Scenarios of Exemption of Capital Gains Tax

Article originally published in Gujarati Mid-day newspaper on June 22, 2021. Here is the transcript of the same.

Today, let us understand the provisions relating to computation of capital gain in case of transfer of asset by way of gift, will, etc.

Let us first understand what are capital assets. Capital assets are any kind of immovable property and held by a person. Generally, inventory and movable property are not considered as capital assets except for jewelry, archaeological collections, drawings, paintings, sculptures, or any work of art which are specifically considered in the definition of capital assets.

The taxability of capital gain depends on the holding period i.e. whether short-term or long-term. The tax rates for long-term capital gain and short-term capital gain are different. Similarly, computation provisions are different for long-term capital gains and short-term capital gains.

Any capital asset held by a person for a period of more than 36 months immediately preceding the date of its transfer will be treated as a long-term capital asset. However, in respect of certain assets like listed shares, equity mutual funds, etc the period of holding to be considered is 12 months instead of 36 months. In the case of unlisted shares in a company and immovable property, the period of holding to be considered is 24 months instead of 36 months.

Capital gain is computed by deducting from the Sale Consideration any Expenditure incurred wholly and exclusively in connection with the transfer of the capital asset, Cost of acquisition and Cost of Improvement. Indexation benefit is available in case long term capital assets are sold.

Capital gain arises when a person transfers capital assets. However, certain transactions are specifically excluded from being considered as transfer of asset i.e. transfer of assets by way of Gift, Will, etc. Hence, no capital gain will arise when a person transfers his capital assets to another person by way of a gift. However, for the person receiving the gift, this may be chargeable to tax depending on from whom the gift is received, what was the value of the assets transferred as a gift, etc. Gifts are not always exempt from Tax. There are a set of complex rules with respect to gifts under the Income Tax Law. However, the thumb rule is that gifts from relatives are exempt from tax subject to the definition of relative under the Income Tax Law.

If the person receiving the capital asset by way of gift, will, etc. subsequently transfers such asset, capital gain will arise in his hands. In such a case, the cost of acquisition of the capital asset will be the cost of acquisition to the previous owner and the period of holding of the capital asset will be computed from the date of acquisition of the capital asset by the previous owner.

Example, In December 2019, Mr Ravi inherited a house property from the Will of his father. He sold the house in March 2021 for Rs 50 lakhs and paid Rs 50,000 brokerage. The house was purchased by his father in the year April 2003 for Rs. 8 lakhs.

Since Mr Ravi has inherited the house from the Will of his father, no tax will be payable by him on receiving this house property in December 2019. When he sold the house property in December 2020, he shall be liable to pay tax. As explained above, the period of holding will be considered from April 2003 and not from December 2019. Accordingly, the house is held for more than 24 months and so it is considered as long term capital asset. Hence indexation benefit is available. The Capital Gains on the Sale will be Rs. 27.50 lakhs, computed as Sale Value (Rs. 50 lakhs) – Brokerage (Rs. 50,000) – Indexed Cost of Acquisition (Rs. 22 lakhs). Indexed Cost concept and computation has been explained in detail in our previous articles.

Question:

I have inherited jewelry from my mother’s will. My mother bought this jewelry for Rs 20 lakhs in 2002. I want to now gift this jewelry to my granddaughter. How much Capital Gains Tax I will have to pay?

Since you are gifting the jewelry to your granddaughter there will be no Capital Gains tax in your hands. Since the granddaughter is covered in the definition of relative under Income Tax Law, she will also not be liable to pay tax at the time of receiving the gift.

However, when the granddaughter sells this jewelry in future, the cost of the jewelry considered for tax purposes will be the cost to the previous owner i.e. the cost to you. Since you also have received it as a gift, the cost to you will be considered as the cost to the previous owner i.e. your mother. Hence, whenever your granddaughter will sell the jewelry the cost will be considered as Rs 20 lakhs indexed to the year of sale.