Capital Gains Tips & Tricks – Part II

Continuing from last week, we present the second and concluding part of the series of some interesting nuances in the tax law concerning capital gains. The idea is that the taxation principles and concepts would be of general interest to taxpayers and will also help in tax planning. Readers who have missed the first part can most certainly go through this article and then catch the earlier one on the web as both articles though on the same subject are not related to each other. Switch Option and Capital Gains When you switch from one scheme to another of the same MF, essentially (though notionally), you are selling the units of one scheme at its prevalent repurchase price and purchasing units of another scheme at its sale price. The time and wastage involved in receiving a cheque, crediting it to your bank account and issuing a cheque for purchase of new units is eliminated but that does not mean that a constructive transfer has not taken place. It attracts the provisions of capital gains. The same rule applies even when you switch from one option to another option (dividend to growth or vice versa) within the same scheme. However, switching between ‘dividend’ and ‘dividend reinvestment’ options cannot be considered as a transfer. The recent FA16 has made such switches within the scheme tax-free. It has also made switches arising from mergers of different schemes tax-free. Sale of Shares in a Private Limited Co

LTCG arising out of sale of any shares, listed or not, is always taken as a separate block and charged to tax at a flat rate of 20.6% with indexation or 10.3% without indexation. STCG is added to the normal income and taxed at the rate applicable to you. However, if the sale takes place on a recognised stock exchange in India, and STT has been paid on such sale, the LTCG is exempt and the STCG is charged to tax @15.45%. The recent FA16 has clarified that the LTCG arising from transfer of share of a private limited company shall be charged to tax @10.3%. Moreover, the period for getting benefit of LTCG in case of shares of unlisted companies has been reduced from 3 to 2 years Dissolved Partnership Firm and Sec. 54EC

Tax on long-term capital gains can be saved by purchasing Bonds of NHAI and REC. These have a lock-in of 3 years and are nontransferable. A difficulty arises when a registered partnership firm (or HUF) invests its long term capital gains in these Bonds and the firm gets dissolved within the lock-in period. Despite the dissolution, the firm will continue to receive interest from the Bonds and suffer TDS every year. I strongly feel that the authorities should allow the partners to transfer the Bonds directly in their names. In the regular course, the assets and

liabilities of a dissolved firm devolve on its partners in any case. Same is the case with HUFs. Transfer of Assets to a Firm Sec. 45(3) states that any gains arising out of the transfer of any capital asset by a person to a firm in which he is or becomes a partner will be chargeable to tax as his income for the year. The capital contributed need not be in cash. It may be in kind. Amount recorded in the books of the firm would be taken as the selling price for computing capital gains. However, in Sunil Siddharthbhai

v. CIT (1985) 156ITR509 (SC), the apex court held that where a partner in a firm makes over his personal assets as his contribution to its capital, though there is a transfer of such assets, the consideration which a partner receives on making over his personal assets to the firm as his contribution, cannot fall within the terms of Sec. 48, and as that provision is fundamental to the computation machinery incorporated in the schemes relating to the determination of the charge provided u/s 45, such case must be regarded as falling outside the scope of capital gains tax altogether. Depreciable Asset and Sec. 54EC CIT v. Assam Petroleum Industries (P.) Ltd. (2003) 30TCR61 (Gau) is an important case where it is laid down that merely because depreciation has been charged on an asset, it does not change the longterm character of a capital asset if it is held for more than 3 years. Reinvestment of sales proceeds of the asset within 6 months from the date of its sale makes it eligible for the exemption u/s 54EC.

The court observed —- “Sec. 54E is an independent provision, which is not controlled by Sec. 50 of the Act. Sec. 50 is a special provision where the mode of computation of capital gains is substituted if the assessee has claimed the depreciation on capital assets. Sec. 50 nowhere says that depreciated asset shall be treated as shortterm asset, whereas Sec. 54E has an application where long-term capital asset is transferred and the amount received is invested or deposited in the specified assets as required u/s 54E. For application of Sec. 54E the necessary prerequisite condition and enquiry would be, whether the assessee has transferred long-term capital asset and whether the consideration so received is invested or deposited within the time limit in specified asset.

Capital gain may have been received by the assessee on depreciable assets, if the conditions necessary u/s 54E are complied with by the assessee, he will be entitled to the benefit envisaged in Sec. 54E of the Income Tax Act.

Thus the assessee is entitled for exemption or deduction as provided u/s 54E.”

Though Sec. 54E has been deleted, surely, the principles laid down by the learned judge are applicable to Sec. 54EC.

Unfortunately, some of the ITOs have been taking different views.

Next week we will present some other interesting aspects in the general field of Budget and taxation.