Introduction
Capital gains refer to the profits or gains derived from the transfer of a capital asset. As per Section 45(1) of the Income Tax Act, such gains are chargeable to income tax in the year in which the transfer takes place unless exempted under specific provisions like Sections 54, 54B, 54D, etc. This blog provides a detailed overview of capital gains taxation under Section 45 and its various subsections.
What Constitutes Capital Gains?
Capital gains arise when a person transfers a capital asset such as land, building, shares, or mutual funds. The computation of capital gains is based on the sale consideration received, from which the cost of acquisition, cost of improvement, and any eligible exemptions are deducted.
Taxation of Capital Gains Under Section 45
1. General Provision (Section 45(1))
Capital gains are taxable in the year of transfer, except when covered under specific exemptions.
2. Insurance Compensation (Section 45(1A))
Any money or assets received as insurance compensation due to natural calamities, riots, fire, or enemy action are also treated as capital gains and taxed accordingly.
3. Unit Linked Insurance Policy (ULIP) Proceeds (Section 45(1B))
If an individual receives money from a ULIP where exemption under Section 10(10D) does not apply, the amount is taxable as capital gains.
4. Conversion of Capital Asset into Stock-in-Trade (Section 45(2))
When a capital asset is converted into stock-in-trade, capital gains are computed based on the fair market value at the time of conversion and taxed in the year of actual sale.
5. Beneficial Interest in Securities (Section 45(2A))
If a person holds securities in a depository system, the capital gains on their transfer are calculated using the First-In-First-Out (FIFO) method.
6. Capital Contribution to Firms (Section 45(3))
When a partner contributes a capital asset to a firm, the value recorded in the firm’s books is considered as the sale consideration, and capital gains are taxed accordingly.
7. Reconstitution of Entity (Section 45(4))
If a specified person receives money or assets from a restructured entity, capital gains are determined using the prescribed formula and taxed accordingly.
8. Compensation for Compulsory Acquisition (Section 45(5))
In cases of compulsory acquisition of assets by the government, the capital gain is taxed in the year of receipt of compensation. Any enhanced compensation is taxed in the year it is received.
9. Capital Gains in Development Agreements (Section 45(5A))
For landowners entering into a joint development agreement, capital gains tax arises in the year the completion certificate is issued unless the landowner transfers their share before completion.
10. Repurchase of Specific Units (Section 45(6))
The difference between the repurchase price and the initial investment in certain specified units is taxed as capital gains.
Short-Term vs. Long-Term Capital Gains
Capital gains are categorized based on the holding period of the asset:
Short-term capital gains (STCG): Assets held for less than 36 months (or 12/24 months for specific assets like listed shares and real estate)
Long-term capital gains (LTCG): Assets held for more than 36 months (or 12/24 months for specific assets like listed shares and real estate)
Conclusion
Section 45 of the Income Tax Act provides comprehensive taxation guidelines on capital gains. Taxpayers should be aware of these provisions to ensure proper tax calculation and explore exemptions where applicable.
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