land used for Agricultural Purposes:

The exemption u/s 54B is available in respect of capital gains arising from transfer of agricultural land, if following conditions are satisfied:

  1. the agricultural land had been transferred by an individual or HUF;
  2. the agricultural land has been used by the individual or his parents or by HUF for agricultural purposes during the 2 years immediately preceding the date of transfer;
  3. the assessee had purchased another agricultural land (rural or urban) within a period of 2 years after the date of transfer of the original agricultural land to be used for agricultural purpose.
1. Transfer of agricultural land can be after or before 3 years of acquisition, but it must be used by the assessee or his parents or HUF for a period of at least 2 years immediately preceding the date of transfer, for agricultural purposes.  

2. It may be noted that capital gain on the compulsory acquisition of urban agricultural land is exempt if conditions mentioned under section 10(37) are satisfied.

Quantum of deduction

  1. If the amount of capital gain is equal to or less than the cost of the new agricultural land, the entire capital gain shall be exempt.
  2. If the amount of capital gain is greater than the cost of the new agricultural land, the cost of the new agricultural land shall be allowed as an exemption.

In other words, capital gain will be exempt to the extent it is invested for acquiring the new agricultural land.

Consequences where the new agricultural land is transferred within a period of 3 years of its purchase:

In this case, the capital gain which was exempt earlier u/s 54B shall be reduced from the cost of the new agricultural land for the purpose of computation of capital gain in respect of the new agricultural land. Such Capital Gain will be :

  1. Short-term Capital Gain if the new Agricultural Land is transferred within 2 years.
  2. Long-term Capital Gain if the new Agricultural Land is transferred after 2 years but before 3 years from the date of its acquisition. Benefit of Indexation of the net cost of acquisition (i.e. Cost of Acquisition – Capital Gain exempt U/s 54) will also be allowed.

4. (Section 54D) : Exemption of Capital Gains on Compulsory Acquisition Of Land And Buildings forming part of Industrial Undertaking.

The capital gain arising from the transfer, by way of compulsory acquisition under any law, of land or buildings forming part of an industrial undertaking belonging to the assessee are exempt, if the following conditions are satisfied:

  1. the transfer is by way of compulsory acquisition of the asset;
  2. the asset transferred is land or buildings forming part of an industrial undertaking belonging to the assessee;
  3. such land or buildings were in use by the assessee for the purpose of the business of the industrial undertaking for at least 2 years immediately preceding the date of transfer;
  4. capital gain on compulsory acquisition of land and buildings can be short-term or long-term. However, since building is being used for business, it is a depreciable asset and therefore, capital gain on transfer of such building, even if, it is held for more than 3 years, will be a short-term capital gain. Land is however, not a depreciable asset and as such the period of holding will be important for computing long-term/short-term capital gain;
  5. the assessee purchases/constructs other land and buildings within a period of 3 years after the date of transfer for the purpose of shifting or re-establishing the said industrial undertaking or setting up another industrial undertaking.

Quantum of Deduction

  1. If the amount of capital gain is equal to or less than the cost of the new asset, the entire capital gain shall be exempt.
  2. If the amount of capital gain is greater than the cost of the new asset, the cost of the new asset shall be allowed as an exemption.

In other words, capital gain shall be exempt to the extent it is invested in the purchase/construction of new land/building for the industrial undertaking.

Consequences where the new asset is transferred within a period of 3 years of its purchase or construction:

In this case, the capital gain which was exempt under this section earlier, shall be reduced from the cost of the new asset for the purpose of computation of capital gain in respect of the transfer of the new asset.

5. (Section-54EC) : Exemption of Capital Gain on Transfer of any Long Term Capital Asset on the basis of Investment in certain Bonds

Long-term capital gain arising on the transfer of any capital asset being land or building or both is exempt u/s  54EC in the following circumstances: 

  1. The asset (i.e land or building or both) transferred is a long-term capital and hence, there is a long-term  capital gain
  2. The asset is transferred by any assessee. 
  3. The assessee has within a period of 6 months after the date of such transfer invested the capital gain in the  long-term specified assets. 
  4. The cost of long term specified assets which is considered for the purpose of exemption under this section  i.e., 54EC, shall not be eligible for deduction with reference to such cost u/s 80C. 

Quantum of deduction 

  1. If the amount of capital gain is equal to or less than the cost of the long-term specified assets acquired  within 6 months of the date of transfer, the entire capital gain shall be exempt. 
  2. If the amount of capital gain is greater than the cost of the long-term specified assets, than the cost of the  long-term specified assets shall be allowed as exemption. 

In other words, capital gain shall be exempt to the extent it is invested in the long-term specified assets  within a period of 6 months from the date of such transfer. 

Investment in bonds limited to ₹50,00,000:

The investment made in the long-term specified asset by an  assessee out of capital gains arising from transfer of one or more original asset during any financial year in  which the original asset or assets are transferred and in the subsequent financial year cannot exceed ₹50 lakh. 

Consequences if the long-term specified asset is transferred or converted into money within 5 years: 

Where the long term specified asset is transferred or converted (otherwise than by transfer) into money at any  time within a period of 5 years from the date of its acquisition, the amount of capital gain exempt u/s 54EC  earlier, shall be deemed to be long-term capital gain of the previous year, in which the long term specified asset is  transferred or converted (otherwise than the transfer) into money.

6. (Section 54EE) : Capital Gain not to be charged on Investment in Units of a Specified Fund

As per Section 54EE(1), any Long-term capital gain arising on the transfer of any capital asset is exempt under section  54EE in the following circumstances: 

  1. The asset transferred is a long-term capital asset and hence, there is a long-term capital gain
  2. Such asset is transferred on or after 1.4.2016. 
  3. The asset is transferred by any assessee. 
  4. The assessee has within a period of 6 months after the date of such transfer invested the capital gain in the long-term specified assets. 

Provided that the investment made on or after 1.4.2016 in the long-term specified asset by an assessee during any financial year cannot exceed ₹50 lakh. 

Further, provided that the investment made by an assessee in the long-term specified asset, out of capital gains arising from transfer of one or more original asset, during the financial year in which the original asset or assets are transferred and in the subsequent financial year does not exceed ₹50 lakh.

Quantum of deduction 

  1. If the amount of capital gain is equal to or less than the cost of the long-term specified assets acquired  within 6 months of the date of transfer, the entire capital gain shall be exempt. 
  2. If the amount of capital gain is greater than the cost of the long-term specified assets, than the cost of the  long-term specified assets shall be allowed as exemption. 

In other words, capital gain shall be exempt to the extent it is invested in the long-term specified assets  within a period of 6 months from the date of such transfer. 

Consequences if the long-term specified asset is transferred within 3 years [Section 54EE(2)]:

Where the  long term specified asset is transferred by the assessee at any time within a period of three years from the date of  its acquisition, the amount of capital gain exempt under section 54EE earlier, shall be deemed to be long-term  capital gain of the previous year, in which the long term specified asset is transferred.

7. [Section 54F] : Exemption of Capital Gain on Transfer Of Long-Term Capital Assets other than a House Property

Where an individual or HUF transfers any long-term capital asset, not being a residential house, and invests the net sale proceeds to acquire a residential house, the exemption u/s 54F is available provided following conditions are satisfied:

  1. the asset is transferred by an individual or HUF;
  2. the asset transferred is a long-term capital asset;
  3. the asset transferred is any capital asset other than a residential house;
  4. the assessee has purchased one residential house in India within one year before or 2 years after the date on which the transfer took place or constructed one residential house in India within a period of 3 years after the date on which transfer took place;
  5. the assessee does not own more than one residential house on the date of transfer of the original asset, exclusive of the one purchased for claiming exemption under this section i.e., section 54F;
  6. the assessee should not purchase, within a period of two years after the date of transfer of original asset or construct within a period of 3 years after the date of transfer of original asset, any other residential house other than the new asset.

Quantum of deduction

1. If the net sale consideration of the original asset is equal to or less than the cost of the new house, the entire capital gain shall be exempt.

2. If the net sale consideration of the original asset is greater than the cost of the new house then the exemption shall be allowed in the same proportion in which the cost of the new house bears to the net sale considerations i.e. it shall be allowed proportionately as under:

Exemption of Capital Gains under Sections 10 and 54

Consequences where the new house is transferred within a period of 3 years of its purchase or construction:

In this case, there will be following 2 capital gains:

(a) Capital gain/loss on transfer of new house which will always be short-term capital gain/loss;

(b) Capital gain exempt earlier under this Section i.e. 54F shall be treated as long-term capital gain of the previous year in which the new asset is transferred.

Consequences where the assessee purchases, within a period of two years of the transfer of the original asset, or constructs, within a period of 3 years of transfer of such an asset, a residential house other than the new house bought/constructed, whose income is chargeable under the head Income from House Property:

In this case, the capital gain exempt u/s 54F earlier shall be treated as long-term capital gain of the previous year in which the second house is bought/ constructed.

8. [Section 54G] : Capital Gain on Shifting of Industrial Undertaking from Urban Areas to Non-Urban Areas

The exemption is available to all categories of assessees in respect of capital gain arising on the transfer of fixed assets other than furniture and fixtures of industrial undertaking effected to shift it from an urban area.

The conditions for claiming exemptions are as under:

  1. the transfer is effected in the course of or in consequence of shifting the undertaking from an urban area to any other area. Any other area means an area not declared as an urban area. ‘Urban area’ means any such area within the limits of a municipal corporation or municipality, as the Central Government may, having regard to the population, concentration of industries, need for proper planning of the area and other relevant factors, by general or special order, declare to be an urban area for the purposes of this sub-section;
  2. asset transferred is machinery, plant, building, land or any right in building or land used for the business of industrial undertaking in an urban area;
  3. the capital gain arising on the asset transferred may be short-term or long-term capital gain. Normally, it will be short-term capital gain because most of the assets of the industrial undertaking will be depreciable assets;
  4. the capital gain is utilised within one year before or 3 years after the date of transfer for the specified purpose.

Specified purpose includes the following:

(a) for purchase of new machinery or plant for the purpose of business of the Industrial Undertaking in the area to which the said undertaking is shifted;

(b) acquisition of building or land or construction of building for tax payer’s business in that other area;

(c) expenses on shifting of the old undertaking and its establishment to the other area; or

(d) incurring of expenditure on such other purposes as specified by the Central Government for this purpose.

Quantum of deduction

1. If the capital gain, on transfer of the original asset, is equal to or less than the cost and expenses incurred for the above specified purposes, the entire capital gain shall be exempt.

2. If the capital gain on transfer of the original asset is greater than the cost and expenses incurred for the specified purposes then the exemption shall be allowed to the extent of the cost and expenses incurred.

In other words, capital gain shall be exempt to the extent it is spent for the specified purpose.

Consequences where the new asset is transferred within a period of 3 years of its purchase or construction:

In this case, the capital gain, which was exempt earlier u/s 54G, shall be deducted from the cost of acquisition of the new asset for the purpose of computation of capital gain in respect of the transfer of the new asset.

9. [Section 54GA] : Exemption of Capital Gain on transfer of Assets in case of shifting of Industrial Undertaking from an Urban area to any Special Economic Zone (SEZ)

The exemption is available to all categories of assessees in respect of capital gain arising on the transfer of fixed assets other than furniture and fittings of industrial undertaking effected in the course of shifting of such industrial undertaking to any Special Economic Zone.

The conditions for claiming exemptions are as under:

  1. the transfer is effected in the course of or in consequence of shifting the undertaking from an urban area to any Special Economic Zone. The Special Economic Zone may be developed in any urban area or any other area.
  2. asset transferred is machinery, plant, building, land or any right in building or land used for the business of industrial undertaking in an urban area;
  3. the capital gain arising on the asset transferred may be short-term or long-term capital gain. Normally, it will be short-term capital gain because most of the assets of the industrial undertaking will be depreciable assets;
  4. the capital gain is utilised within 1 year before or 3 years after the date of transfer for the specified purpose.

Specified purpose includes the following:

(a) for purchase of new machinery or plant for the purpose of business of the Industrial Undertaking in the Special Economic Zone to which the said undertaking is shifted;

(b) acquisition of building or land or construction of building for the purposes of the assessee’s business in the Special Economic Zone;

(c) expenses on shifting of the old undertaking and its establishment to the Special Economic Zone; and

(d) incurring of expenditure on such other purposes as specified by the Central Government for this purpose.

Note: The quantum of deduction and the scheme of deposit are the same as given under section 54G.

10. (Section 54GB) : Exemption of Long term Capital Gain Tax on Transfer of Residential Property if Net Consideration is Invested in the Equity Shares of a new Start-up SME Company 

As per section 54GB, any capital gain arising to an individual or HUF from the transfer of a long-term capital asset being a residential property (a house or plot of land) shall be exempt proportionate to the net consideration price so invested in the subscription of equity shares of a eligible company before the due date of furnishing the return of income under section 139(1).

1. Essential Conditions to be satisfied:

The above exemption shall be allowed if the following conditions are satisfied:

1. There should be a long-term gain from the transfer of a residential property (i.e. a house or plot of land).

2. Such long-term capital gain should arise to an individual or HUF,

3. The amount of net consideration should be utilized by the individual or HUF before the due date of furnishing of return of income under section 139(1), for subscription in equity shares of a eligible company (hereinafter referred to as company). If the full amount of net consideration is not utilized for subscription in equity shares, the exemption shall be allowed proportionate to the amount so invested.

4. The amount of subscription as share capital is to be utilized by the company for the purchase of new asset (eligible plant and machinery) within a period of one year from the date of subscription in the equity shares.

5. The equity shares of the company or the new asset acquired by the company should not be sold or otherwise transferred by the individual/HUF or the company as the case may be with in a period of 5 years from the date of their acquisition.

6. The exemption will be available in case of any transfer of residential property made on or before 31.3.2017. (On or before 31.3.2019 in case of an investment in eligible start up instead of eligible small or medium enterprise).

2. Consequence if equity shares or new asset is transferred within a period of 5 years from the date of its acquisition:

(a) If the equity shares acquired by the individual or HUF are sold or otherwise transferred within a period of 5 years from the date of its acquisition, the capital gain shall arise as under:

(i) the capital gain arising from the transfer of equity shares shall be taxable in the previous year in which such shares are transferred, which can be short-term or long-term depending upon the period of holding.

And

(ii) the amount of capital gain arising from the transfer of residential property not charged under section 45(1) earlier shall be deemed to be the long-term capital gain of the previous year in which such shares are sold or otherwise transferred and hence taxable.

(b) Similarly, if the new asset (eligible plant and machinery) is sold or otherwise transferred by the company within a period of 5 years from the date of its acquisition, the capital gain shall arise as under:

(i) the capital gain, if any arising from the transfer of such asset will be taxable in the hands of company, which will be short-term as asset is a depreciable asset forming part of block of asset,

And

(ii) the amount of capital gain which was exempt under section 45(1) earlier shall be taxable as long-term capital gain in the hands of such individual or HUF in the previous year in which such asset (eligible plant and machinery) is sold or otherwise transferred.

3. Capital Gain Scheme also applicable:

If the amount of net consideration which has been received by the company for the issue of equity shares by the individual or HUF is not utilized by the company for the purchase of a new asset (eligible plant and machinery) before the due date of furnishing the return of income under section 139, the unutilized amount should be deposited before the said due date under a deposit scheme, notified by the Central Government in this behalf and the return furnished by the assessee shall be accompanied by proof of such deposit having been made.

The amount so utilized and the amount so deposited in the deposit scheme shall be deemed to be the cost of a new asset (eligible plant and machinery).

4. Consequences if the amount deposited in deposit scheme is not utilized for purchase of new asset:

Where the amount so deposited in deposit scheme is not utilized, wholly or partly for the purchase of new asset within a period of one year from the date of subscription in equity shares by the individual or HUF, then the difference between:

(a) the exemption allowed under section 54GB earlier; And

(b) the exemption that should have been allowed based on the amount actually utilized, in the purchase of new asset (eligible plant and machinery)

shall be taxable as long-term capital gain in the hands of individual or HUF in which the period of one year from the date of subscription in equity share by the assessee expires and the company shall be entitled to withdraw such amount in accordance with the scheme.

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