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SVKMS NMIMS SCHOOL OF LAW

A PROJCT SUBMITTD ON

CAPITAL GAINS TAX UNDER INCOME TAX ACT, 1961 PROVISIONS AND ANALYSIS

IN COMPLIANC TO TH PARTIAL FULFILLMNT OF TH MARKING SCHM FOR


TRIMSTR X 2016-17, IN TH SUBJCT OF PRINCIPLES OF TAXATION LAW - I

SUBMITTD TO FACULTY PROF. RAJDEEP BANERJEE FOR VALUATION

SUBMITTD BY: KHUSHIL SHAH (A052)


COURS: - B.A. LL.B. (hons.)
DAT: - 5th JANUARY, 2017
TIM: - 4:00 P.M.

RCIVD BY: - ..
ON DAT: - ..
TIME:-..
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PRINCIPLES OF TAXATION LAW - I

INDEX

SERIAL

TOPICS

NUMBER

PAGE
NUMBER

ABBREVIATIONS

TABLE OF CASES/ STATUTES

INTRODUCTION

RESEARCH METHODOLOGY

CRITICAL ANALYSIS

CONCLUSION

26

BIBLIOGRAPHY

28

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PRINCIPLES OF TAXATION LAW - I

ABBREVIATIONS
i.e. that is
SC Supreme Court
HC High Court
ITR Income Tax Reporter
CIT Commissioner of Income Tax
IT Income Tax
Ed. Edition
Co. Company
Wvg. Weaving
Mfg. Manufacturing

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PRINCIPLES OF TAXATION LAW - I

TABLE OF STATUTES/ CASES


Statutes referred: 1. Income Tax Act, 1961
2. Circular No. 768, dated 25-06-1998, issued by CBDT

Cases: 1. Rajnagar Vaktapur Ginning, Pressing and Manufacturing Co. Ltd. v. CIT (1975) 99
ITR 264
2. V. A. Vasumathi v. CIT (1980) 123 ITR 94 (Ker.)
3. CIT v. Chimanlal B Parikh (1973) 92 ITR 59
4. Howrah Trading Co. Ltd v. CIT (1959) 36 ITR 215 (SC)
5. Kannan Rice Mills Ltd. v. CIT (1954) 26 ITR 351
6. CIT v. Rasiklal Maneklal (HUF) (1989) 177 ITR 198
7. C. Leo Machodo v. Commissioner of Income Tax 1988 172 ITR 744 Mad.
8. Navin Chandra Mafatlal v. CIT (1955) 27 ITR 245
9. Travancore Rubber v. State of Kerala (1963) 48 ITR (SC) 102
10. Ahmed G.H. Arif v. CWT (1970) 76 ITR 471 (SC)
11. CIT v. Krishna Warrier (1964) 53 ITR 176 (SC)
12. Well Pack Packaging v. CIT (2003) 78 TTJ 448 Ahd.
13. Sunil Siddharthbhai v. CIT (1985) 156 ITR 509 (SC)
14. CIT v. Narang Daily Products ( 1996) 219 ITR 478 (SC)
15. CIT V. JK Cotton Spinning and Weaving Mills
16. Vodafone Holdings B.V. v. Union of India

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PRINCIPLES OF TAXATION LAW - I

CHAPTER 1: INTRODUCTION

It is a matter of general belief that taxes on income and wealth are of recent origin but there is
enough evidence to show that taxes on income in some form or the other were levied even in
primitive and ancient communities. In India, the system of direct taxation as it is known today,
has been in force in one form or another even from ancient times. There are references both in
Manu Smriti and Arthasastra to a variety of tax measures. However, Kautilyas Arthasastra
was the first authoritative text on public finance, administration and the fiscal laws in this
country. His concept of tax revenue and the on-tax revenue was a unique contribution in the
field of tax administration. The organizational history of the Income-tax Department starts in
the year 1922. The Income tax Act, 1922, gave, for the first time, a specific nomenclature to
various Income-tax authorities. The foundation of a proper system of administration was thus
laid. However, the present, Income-tax Act, 1961 came into existence w.e.f. 1-4-1962.
The Income Tax Act, 1961 is consists of 298 sections contained in 23 chapters. Besides, there
are 14 schedules and 1 annexure to it. Moreover, there is Income Tax Rules, 1962 which
contains over 125 rules relating to Income Tax Act. Chapter IV of the income tax, which
contains section 14 59, is the most important chapter as it deals with the computation of total
income for the purpose of calculation of income tax. This is one act which is amended at least
once every year i.e. when the Finance Bill is passed in the parliament. However, there may be
up to 3 amendments each year. Finance Bill 2009 promises to introduce new income tax code
by December this year. For the purpose of computation of total income, the income is assessed
under five different heads being:

Salary Income (section 15-17)

Income from house property (Section 22-27)

Profits and gains from business and professions (section 28 44 DB)

Capital Gains (section 45 -55A); and

Income from other sources (section 56-59)

Professor Nicholas Kaldor of Combridge University was invited in 1956 giving suggestions of
tax reforms to meet the financial needs of second direct tax reforms. He was of the opinion that
direct taxation of India was inefficient as well as inequitable. He suggested that
(i)

Direct Tax should be widened and thereby wealth tax, capital gain tax, gift tax and
expenditure tax should be imposed along with the income tax. But the maximum rate
of income tax should not be allowed to exceed 45 percent

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(ii)

He recommended progressive rate of personal expenditure taxation from 25 percent to


30 percent, wealth tax from 0.66 to 1.66 percent and income tax up to 44 percent.

(iii)

For doing away with the tax evasions, compulsory enquiry over personal income of Rs.
one lakh must be conducted. All of these recommendations were implemented by the
government.

The origin of capital gains tax in India dates back to 1956, following the recommendations of
Prof Kaldor to levy tax on profits arising on sale/transfer of specified non-inventory asset. As
a result of constant evolution, capital gains tax, as it stands today, is levied on transfer of all
capital assets (other than held as stock-in-trade) with a computation mechanism prescribed
under sections 45 55A of the Income Tax Act. Over the past two decades, several exemptions
were incorporated in the statute to rationalize the levy with a view to mitigate undue hardship
to taxpayers. In the past few years, the levy (or non-levy) of capital gains tax on profits or gains
arising on transfer of capital market instruments (shares, units, etc) has emerged as an effective
tool to foster the growth of capital market.

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CHAPTER 2: RESEARCH METHODOLOGY

OBJECTIVES

To understand the meaning of capital asset.

To understand the concept of capital asset and then the purpose of levying tax on the capital
gains and its essential ingredients.

To determine the concept of transfer and its exceptions.

To analyse the provision for income under capital gains under the Income Tax Act, 1961.

RESEARCH QUESTIONS

What is a capital asset?

What is a capital gain? What is the need for capital gains tax?

What is the basis of charging a capital gain?

What constitutes a transfer? What does transfer exclude?

TENTATIVE CHAPTERIZATION

Introduction

Critical Analysis

Judicial pronouncements

Conclusion

Suggestions Way forward

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CHAPTER 3: CRITICAL ANALYSIS

Section 45-55A Income-tax Act, 1961 deals with Capital Gain. Section 45 of the Act, provides
that any profits or gains arising from the transfer of a capital asset effected in the previous year
shall, save as otherwise provided in Sections 54, 54B, 54D, 54EC, 54ED, 54F, 54G, 54GA and
54H be chargeable to income tax under the head "Capital Gains", and shall be deemed to be
the income of the previous year in which the transfer took place.
Section 2(24)(vi) of the Income-tax Act specifically provides that "Income" includes "any
capital gains chargeable under Section 45(1)". The Constitutional validity of taxing capital
gains was challenged in Navin Chandra Mafatlal v. C.I.T. 1, wherein the Apex Court, while
upholding the legislative competence of parliament with regard to capital gains as part of
income,2 observed that the term income should be given the widest connotation so as to include
capital gains within its scope. However, all capital profits do not necessarily constitute capital
gains. For instance, profits on reissue of forfeited shares, profits on redemption of debentures,
premium on issue of shares, 'pagri' from tenants etc. are capital profits and not capital gains,
hence, not liable to tax.
The essentials for of taxing capital gains under Section 45(1) are (a) that there must be a capital
asset, (b) the capital asset must have been transferred, (c) the transfer must have been effected
in the previous year, and (d) there must be a gain arising on such transfer. There are certain
types of capital gain which are otherwise exempted. These capital gain are enlisted under
Sections 54, 54B, 54D, 54EC, 54ED, 54F, 54G, or 54GA of the Income-tax Act, 1961.

Capital Asset
Section 2(14) of the Income-tax Act defines the term "capital asset" which means property of
any kind held by an assessee whether or not connected with his business or profession but does
not include (i) any stock-in-trade, consumable stores or raw materials held for the purposes of
his business or profession; (ii) personal effects that is to say, movable property (including
wearing apparel and furniture but excluding jewellery) held for personal use by the assessee or
any member of his family dependent on him; (iii) agricultural land in India, (iv) 6.5 per cent
Gold Bonds, 1977 or 7 per cent Gold Bonds, 1980 or National Defence Gold Bonds, 1980
issued by the Central Government;(v) Special Bearer Bonds 1991 issued by the Central

1
2

Navin Chandra Mafatlal v. CIT (1955) 27 ITR 245


Travancore Rubber v. State of Kerala (1963) 48 ITR (SC) 102

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Government; (vi) Gold Deposit Bonds issued under the Gold Deposit Scheme, 1999 notified
by the Central Government.

Capital Gains-Short Term and Long Term


Any capital gain arising as a result of transfer of a short term capital asset is known as short
term capital gain. According to Section 2(42A) of the Income-tax Act, 1961 "Short term"
capital asset means a capital asset held by an assessee for not more than thirty six months
immediately preceding the date of its transfer. However, in the case of capital assets (being
equity or preference share in a company) held by an assessee for not more than 12 months
immediately prior to its transfer. Assets other than short term capital assets are known as 'longterm capital assets' and the gains arising therefrom are known as 'long term capital gains'.
Calculation of period for the purpose of determining whether the asset is short term or long
term, certain factors are material. For example:

In the case of shares held in a company in liquidation, the period subsequent to the date
on which the company goes into liquidation shall be excluded.

In case the asset becomes the property of the assessee under the circumstances
mentioned in Section 49(1), the period for which the asset was held by the previous
owner shall be included.

In the case of the shares in an Indian Company which become the property of the
assessee in a scheme of amalgamation, the period for which the shares in the
amalgamating company were held by the assessee shall be included.

In the case of a capital asset, being a share or any other security subscribed to by the
assessee on the basis of his right to subscribe to such financial asset or subscribed to by
the person in whose favour the assessee has renounced his right to subscribe to such
financial asset, the period shall be reckoned from the date of allotment of such financial
asset.

In the case of capital assets, being the right to subscribe to any financial asset, which is
renounced in favour of any other person, the period shall be reckoned from the date of
the offer of such right by the company or institution, as the case may be, making such
offer.

In the case of a capital asset, being a financial asset, allotted without any payment and
on the basis of holding of any other financial asset, the period shall be reckoned from
the date of the allotment of such financial asset.

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In the case of a capital asset, being a share or shares in an Indian company, which
becomes the property of the assessee in consideration of a demerger, there shall be
included the period for which the share or shares held in the demerged company were
held by the assessee.

In the case of a capital asset, being trading or clearing rights of a recognized stock
exchange in India acquired by a person pursuant to demutualisation or corporatisation
of the recognized stock exchange in India as referred to in Clause (xiii) of Section 47,
there shall be included the period for which the person was a member of the recognized
stock exchange in India immediately prior to such demutualization or corporatisation;

In the case of a capital asset, being equity share or shares in a company allotted pursuant
to demutualisation or corporatisation of a recognised stock exchange in India as referred
to in Clause (xiii) of Section 47, there shall be included the period for which the person
was a member of the recognized stock exchange in India immediately prior to such
demutualisation or corporatisation.

There is another type of asset which though not capital asset, still the transfer of the same would
result into capital gains. 'Zero Coupon Bonds' as defined under Section 2(48) means a bond (a)
issued by any infrastructure capital company or infrastructure capital fund or public sector
company on or after the 1st day of June, 2005; (b) in respect of which no payment or benefit is
received or receivable before maturity or redemption from infrastructure capital company or
infrastructure capital fund or public sector company; and (c) which the Central Government
may, by notification in the Official Gazette, specify in this behalf.
The profits arising on the transfer of such zero coupon bond shall be chargeable under the head
"capital gains". Section 2(42A) provides that if zero coupon bonds are held for not more than
12 months, such bond/ asset will be termed as short term capital asset. If these bonds are held
for more than 12 months, transfer of the same would attract long term capital gain.
The proviso under Section 112(1) has provided deferential treatment to zero coupon bonds.
The long term capital gain on zero coupon bonds shall be chargeable to tax at minimum of: (a)
20% of long term capital gain after indexation of cost of such bonds, or (b) 10% of long term
capital gain before indexation of cost of such bonds.
The Supreme Court in the case of Vodafone International Holdings B.V. v. Union of India
[2012] 341 ITR 1 (SC) : (2012) 247 CTR 1 (SC) held that influence/ persuasion of a parent
company over its subsidiary could not be construed as a right in the legal sense. To supersede
this ruling with retrospective effect from 1 April, 1962, an Explanation has been inserted to
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clarify that 'property' includes and shall be deemed to have always included any rights in or in
relation to an Indian company, including rights of management or control or any other rights
whatsoever.
With the exception of the aforementioned assets, all other assets are included in the category
of capital asset.3 "Capital asset" includes movable/ immovable asset, tangible/ intangible assets,
and incorporeal rights, share of a partner in a firm, goodwill of a firm, mining rights, industrial
licence acquired by consideration, tenancy right or leasehold right, foreign currency, right to
subscribe for shares, the contractual right of a purchaser to obtain title to an immovable
property, etc. Every kind of property held by an assessee, whatever be its nature or character,
is within the connotation of the expression 'capital asset' provided, of course, it does not fall
within the excepted categories specified in clauses (i) to (vi).
In C.I.T. v. V. K. Rathnam Nadar,4 it was held that capital gain arises only on the transfer of
capital asset which had actually cost something to the assessee. Such actual cost in the context
of the Income-tax Act being cost in terms of money, it cannot apply to transfer of capital asset
which did not cost anything to the assessee in terms of money in its creation or acquisition.
However, by an amendment, the cost of goodwill, tenancy rights, route permits and loom hours,
though the cost of acquisition for computation of capital gain shall be deemed to be nil, but
where it has been purchased, the cost will be taken to be the actual price paid for it.
A new Subsection (1A) has been inserted in Section 45 by the Finance Act, 1999 w.e.f. 1 April,
2000. It provides that where any person receives any money or other assets under an insurance
from the insurer on account of damage to or destruction of any capital asset, as a result of flood,
typhoon, hurricane, cyclone, earth quake or other convulsion of nature or on account of riot or
civil disturbance or accidental fire or explosion or because of action by an enemy or action
taken in combating an enemy (whether with or without a declaration of war), then any profits
or gains arising from receipt of such money or other asset shall be chargeable to income tax
under Revaluation of Asset will not amount to 'transfer' and hence will not result into any
liability under the Income-tax Act.5

Transfer
The essential requirement for the incidence of tax on capital gains is the transfer of a 'capital
asset'. Section 2(47) of the Act defines the expression 'transfer', in relation to a capital asset,
3

Ahmed G.H. Arif v. CWT (1970) 76 ITR 471 (SC); CIT v. Krishna Warrier (1964) 53 ITR 176 (SC)
(1969) 71 ITR 433 (Mad.)
5
Well Pack Packaging v. CIT (2003) 78 TTJ 448 Ahd.
4

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which includes, (i) the sale, exchange or relinquishment of the asset; or (ii) the
extinguishment of any rights therein; or (iii) the compulsory acquisition thereof under any
law; or (iv) in a case where the asset is converted by the owner thereof into, or is treated by
him as, stock- in- trade of a business carried on by him, such conversion or treatment; or (v)
any transaction involving the allowing of the possession of any immovable property to be
taken or retained in part performance of a contract of the nature referred to in Section 53A of
the Transfer of Property Act, 1882 1 (4 of 1882); or (vi) any transaction (whether by way of
becoming a member of, or acquiring shares in, a co-operative society, company or other
association of persons or by way of any agreement or any arrangement or in any other
manner whatsoever) which has the effect of transferring, or enabling the enjoyment of, any
immovable property.6
It is a definition which includes within its scope of ambit not only the transactions which
would constitute 'transfer' according to the accepted connotation of that word, but also
transactions which would not ordinarily be regarded as transfer according to its ordinary
natural sense. The definition given an extended statutory meaning to the word 'transfer' and
includes within it relinquishment of a capital asset or the extinguishment of any rights
therein.
The Supreme Court in Sunil Siddharthbhai v. CIT,7 held that definition under Section 2(47) is
merely inclusive and does not exhaust other kinds of transfer. The expression 'transfer' in
Section 2(47) must be read widely and not narrowly. This view was again affirmed by the
Supreme Court in CIT v. Narang Daily Products,8 and the apex Court went to the extent
that"even assuming that the transaction may not be a transfer as defined under Section
2(47) of the Act, in our view, the definition of section is an inclusive one and does not
exclude a contractual or the ordinary meaning of the word 'transfer'."
In CIT v. J. K. Cotton Spg. & wvg. Mills co. Ltd.,9 it was held that when an assessee receives
money from an insurance company as compensation for the extinguishment of his capital asset,
he receives that money in lieu of the capital asset and not in lieu of the premia paid to the
insurance company and this amounts to a transfer within the meaning of Section 2(47) and the
amount received would be liable to be taxed as capital gains.10

Arvind P Datar, Kanga And Palkhivalas, The Law and the Practise of Income Tax, 10 th Edition Vol. 1, Lexis
Nexis, pg. 1181
7
Sunil Siddharthbhai v. CIT (1985) 156 ITR 509 (SC)
8
CIT v. Narang Daily Products ( 1996) 219 ITR 478 (SC)
9
CIT V. JK Cotton Spinning and Weaving Mills
10
C. Leo Machodo v. Commissioner of Income Tax 1988 172 ITR 744 Mad.
6

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The Supreme court in the case of Vodafone International Holdings B.V v. Union of India,11
held that (a) the transfer of shares in the foreign holding company does not result in a
extinguishment of the foreign company's control of the Indian company, (b) it does not
constitute an extinguishment and transfer of an asset situated in India, (c) transfer of foreign
holding company shares offshore, cannot result in an extinguishment of the holding companies
right of control of the Indian company and the same does not constitute extinguishment and
transfer of an asset/management and control of property situated in India. To supersede this
ruling with retrospective effect from 1 April, 1962, Explanation 2 to Section 2(47) has been
inserted which defines transfer as follows: 'Transfer' includes and shall be deemed to have
always included disposing of or parting with an asset or any interest therein, or creating any
interest in any asset in any manner whatsoever, directly or indirectly, absolutely or
conditionally, voluntarily or involuntarily by way of an agreement (whether entered into in
India or outside India) or otherwise, notwithstanding that such transfer of rights has been
characterized as being effected or dependent upon or flowing from the transfer of a share or
shares of a company registered or incorporated outside India. The above transactions would be
deemed as a transfer notwithstanding that such transfer of rights has been characterized as
being effected or dependent upon or flowing from the transfer of a share or shares of a company
registered or incorporated outside India.

Transactions which do not Constitute Transfer


Section 46 and 47 provides certain categories of transactions which do not constitute transfer.
Transfer of capital assets falling in any of these categories would not attract liability to capital
gains tax. These are categories are as follows:

Any distribution of capital assets on the total or partial partition of a Hindu Undivided
Family;

Any transfer of a capital asset under a gift or will or an irrevocable trust; provided that
this clause shall not apply to transfer under a gift or an irrevocable trust of a capital
asset being shares, debentures or warrants allotted by a company directly or indirectly
to its employees under the Employees' Stock Option Plan or Scheme of the company
offered to such employees in accordance with the guidelines issued by the Central
Government in this behalf;

11

341 ITR 1 (SC) : (2012) 247 CTR 1 (SC)

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Any transfer of a capital asset by a company to its subsidiary company, if(a) the
parent company or its nominees hold the whole of the share capital of the subsidiary
company, and (b) the subsidiary company is an Indian company;

Any transfer of a capital asset by a subsidiary company to the holding company, if


(a) the whole of the share capital of the subsidiary company is held by the holding
company, and (b) the holding company is an Indian company;

Any transfer, in a scheme of amalgamation, of a capital asset by the amalgamating


company to the amalgamated company if the amalgamated company is an Indian
company;

Any transfer in a scheme of amalgamation of a capital asset being share or shares held
in an Indian Company, by the amalgamating foreign company to the amalgamated
foreign company, if(a) at least twenty-five per cent of the shareholders of the
amalgamating foreign company continue to remain shareholders of the amalgamated
foreign company; and(b) such transfer does not attract tax on capital gains in the
country, in which the amalgamating company is incorporated (applicable from the
assessment year 1993-94);

Any transfer in a scheme of amalgamation of a banking company with a banking


institution sanctioned and brought into force by the Central Government under
Subsection (7) of Section 45 of the Banking Regulation Act, 1949, of a capital asset by
the banking company to the banking institution.

Any transfer, in a demerger, of a capital asset by the demerged company to the resulting
company, if the resulting company is an Indian company.

Any transfer in a demerger, of a capital asset, being a share or shares held in an Indian
company, by the demerged foreign company to the resulting foreign company, if(a)
the shareholders holding not less than three fourths in value of the shares of the
demerged foreign company continue to remain shareholders of the resulting foreign
company; and (b) such transfer does not attract tax on capital gains in the country in
which the demerged foreign company is incorporated provided that the provisions of
Sections 391 to 394 of the Companies Act, 1956 (1 of 1956) shall not apply in case of
demerger referred to in this clause.

Any transfer or issue of shares by the resulting company in a scheme of demerger to


the shareholders of the demerged company if the transfer or issue is made in
consideration of demerger of the undertaking.

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Any transfer by a shareholder, in a scheme of amalgamation, of a capital asset being a


share or shares held by him in the amalgamating company, if (a) the transfer is made
in consideration of the allotment to him of any share or shares in the amalgamated
company except where the shareholders itself is the amalgamated company, and(b) the
amalgamated company is an Indian company;

Any transfer of a capital asset of such foreign currency convertible bonds or Global
Depository Receipts as are referred to in Section 115AC(1) held by a nonresident to
another nonresident where the transfer is made outside India (applicable from
1.6.1992);

Any transfer of agricultural land in India effected before the first day of March, 1970;

Any transfer of a capital asset being any work of art, archaeological, scientific or art
collection, book, manuscript, drawing, painting, photograph or print to the Government
or a University or the National Museum, National Art Gallery, National Archives or
any such other public museum or institution as maybe notified by the Central
Government in the Official Gazette to be of national importance or to be of renown
throughout any State or States;

Any transfer by way of conversion of bonds or debentures, debenture stock or deposit


certificates in any form, of a company, into shares or debentures of that company.

Any transfer made on or before 31.12.1998 by a person not being a company of a capital
asset being membership of a recognized stock exchange to a company in exchange for
shares allotted by that company to him (transferor).

Any transfer of land by a sick industrial company made at any time beginning with
declaration of it being sick by the BIFR and ending with the previous year in which its
net worth wipes out the accumulated losses.

Where a firm is succeeded by a company in the business carried on by it as a result of


which the firm sells or otherwise transfers any capital asset or intangible asset to the
company: provided that(a) all the assets and liabilities of the firm or of the association
of persons or body of individuals relating to the business immediately before the
succession become the assets and liabilities of the company, (b) all the partners of the
firm immediately before the succession become the shareholders of the company in the
same proportion in which their capital account stood in the books of the firm on the
date of succession. (c) the partners of the firm do not receive any consideration or
benefit, directly or indirectly in any form or manner, other than by way of allotment of

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shares in the company, and (d) the aggregate of the shareholding in the company of the
partners of the firm is not less than fifty percent of the total voting power in the company
and their shareholding continue to be as such for a period of five years from the date of
succession. (e) the demutualization or corporatization of a recognized stock exchange
in India is carried out in accordance with a scheme for corporatization which is
approved by the Securities and Exchange Board of India established under Section 3 of
the Securities and Exchange Board of India Act, 1992.

Any transfer of a capital asset being a membership right held by a member of a


recognised stock exchange in India for acquisition of shares and trading or clearing
rights acquired by such member in that recognised stock exchange in accordance with
a scheme for demutualisation or corporatization which is approved by the Securities
and Exchange Board of India established under Section 3 of the Securities and
Exchange Board of India Act, 1992 (15 of 1992).

Any transfer of a capital asset or intangible asset by a private company or unlisted


public company to a limited liability partnership or any transfer of a share or shares
held in the company by a shareholder as a result of conversion of the company into a
limited liability partnership. Benefits of this clause may arise only when
o all the assets and liabilities of the company immediately before the conversion
become the assets and liabilities of the limited liability partnership
o all the shareholders of the company immediately before the conversion become
the partners of the limited liability partnership and their capital contribution and
profit sharing ratio in the limited liability partnership are in the same proportion
as their shreholding in the company on the date of conversion
o the shareholders of the company do not receive any consideration or benefit,
directly or indirectly, in any form or manner, other than by way of share in profit
and capital contribution in the limited liability partnership
o the aggregate of the profit sharing ratio of the shareholders of the company in
the limited liability partnership shall not be less than fifty per cent at any time
during the period of five years from the date of conversion
o the total sales, turnover or gross receipts in business of the company in any of
the three previous years preceding the previous year in which the conversion
takes place does not exceed sixty lakh rupees

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o No amount is paid, either directly or indirectly, to any partner out of balance of


accumulated profit standing in the accounts of the company on the date of
conversion for a period of three years from the date of conversion.

Where a sole proprietary concern is succeeded by a company in the business carried on


by it as a result of which the sole proprietary concern sells or otherwise transfers any
capital asset or intangible asset to the company. Provided that(a) all the assets and
liabilities of the sole proprietary concern relating to the business immediately before
the succession becomes the assets and liabilities of the company; (b) the shareholding
of the sole proprietor in the company is not less than fifty per cent of the total voting
power in the company and his shareholding continues to so remain as such for a period
of five years from the date of the succession; and (c) the sole proprietor does not receive
any consideration or benefit directly or indirectly in any form or manner, other than by
way of allotment of shares in the company.

Any transfer in a scheme for lending of any securities under an agreement or


arrangement, which the assessee has entered into with the borrower. Of such securities
and which is subject to the guidelines issued by the Securities and Exchange Board of
India, established under Section 3 of the Securities and Exchange Board of India Act,
1992 or the Reserve Bank of India in this regard.

And notified by the Central Government.

The Finance Act 2015 inserted three more categories of transfer which will not be treated as
transfer under section 47. These three categories, which will come into force w.e.f. 1-4-2016
are firstly, any transfer, in a scheme of amalgamation, of a capital asset, being a share of a
foreign company, referred to in the Explanation 5 to of section 9(1)(i), which derives, directly
or indirectly, its value substantially from the share or shares of an Indian company, held by the
amalgamating foreign company to the amalgamated foreign company, if(A) at least twentyfive per cent of the shareholders of the amalgamating foreign company continue to remain
shareholders of the amalgamated foreign company; and (B) such transfer does not attract tax
on capital gains in the country in which the amalgamating company is incorporated.
The second category so inserted by Finance Act, 2015 provides that 'any transfer in a demerger,
of a capital asset, being a share of a foreign company, referred to in the Explanation 5 to section
9(1)(i), which derives, directly or indirectly, its value substantially from the share or shares of
an Indian company, held by the demerged foreign company to the resulting foreign company,
if (a) the shareholders, holding not less than three-fourths in value of the shares of the demerged
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foreign company, continue to remain shareholders of the resulting foreign company; and (b)
such transfer does not attract tax on capital gains in the country in which the demerged foreign
company is incorporated, provided that the provisions of sections 391 to 394 of the Companies
Act, 1956 shall not apply in case of demergers referred to in this clause.
The third category added by Finance Act, 2015 provides that "any transfer by a unit holder of
a capital asset, being a unit or units, held by him in the consolidating scheme of a mutual fund,
made in consideration of the allotment to him of a capital asset, being a unit or units, in the
consolidated scheme of the mutual fund, provided that the consolidation is of two or more
schemes of equity oriented fund or of two or more schemes of a fund other than equity oriented
fund.
Explanation attached with this clause further provides that (a) "consolidated scheme" means
the scheme with which the consolidating scheme merges or which is formed as a result of such
merger; (b) "consolidating scheme" means the scheme of a mutual fund which merges under
the process of consolidation of the schemes of mutual fund in accordance with the Securities
and Exchange Board of India (Mutual Funds) Regulations, 1996 made under the Securities and
Exchange Board of India Act, 1992; (c) "equity oriented fund" shall have the meaning assigned
to it in clause (38)of section 10; and (d) "mutual fund" means a mutual fund specified under
clause (23D) of section 10.
In the case of transfer of shares held as capital asset, the date of transfer is the date of delivery
of the share certificates to the transferee and not the date of registration of the shares in the
name of the transferee in the register of company. The notional profit arising from transfer by
way of conversion of capital asset into stock-in-trade will be chargeable to tax in the year in
which stock-in-trade is sold. For computing the capital gain in such cases, the Fair Market
Value of the capital asset on the date on which it was converted or treated as stock-in-trade will
be deemed to be the full value of consideration receiving or accruing as a result of the transfer
of the capital asset.
Where the assessee, who is shareholder of company A, and company A was amalgamated with
another company B, whereby the assessee received shares of the company B in lieu of the
shares of A, neither an 'exchange' nor a 'relinquishment' would take place in such a case, and
hence no capital gains will be leviable.12

12

CIT v. Rasiklal Maneklal (HUF) (1989) 177 ITR 198

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COST OF ACQUISITION, COST OF IMPROVEMENT

Withdrawal of Exemption
According to Section 47 of the Income-tax Act, transaction of a nature, where any transfer of
a capital asset by a subsidiary company to the holding company, if(a) the whole of the share
capital of the subsidiary company is held by the holding company, and (b) the holding company
is an Indian company; or any transfer, in a scheme of amalgamation, of a capital asset by the
amalgamating company to the amalgamated company if the amalgamated company is an Indian
company, such transaction are not treated as transfer, not will not result into capital gains.
However, Section 47A provides that if, at any time, before the expiry of eight years from the
date of transfer of a capital asset by a company to its wholly owned subsidiary company or by
the subsidiary company to the holding company respectively, such capital asset is converted
by the transferee company into or is treated by it as, stockintrade of its business, or the parent
company (or its nominee) or the holding company ceases to hold the whole of the share capital
of the subsidiary company before the expiry of the period of eight years aforesaid, the amount
of capital gains exempted from tax by virtue of the provisions contained in Section 47 will be
deemed to be income of the transferor company chargeable under the head "capital gains" of
the year in which such transfer took place.
Section 47A(2) of the Income-tax Act provides that where a person gets exemption from capital
gains tax on transfer of his membership in a recognised stock exchange during the course of
corporatisation of his business in terms of Section 47(xi) and he within three years from the
date of such transfer sells any of the shares allotted in lieu thereof by the company, the capital
gains exempted vide Section 47(xi) will become the capital gains of the previous year in which
the shares are transferred.
Section 47A(4) of the Income-tax Act provides that where any of the conditions laid down in
the proviso to clause (xiiib) of Section 47 are not complied with, the amount of profits or gains
arising from the transfer of such capital asset or intangible asset or share or shares not charged
under Section 45 by virtue of the conditions laid down in the said proviso shall be deemed to
be the profits and gains chargeable to tax of the successor Limited Liability Partnership or the
shareholder of the predecessor company, as the case may be, for the previous year in which the
requirements of the said proviso are not complied with.
Section 46(1) of the Income-tax Act provides that notwithstanding anything contained in
Section 45, where the assets of a company are distributed to its shareholders on its liquidation,
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such distribution shall not be regarded as a 'transfer' by the company for the purposes of Section
45. Capital gains made by the liquidator of a company on sale of the company's assets with the
object of distributing the sale proceeds among shareholders, are assessable in the hands of the
company13 The distribution of assets should have been made to the shareholders of the
company, and if it is done otherwise than on liquidation of the company, this section cannot be
attracted.14 Section 46(2) of the Act provides that where a shareholder, on the liquidation of a
company, receives any money or other assets from the company, he shall be chargeable to
income tax under the head "capital gains" in respect of the money so received or the market
value of the other assets on the date of distribution, as reduced by the amount assessed as
dividend within the meaning of Section 2(22)(c) and the sum so arrived at shall be deemed to
be the full value of the consideration for the purpose of Section 48. However, for this
subsection, any cash or other assets received by a shareholder on liquidation of the company
would not be assessable to tax as capital gains.15

Mode of Computation
Section 48 of the Act provides that the income chargeable under the head 'capital gains' shall
be computed by deducting from the full value of consideration received or accruing as a result
of the transfer of the capital asset the following amounts: (i) the expenditure incurred wholly
and exclusively in connection with such transfer; (ii) the cost of acquisition of the capital asset
and the cost of any improvement thereto.16
The Finance Act, 1997 has with effect from 1 April, 1998 denied the benefit of indexation of
cost of bonds and debentures other than indexed bonds issued by the Government. Provided
also that where shares, debentures or warrants referred to in the proviso to Clause (iii) of
Section 47 are transferred under a gift or an irrevocable trust, the market value on the date of
such transfer shall be deemed to be the full value of consideration received or accruing as a
result of transfer for the purposes of this section. 'Indexed cost of acquisition' means an amount
which bears to the cost of acquisition the same proportion as Cost Inflation Index for the year
in which the asset is transferred bears to the Cost Inflation Index for the first year in which the
asset was held by the assessee or for the year beginning on the 1 April, 1981 whichever is later.

13

Kannan Rice Mills Ltd. v. CIT (1954) 26 ITR 351


Shareholders would mean registered shareholders only and not the beneficial owners of shares. Howrah
Trading Co. Ltd v. CIT (1959) 36 ITR 215 (SC)
15
CIT v. Chimanlal B Parikh (1973) 92 ITR 59
16
Arvind P Datar, Kanga and Palkhivala, The Law and Practise of Income Tax, 10th Ed. Vol.(1), Lexis Nexis P.
1217
14

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'Indexed cost of any improvement' means an amount which bears to the cost of improvement
in the same proportion as Cost Inflation Index for the year in which the asset is transferred
bears to the Cost Inflation Index for the year in which the improvement to the asset took place;
and 'cost inflation index', in relation to a previous year, means such Index as the Central
Government may, having regard to seventy five per cent of average rise in the Consumer Price
Index for urban non manual employees for the immediately preceding previous year to such
previous year, by notification in the Official Gazette, specify in this behalf Commission paid
to a broker for effecting sale of the asset, expenditure incurred on litigation for getting enhanced
compensation are the expenditure wholly and exclusively incurred in connection with transfer
of the capital asset and is deductible.17
Capital gains are ascertained after taking into consideration the cost of acquisition of the capital
asset by the assessee. The cost of acquisition is easily determinable where the asset has been
purchased by the assessee. In some cases the assessee would have acquired the asset not
necessarily by purchase but by the following modes namely:
Cost to the previous owner: i.e. assessee receives the asset
a. on the distribution of assets on the total or partial partition of a Hindu Undivided
Family
b. under a gift or will
c. by succession, inheritance or devolution; or (b) on any distribution of assets on
the dissolution of a Firm, Body of Individuals or other Association of Persons
where such dissolution has taken place at any time before IApril, 1987; or (c)
on any distribution of assets on the liquidation of a company; or (d) under a
transfer to a revocable or irrevocable trust; or (e) under any such transfer as is
referred to in clause (iv) or clause (v) or clause (vi) or clause (via) of Section
47;
d. by the mode referred to in Subsection (2) of Section 64 at any time after 31
December, 1969, by an assessee, being a Hindu Undivided Family.
In all the above cases, the cost of acquisition of the assets shall be deemed to be the cost for
which the previous owner of the property acquired it, as increased by the cost of any
improvement of the assets, incurred or borne by the previous owner or the assessee as the case
may be. Here, the phrase 'previous owner of the property' means the last previous owner of the
capital asset18 Section 55(3) of the Act provides that where the cost for which the previous
17

V. A. Vasumathi v. CIT (1980) 123 ITR 94 (Ker.)

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owner acquired the property cannot be ascertained, the cost of acquisition to the previous owner
means the fair market value on the date on which the capital asset became the property of the
previous owner.

Cost of shares in the amalgamated company


Subsection (2) of Section 49 of the Act provides that where the capital asset being a share or
shares in an amalgamated company which is an Indian company became the property of the
assessee in consideration of a transfer referred to in clause (vii) of Section 47, the cost of
acquisition of the asset shall be deemed to be the cost of acquisition to him of the share or
shares in the amalgamating company.

Cost of acquisition in cases of conversion of debenture/debenture stock/ deposit certificate into


shares
Subsection 2A of Section 49 of the Act18 states that where the capital asset being a share or
debenture in a company became the property of the assessee in consideration of a transfer
referred to in Section 47(x), the cost of acquisition of the asset to the assessee shall be deemed
to be that part of the cost of debenture, debenture stock or deposit certificates in relation to
which such asset is acquired by the assessee.
According to Section 49(2AA) of the Act where the capital gain arises from the transfer of
specified security or sweat equity shares,20 the cost of acquisition of such security or shares
shall be the fair market value which has been taken into account for the purposes of the said
subclause.
Section 49(3) of the Act provides that where the capital gain arising from the transfer of a
capital asset referred to in Section 47(iv) or (v) is deemed, by virtue of the provisions in Section
47A, to be income chargeable under the head 'capital gains', the cost of acquisition of such
asset to the transferee company will be the cost for which such asset was acquired by it.

Cost of Acquisition
Section 55(2) of the Income-tax Act states that for the purposes of Sections 48 and 49, 'cost of
acquisition' of goodwill of a business or a right to manufacture, produce or process any article
or thing, tenancy rights, stage carriage permits or loom hours is (i) in the case of acquisition of

18

As inserted retrospectively from 1.4.1962 by Finance (No. 2) Act, 1991

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such asset by the assessee by purchase from a previous owner, cost of acquisition means the
amount of the purchase price; and (ii) in any other case cost of acquisition shall be Nil.
However, if the asset is acquired before 1 April, 1981, cost of acquisition means the cost of
acquisition of the asset to the assessee or the fair market value of the asset as on 1.4.1981 at
the option of the assessee and the indexation of cost will be available with reference to such
actual cost of acquisition or the FMV as opted for by the assessee. Where the capital asset
became the property of the assessee by any of the modes specified in Section 49(1) and the
capital asset became the property of the previous owner before 1 April, 1981 cost of acquisition
means the cost of capital asset to the previous owner or the Fair Market Value of the asset as
on 1 April, 1981 at the option of the assessee. However the indexation will commence from
the year in which the asset became the property of the assessee and not 1981-82. If a depreciable
capital asset becomes the property of assessee under the circumstances mentioned, he has got
an option to substitute the Fair Market Value of the asset on 1 April, 1981 in place of its cost
of acquisition.
If, however, an assessee acquires a depreciable asset in the circumstances, other than those
circumstances, he cannot opt for fair market value on 1 April, 1981 in the place of its cost of
acquisition.19 The option given to the assessee to substitute the Fair Market Value of the asset
on 1 April, 1981 is to ensure that capital gains are not computed with reference to some
historical cost, and thus mitigate the hardship to some of the assessees who would have
acquired the asset at cheaper cost, fifteen or even twenty years back.
Where the capital asset became the property of the assessee on the distribution of capital assets
of a company on its liquidation and the assessee has been assessed to income tax under the
head 'capital gains' in respect of that asset under Section 46, 'cost of acquisition' means the
market value of the asset on the date of distribution. Cost of original shares, acquired directly
from a company or otherwise, shall be deemed to be the actual price paid therefore just as the
cost of rights shares shall be deemed to be the actual price paid therefore to the company plus
any amount to the renouncer. Cost of bonus shares shall be deemed to be Nil. Cost of
renunciation of rights shall also be deemed to be Nil. Where the capital asset, being a share or
a stock of a company, became the property of the assessee on (a) the consolidation and
division of all or any of the share capital of the company into shares of larger amount than its
existing shares; (b) the conversion of any shares of company into stock; (c) the reconversion

19

Section 50(2), Income Tax Act, 1961. Rajnagar Vaktapur Ginning, Pressing and Manufacturing Co. Ltd. v. CIT
(1975) 99 ITR 264

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of any stock of company into shares; (d) the subdivision of any of the shares of the company
into shares of smaller amount; or (e) the conversion of one kind of shares of the company into
another kind, the 'cost of acquisition' means the cost of acquisition of the asset calculated with
reference to the cost of acquisition of the shares or stock from which such asset is derived. In
relation to a capital asset, being equity share or shares allotted to a shareholder of a recognised
stock exchange in India under a scheme for corporatisation approved by the Securities and
Exchange Board of India Act, 1992 (15 of 1992), shall be the cost of acquisition of his original
membership of the exchange.
Section 55(1)(b) of the Act provides that where the capital asset became the property of the
previous owner or the assessee before 1 April, 1981, the cost of any improvement means all
expenditure of a capital nature incurred in making any additions or alterations to the capital
asset on or after the said date by the previous owner or the assessee. If, however, any part of
the expenditure is deductible in computing the income chargeable under the head "Interest on
securities", "Income from house property", "Profits and gains of business or profession" or
"Income from other sources", such expenditure cannot be included as cost of improvement.
According to Section 45(1A) of the Act, provides that where any person receives at any time
during the previous year any money or other asset under an insurance from an insurer on
account of damage to or destruction of, any capital asset, as a result of flood, typhoon,
hurricane, cyclone, earthquake, or other convulsion of nature; or riot or civil disturbance; or
accidental fire or explosion; or action by an enemy or action taken in combating an enemy
(whether with or without a declaration of war), any profits or gains arising from receipt of such
money or other asset shall be chargeable to tax under the head 'Capital Gains'. Such income
shall be deemed to be the income for the previous year in which such money or other asset is
received, and the value of any money or the Fair Market Value of asset received on the date of
receipt shall be deemed to be the full value of consideration received or accruing as a result of
the transfer of damaged asset.
Section 51 of the Act provides that where any capital asset was on any previous occasion the
subject of negotiation for its transfer, any advance or other money received and retained by the
assessee in respect of such negotiations shall be deducted from the cost for which the asset was
acquired or the Written Down Value or the Fair Market Value, as the case may be in computing
the cost of acquisition.
Section 45(2A) of the Act states that where any person has had at any time during the previous
year any beneficial interest in securities, then, any profits or gains arising from the transfer
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made by the depository or participant of such beneficial interest in respect of securities shall
be chargeable to tax as the income of the beneficial owner of the previous year in which transfer
took place and not of the Depository who is deemed to be the registered owner of Securities.
The cost of acquisition and the period of holding of any securities shall be determined on First
In First Out basis.20 Computation of Capital Gains on purchase by company of its own shares
or other specified securities from its holder, then the capital gains shall be chargeable to tax in
the hands of transferor. The capital gains shall be computed as provided in Section 48 in the
year in which such shares or specified securities are purchased by the company.

Capital Gains Exempted from Tax


Certain capital gains such as profit on sale of property used for residence,21 transfer of land
used for agricultural purposes,22 compulsory acquisition of lands and buildings,23 investments
made in specified bonds,24 capital gains on transfer of certain listed securities or unit,25 capital
gain on the transfer of certain capital assets invested in residential house,26 capital gain on
shifting of industrial undertaking from urban area,27 capital gain on transfer of assets of shifting
of industrial undertaking from an urban area to a Special Economic Zone,28 capital gain on
Transfer of residential House Property,29 are exempted from capital gains.
Section 54H of the Act states that where the transfer of the original asset is, by way of
compulsory acquisition under any law and the amount of compensation awarded for such
acquisition is not received by the assessee on the date of such transfer, the period of acquiring
the new asset by the assessee referred to in Sections 54, 54B, 54D, 54EC and 54F or for
depositing or investing the amount of capital gain shall be extended.30 This extended period
shall be reckoned from the date of receipt of such compensation.

20

Circular No. 768, dated 25-06-1998, issued by CBDT


Section 54, Income Tax Act, 1961
22
Section 54B, Income Tax Act, 1961
23
Section 54D, Income Tax Act, 1961
24
Section 54EC, Income Tax Act, 1961
25
Section 54ED, Income Tax Act, 1961
26
Section 54F, Income Tax Act, 1961
27
Section 54G, Income Tax Act, 1961
28
Section 54GA, Income Tax Act, 1961
29
Section 54GB, Income Tax Act, 1961
30
Arvind P Datar, Kanga and Palkhivala, The Law and Practise of Income Tax, 10th Ed. Vol.(1), Lexis Nexis P.
1280
21

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CHAPTER 5: CONCLUSION

Any profits or gains arising from the transfer of capital assets is called capital gain. Property or
capital asset may be movable or immovable like land and buildings. Plant and machinery furniture,
tangible or intangible like shares, debentures, good will etc., certain properties are however
excluded from the definition of capital assets. Capital gain may be short term capital gain or long
term capital gain. Capital gain is considered to be short term if a capital asset is transferred within
three years of acquiring the same but in case of shares or other financial securities such as mutual
fund units are sold within one year of purchase, the profit earned is treated as short term capital
gain capital gain becomes long term if a capital asset is transferred on or after 3 years of acquiring
the same. Subject to certain exceptions, capital gain is computed in the following manner: - Capital
gain = (Full value of consider received on transfer of capital asset)-(cost of acquisition of capital
asset + cost of improvement of capital asset + selling expenses). Cost of acquisition is based up on
the nature of acquisition of the capital asset, if the asset was acquired by means of gift succession,
inheritance, will, partition etc., the cost of such assets shall be cost to the previous owner who has
acquired and cost of acquisition for assets acquired before 1.4.1981 shall be the actual cost of
acquisition or fair market value of the asset as on 1.4.1981 whichever is higher. However, the
above rule is not applicable for an asset acquired on or after 1.4.1981 or depreciable assets, if any
advance money received during the time of negotiation and fortified later shall be reduced from
the cost of acquisition. Any improvements made on or after 1.4.1981 shall only be considered i.e.,
improvements made before 1.4.1981 shall be ignored. Expenditure incurred wholly and
exclusively in connection with the transfer of capital asset such as stamp duty, registration charges
legal fees, brokerage etc. shall be considered as selling expenses. In respect of long term capital
assets, cost of acquisition and cost of improvement to be considered for computation of taxable
capital gain and it is worked out as under: - cost of acquisition or improvement X cost inflation
index of year sale cost inflation index of year acquisition / as on 1.4.1981/ improvement. The
cost inflation index is notified by the Central Government for every year. But the cost of bonus
shares, self-generated goodwill shall be taken as nil. Short term capital gains are taxed in the same
manner as income under the other heads. Barring certain exceptions, long term capital gains are
taxed at the flat rate of 20 percent. Depending up on the nature of the capital asset and the manner
of utilization of the consideration received on transfer, various exemptions are available under
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section 54 (sale and purchase of new residential house with in one year before or within 3 years
after the date of transfer to the extent of cost of new house), 54B (sale and purchase of new
agricultural land), 54D (compulsory acquisition of industrial undertaking), 54EC (Transfer of any
long term capital asset and invested in specified capital asset, within 6 months), 54F (Transfer of
any capital asset and invested in a residential house), 54G (transfer of industry to Rural area).

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CHAPTER 6: BIBLIOGRAPHY

Books referred: 1. The Law and Practise of Income Tax, Kanga and Palkhivala by Arvind P Datar
2. Tax Law I by Girjesh Shukla and Mahima V Tiwari

Websites referred: 1. Taxguru.com


2. Moneycontrol.com
3. Incometaxindia.gov.in
4. Businessstandard.com

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