Monday, 5 May 2014

TAX PLANNING FOR CAPITAL GAINS

1.hose who have been making investments in shares and securities should carefully decide the time for sale to ensure that it becomes a long term asset. In case of long term capital gains, the tax rates are lower. It may be noted that with effect from assessment year 1995-96, in addition to shares, any security including debentures listed in a stock exchange in India or units of UTI or Units of Mutual Fund specified in section10 (23D) shall be treated as long term capital asset, if the same are held for more than 12 months. For other assets the minimum period of holding is 36 months for treating the same as long term capital asset.



It may be noted that in case of Long Term Capital Gain Indexation of cost is also allowed . However w.e.f. assessment year 1998-99 indexation is not permitted in case of bonds and debentures.
2.
Short term capital gain is taxed at the normal rate, whereas the long term capital gain is taxed as per section 112 as under :-
a)
For individuals and H.U.Fs — W.e.f. assessment year 2000-2001, the LTCG will be taxed @ 10% in case of transfer of listed securities if no indexation benefit is taken otherwise LTCG will be taxed @ 20% as earlier. It may be noted that the tax on LTCG shall be chargeable only on that amount of capital gain which exceeds the exemption limit i.e. the maximum amount on which no tax is charged, including the other income. For example, if an individual has income from interest on loan of Rs.10,000 and has long term capital gain on sale of listed shares amounting to Rs.47,500 for assessment year 1999-2000, he has to pay Income Tax on Rs.7,500 i.e. (Rs.57,500 minus exemption limit Rs.50,000) @ 20%, which comes to Rs.1,500). It may be pointed out that the normal rate of tax for income slab between Rs.50,000 to Rs.60,000 is only 10% from assessment year 1999-2000 and in the instant example the assessee has to pay tax @ 20%. This anomaly, which existed till assessment year 1999-2000, has been taken care of to a large extent, as suggested by us in this Chapter in the seventh edition. It is gratifying that the Government has provided for the option of levy of tax @ 10% on LTCG arising on transfer of any listed security, without indexation w.e.f. assessment year 2000-01.
Therefore in the above example, the assessee may opt to pay tax on LTCG @ 10% without claiming benefit of indexation undersection 48.
b)
In case of companies w.e.f assessment year 1997-98 at flat rate of 20% (10% without indexation in case of transfer of any listed security w.e.f. assessment year 2000-01). However, if the assessee has any loss without considering the capital gain then the long term capital gain shall be set-off as per section 71 and 72, and only the balance amount of capital gain shall be taxed.
c)
In any other case w.e.f. assessment year 1997-98 at the rate of 20% (10% without indexation in case of transfer of any listed security w.e.f. assessment year 2000-01). Please note that no deduction shall be allowed under Chapter VI-A of the I.T. Act in respect of income from long term capital gain and further no rebate from tax under section 88 shall be allowed on the tax payable on the long term capital gain. However rebate under section 88B & 88C are available even from tax on LTCG.
Please note that no deduction shall be allowed under Chapter VI-A of the I.T. Act in respect of income from long term capital gain and further no rebate from tax under section 88 shall be allowed on the tax payable on the long term capital gain. However rebate under section 88B & 88C are available even from tax on LTCG.
RIGHT SHARES - NEW PROCEDURE :
The tax treatment in respect of right shares has been modified w.e.f. assessment year 1995-96.
Here, the assessee was entitled upto assessment year 1994-95 to adjust the amount of reduction in value of shares after record date for right entitlement from the consideration received on renouncement of entitlement of right shares. But with effect from assessment year 1995-96, as per new provision in sec section 55(2)(aa), the cost of right entitlement in the hands of the original shareholder will be deemed to be nil. That means the total consideration received on renouncing the right entitlement will be taxed and the same will be generally short term capital gain as the date of right offer made by the company will be deemed as the date of acquisition of right entitlement.
It is also clarified that -
a)
If the original shareholder himself applies for right shares, the cost of such shares will be the amount actually paid by him.
b)
For the person getting the shares as renouncee, the cost will be the addition of the amount paid for obtaining the right entitlement and the amount paid for right shares to the company.
TREATMENT OF BONUS SHARES :
With effect from assessment year 1996-97 the cost of bonus shares or securities or any other assets which is received on the basis of his holding without any payment shall be taken to be nil. However the provisions applicable in relation to such assets upto assessment year 1995-96 are different. For the purpose of ascertaining the cost of bonus shares, the averaging method was adopted on the basis of Supreme Court decision in C.I.T. v. Dalmia Investment Co. Ltd. [1964] 52 ITR 567 (SC).
CAPITAL GAINS NOT CHARGEABLE WHERE NO COST OF ACQUISITION IS CONCEIVABLE :
There is an inherent limitation in the concept of capital asset as is evident from various decisions of Courts, discussed hereinafter. The Madhya Pradesh High Court held in CIT v. H. H. Maharaja Sahib Shri Lokendra Singhji [1986]
162 ITR 93 (MP): TC 20R 1065
, the liability to tax on capital gains would arise in respect of only those capital assets in the acquisition of which an element of cost is either actually present or is capable of being reckoned and not in respect of those assets in the acquisition of which the element of cost is altogether inconceivable. In a case where cost cannot be ascertained, the fair market value cannot be taken into consideration under section 55.
However as per amended provisions of section 55(2), w.e.f. 1.4.88 the cost of goodwill where it has been acquired otherwise than for a purchase price shall be taken as nil. Similarly w.e.f. 1.4.95 tenancy rights, stage carriage permits and loom hours for which cost of acquisition cannot be envisaged shall be taken as nil. However, the principle laid down in CIT v. H.H. Maharaja Sahib Shri Lokendra Singhji (Supra) would continue to apply in respect of other capital assets, which have not been specifically mentioned in section 55(2) and in relation to which the cost of acquisition cannot be envisaged.
The very basis of capital gains is that at some point of time the person who initially acquired the property did so at some cost in terms of money. In the above case [162 ITR 93] the assessee, a ruler of a former princely State, had sold some lands which were part of the property which had come to him on inheritance from forefather to whom the property had been gifted by a Moghul emperor and as such there was no cost of acquisition at any point of time. Similar view was taken in the case of CIT v. H.H. Lokendra Singh [1997] 227 ITR 638 (MP): [1996] 134 CTR (MP) 149 and CIT v. H.H. Lokendra Singh [1996] 135 CTR (MP) 45.
The Calcutta High Court held in CIT v. Suman Tea & Plywood Industries (P) Ltd. [1997] 226 ITR 34 (Cal): [1997] 140 CTR (Cal) 454that trees of spontaneous growth had no cost of acquisition/improvement, and therefore, sale proceeds thereof cannot be subjected to capital gains tax.
Likewise in Sri Krishna Dairy and Agricultural Farm v. CIT 169 ITR 291 (AP): TC 20R 1075, where a firm which ran a dairy farm had sold calves which were born to milk producing cows and buffaloes which were used as capital assets in the business, it was held that since the calves born to cows and buffaloes had no cost of acquisition in terms of money, provisions of capital gains tax would not be attracted. Similarly when protected tenancy was created by Land Reforms Act under which protected tenants were given certain rights in land for which they had not incurred any cost, capital gains cannot be computed on compensation received by protected tenant on compulsory acquisition of such land [CIT v. Markapakula Agamma 165 ITR 386 (AP): TC 20R 1077]. This decision was based on the Supreme Court decision in CIT v. B.C. Srinivasa Setty 128 ITR 294 (SC): TC 20R 148 in which while giving reasons for holding that capital gains on transfer of goodwill of a business were not chargeable, it was observed that what is contemplate possessor and an asset in the acquisition of which it is possible to envisage a cost and the intent goes to the nature and character of the asset, that it is an asset which possesses the inherent quality of being available on the expenditure of money to a person seeking to acquire it. In Markapakula Agamma's case as referred above the High Court observed that it may be possible by a process of reasoning to confine the said observation of Supreme Court to incorporal rights like goodwill and not to extend it to tangible assets but there were certain observations in said decision which inhibited the High Court from recording such a finding as the High Court was bound by those observations in view of Article 141 of the Constitution and as such the distinction should be done by the Supreme Court itself.
EXEMPTION OF LONG TERM CAPITAL GAIN ARISING ON TRANSFER OF FINANCIAL ASSETS :
The exemption from capital gain can be availed under section 54F of I.T. Act. An assessee being an individual or HUF, can claim this exemption if he invests the sale consideration in the purchase or construction of a residential house in prescribed manner.
Alternatively exemption can also be claimed by investing the sale proceeds or amount of capital gain as prescribed under  provisions of section 54EA and 54EB (applicable in respect of sale or transfer upto 31.03.2000) or newly inserted section 54ECw.e.f. assessment year 2001-2002 .
THE EXEMPTION OF LTCG ARISING FROM TRANSFER OF OTHER ASSETS:
The exemption can also be claimed in respect of long term capital gains arising from transfer of certain other assets if the consideration is utilised to acquire another asset of same kind.
The following capital gains will fall in this category -
i)gain on transfer of a residential house and land appurtenant thereto - section 54.
ii)gain on transfer of land used for at least two years for agricultural purposes - section 54 B.  
iii)
gain on compulsory acquisition of land and building forming part of an industrial undertaking belonging to the tax payer and being used for the business of that undertaking for at least two years - section 54 D.
iv)
gain arising from transfer of machinery, plant, building, land etc. forming part of an industrial undertaking where transfer is affected for the shifting of the industrial undertaking from an urban area to any non-urban area - section 54G.
In all these cases the exemption will be available only if the tax payer invests in new asset of the same kind. The investment must take place within the time specified for the purpose and the related provisions of the concerned sections should be complied with.
NEW OPTIONS FOR CLAIMING EXEMPTION UNDER SECTION 54EC :
With effect from assessment year 2001-02 a new section 54EC has been inserted, which provides for exemption in case of long term capital gains. The benefit of this section shall also be available to those, who have already taken benefit under section 54 or 54F by investing in a residential house, and to such assessees a new opportunity is available to get exemption from capital gain.
Secondly, the benefit of this new section is available irrespective of the nature of the asset sold or transferred that means a new option in line with old options under section 54EA and 54EB has been offered to the taxpayers for claiming exemption of Capital Gains.
PURCHASE OF IMMOVABLE PROPERTY IN THE NAME OF COMPANY:
If an immovable property is to be purchased for the purpose of investment, it may be purchased by forming a company instead of individual names. The individuals should become the shareholders of the company and the property may be acquired by the company. At the time of sale, instead of transferring the property from the company, the individuals should sell the entire share to the intending buyer so that the benefit of long term capital gain can be availed if the shares are held for more than 12 months. Further no registration is required as the property continues to be in the name of the company, which will also result in savings of stamp duty.
DATE OF ACQUISITION OF SHARES - CBDT CIRCULAR
As per circular No. 704, dated 28th April 1995 published in 213 ITR (St.) 7, for both purchase and sale of shares and securities, the date on which the contract for purchase or sale as the case may be, is entered into, shall be the date of acquisition and date of transfer respectively provided the transaction is followed up by delivery of shares and securities and transfer deeds.
In case the transactions take place directly between the parties and not through stock exchanges, the date of contract of sale as declared by the parties shall be treated as the date of transfer provided it is followed by actual delivery of shares and the transfer deeds.
Where the shares are purchased in lots on different dates and the date of purchase or sale cannot be co-related through specific number of the scripts, in such cases First In - First Out (FIFO) method will be followed. In other words the assets acquired last will be taken to be remaining with the assessee while assets acquired first will be treated as sold.
NO CAPITAL GAIN ON CONVERSION OF PROPRIETORSHIP CONCERN AND PARTNERSHIP FIRM INTO COMPANY:
With effect from assessment year 1999-2000 no capital gain shall arise, where a proprietorship concern or partnership firm is succeeded by a company. Further the benefit of unabsorbed depreciation and carried forward losses of the proprietorship concern and partnership firms shall also be available to the company, on fulfillment of the certain conditions.
BENEFIT ALSO AVAILABLE TO STOCK BROKERS :
The benefit may also be availed by those stock brokers, who could not take benefit of capital gain exemption under section 47(xi) due to inability to transfer the membership card of stock exchange to a company in exchange of shares within prescribed date i.e. 31.12.98. Such share brokers can now avail benefit of sec. 47(xii) or sec. 47(xiv), as the case may be. 
 TAX BENEFITS ON DEMERGER, AMALGAMATION, SLUMP SALE ETC. :
The Finance Act, 1999 has offered tax benefit on demerger, amalgamation and slump sale also. In such cases of business reorganisation, the benefit of carry forward of unabsorbed depreciation and brought forward losses will also be available but subject to fulfillment of criteria prescribed. 
ESOP :
The Finance Act, 2000 has omitted the proviso under section 17(2) (iii). As a result, in case of receipt of any share or other security by employee under ESOP, the same shall no longer be considered as perquisite in the hands of the employee and shall be subject to capital gain tax on its sale. However in case such employee makes a gift of such shares or securities, capital gain tax shall be charged deeming the fair market value on the date of gift, as consideration.
CONCLUSION :
Proper tax planning of capital gains may be helpful in not only minimising the burden of income tax but in certain cases, total exemption may be available. Therefore, whenever, any considerable capital gain is likely to arise, it is advisable to plan the strategy at that time itself and certainly during the same financial year so that investments can be planned, as required, to get exemption.

1 comment:

Paul Haney said...

This is really informative. Thanks for sharing this.
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