INTRODUCTION
Laws in general have an impact on society at large; this is especially true when it comes to laws of taxation. The laws of taxation have a special relationship with public policy. Public policy aims at the overall economic welfare of its people and the laws of taxation become a tool to better enforce and give effect to the planned public policy. Each and every legislation has a rationale behind it and tax laws are no exception.
The provisions of the Income Tax Act, 1961 determine the taxability of events and prescribe the rate and manner in which such events are taxed. Consequently, these provisions have a ripple effect on the economy at large. To promote certain sectors of the economy or to incentivize specific behavior, the Act grants various exemptions subject to the fulfilment of prescribed conditions. The outcome of such exemptions assumes significance since tax revenue represents funds collected from the public, thereby creating a right in their favor to understand its utilization and economic implications.
This paper seeks to examine the rationale behind exemptions granted under the head Income from Capital Gains and to analyze their consequent economic impact. Exemptions relating to capital gains are contained in Sections 54 to 54GB of the Income Tax Act, 1961, and apply to a wide range of assets including residential and agricultural property, industrial undertakings, specified bonds and funds, properties situated in SEZs, and transfers to eligible companies.
CAPITAL GAINS AND THEIR CLASSIFICATIONS
Since exemptions are subject to certain conditions and are based on the type of capital asset, it becomes necessary to understand what qualifies as a capital asset and criteria for their bifurcation.
Capital gains are nothing but an investor’s profit after selling a capital asset. It is earned by selling the asset at a higher price than the purchase price. The transfer of capital asset should occur during the previous financial year to tax the assessee during the current financial year / assessment year.
Capital gains are classified into long-term and short-term. This classification is based solely on PoH (Period of Holding) of the asset. It starts from the day following the date of acquisition and ends on the date of transfer.
The period of holding required to be classified as long-term capital gains is different for different assets as follows:
(i) 12 months PoH for:
• Shares / Debentures / Bonds listed on a recognised stock exchange
• Units of Unit Trust of India
• Units of Equity Oriented Mutual Fund
• Zero Coupon Bonds
Note: If the above assets have PoH below 12 months, they would be classified as short-term gains
(ii) 24 months PoH for:
• Land or Building or Both
• Unlisted equity or preference shares
• Note: The above assets need to be held for at least 2 years (24 months) to qualify as long-term capital gains.
(iii) 36 months PoH for:
• Shares / Debentures / Bonds listed outside India
• Any other assets
1) Section 54 – Capital Gain arising from the transfer of Residential House Property
• Assessee: The following exemption may be claimed by either an individual or a HUF only.
• Asset: The house property must be of a residential nature. It does not matter whether it was self-occupied or let out.
• Nature: The house property must be long-term, i.e., held for more than 24 months.
• Condition: The assessee must purchase or construct a residential house property in India.
• Exemption limit: Amount invested or capital gains, whichever is lower.
• Restriction: The new asset cannot be transferred within 3 years from the date of acquisition.
• Time limit: The new property should be purchased within 2 years after sale of the old house property.
• Unspent amount: Any unspent capital gain is to be deposited in a “Capital Gain Deposit Account” with a nationalised bank.
• Amendment: Effective from Assessment Year 2024–2025 (April 1, 2024 onwards), the maximum exemption allowed under Section 54 is capped at ₹10 crore.
Rationale
This particular exemption has a special focus on the housing industry. The housing industry has often been called the “Engine of Domestic Growth” of the economy1. It has been observed by economists that any investment in construction triggers a series of investment in other sectors. Therefore, the housing sector has a direct relation with the GDP and employment rates in India
As per the National Association of Realtors, the housing sector contributes directly to overall production activities like job growth, tax revenue, benefits of shelter and wealth accumulation2. Roughly 30% of the new home occupant’s income is spent on items produced by local businesses.
Statistical Data3(as per data compiled by the Ministry of Statistics and Programme Implementation)
| Year | Construction (₹ Cr) | GDP (₹ Cr) |
|---|---|---|
| 2000–2001 | 112,223 | 1,954,276 |
| 2004–2005 | 213,515 | 2,923,237 |
| 2008–2009 | 453,932 | 5,387,558 |
| 2010–2011 | 589,616 | 7,277,937 |
From the above data, it can be concluded that there is a positive correlation between construction activity and GDP. Since the housing sector triggers construction, the exemption under Section 54 is justified.
2) Section 54B – Capital Gain arising from land used for agricultural purpose
• Assessee: The following exemption may be claimed only by an individual.
• Asset: Land used for agricultural purpose.
• Condition: The asset must have been used by the assessee or his/her parents for agricultural purposes for at least 2 years immediately preceding the date of transfer.
• Exemption limit: Amount invested or capital gains, whichever is lower.
• Time limit: Another agricultural land must be purchased within 2 years of sale of the former agricultural land.
• Restriction: The new agricultural property cannot be sold until more than 3 years have passed from the date of acquisition.
• Denial of Exemption: On exemption being denied on breach of one or more conditions, the capital gains on the said transfer will be treated as short-term or long-term capital
gains, as applicable, after deduction of the original cost of acquisition.
• Rationale involved herein: In order to appreciate the relevance of the above exemption, it is required to first point to some of the peculiarities with respect to Agricultural land
Agricultural and allied activities are said to contribute around 17%4 of the GDP as of 2021. Nearly half the population is engaged in such activities. There is a lot of fragmentation taking place in agricultural lands due to India being the second most populated nation in the world. Fragmentation hampers productivity by increasing transportation costs, difficulty in supervision, need for more land reserved for fencing, and difficulty in growing crops such as fruit crops which require more area5. India, being a developing country, involves in building of highways, dams, roads and factories which play a key role in the development of the economy. This causes a relocation of the agriculturists, and compensation by the government is often found inadequate.6 Water issues often force farmers to move from one particular area to another. Furthermore, not all lands are suitable for using proper water conservation techniques. For the above reasons, we can contemplate the necessity by which a farmer may have had to sell his/her agricultural land. Any tax for such a sale would be extremely punitive in nature, hence this exemption.
3) Section 54D – Capital Gain on compulsory acquisition of land and building forming part of industrial undertaking
• Assessee: Available to any person.
• Asset: Includes both land as well as building, but must have formed part of an industrial undertaking.
• Condition: The asset must have been used for a period of 2 years immediately preceding the date of compulsory acquisition by the government.
The purpose of use must also be for an industrial undertaking.
• Time limit: A new land or building being used for industrial purpose must be purchased within a period of 3 years from the date of receiving initial compensation.
• Exemption limit: Amount invested or capital gains, whichever is lower.
• Restriction: The new asset cannot be sold for a period of 3 years.
• Denial of Exemption: Where exemption is denied, the capital gain from such acquisition will be taken as sale consideration minus original cost of acquisition.
• Rationale involved herein: The rationale may be understood by analysing two different case laws independently and then drawing a common conclusion
Right to Property and Compulsory Acquisition
(i) State of West Bengal v. Bela Banerjee (AIR 1954 SC 170)7
The Government of West Bengal had passed the West Bengal Land Development and Planning Act, 1948, which provided for compulsory acquisition of land for planned development schemes. The respondent’s premises were compulsorily acquired for a planned development scheme under the said Act. The acquisition was challenged on the ground that the compensation offered was inadequate.
The Court laid down important guidelines with respect to compulsory acquisition:
a. Compensation in cases of compulsory acquisition should not only cover the market value but must also include additional compensation to make good the hardship undergone by the respondent.
b. The acquisition must be for a public purpose.
(ii) CIT v. Modem Translators Ltd. (2008) 170 Taxman 3288
In the above case, the Court held that the purpose under Section 54D must be a public purpose. It was further held that where the prescribed conditions are satisfied, non-grant of exemption would be violative of the right to property.
Thus, the two cases highlight the rationale underlying exemptions granted in cases of compulsory acquisition.
4) Section 54EC – Capital Gains not to be charged on investment in certain bonds
• Assessee: Exemption available to any person.
• Asset: Asset involved here may be land or building or both, but must be of long-term nature.
• Condition: Assessee is required to purchase specified bonds issued by:
a. NHAI – National Highways Authority of India, or
b. RECL – Rural Electrification Limited
Such bonds are non-redeemable for a period of five years.
• Time Limit: Such bonds are to be purchased within a period of six months from the date of transfer of the long-term asset.
• Exemption Limit: Amount invested or capital gains, whichever is lower.
• Period of Exemption: If the said bonds are not bought within the six-month period, or are transferred or redeemed within five years from the date of purchase, the exemption shall not be available.
• Clarification: Availment of any loan using the said bonds as security shall be deemed to be a transfer on the date of sanction of such loan.
• Rationale involved herein: In the first instance, we may note that the bonds available for purchase are of two specific categories – Companies only and none other this my bring into question the validity of the said exemption has been violative of article 14. The same maybe addressed by way of a case law which also makes clear the rational behind the said exemption.
In Union of India versus Tulsyan NEC Ltd9 the supreme court lay down certain guidelines to understand the constitutional validity of section 54 EC. And examination of the section made clear at the legislative intent was to promote infrastructure development through investments in specified bonds. It was emphasized the welfare role of the state and that States was bound to venture into areas of business where incentives are rather low, due to huge capital expenditure, low margin of profit and delayed realisation of said profit . It was observed the power distribution to rural areas was not much profitable and that cash conversion cycle in highway projects was very long. Therefore government entities in such areas formed a class legislative in themselves. Therefore government promoting government entities through tax savings bonds were held to be valid. The above case highlights the needs for and restaurants behind section 54 EC and formation of RECL and NHAI has a separate class.
5) Section 54 EE exemption from capital gains on investment in units of a specified fund.
• Assessee: all persons are eligible to claim this exemption.
• Asset: any long term capital asset.
• Condition: purchase of long term specified asset notified by central government.
• Exemption limit: maximum investment that may be made in any such unit cannot exceed 50 lakh. Further exemption allowed shall be amount invested or capital gain which ever is less.
• Restrictions: units purchased cannot be sold or transferred for a period of 3 years from date of acquisition.
• Breach: on sale of specified units, capital gains shall deem to have occurred in previous year.
• Clarification: Availment of any loan on set units sell also be deemed as transfer and breach of condition will be presumed.
• Rationale involved hear in: This provision was introduced through the Finance Act 2016 around the same time the startup action plan was launched by the government of India. It was introduced to create a conclusive ecosystem for startups promote job creation and drive economic growth.
As per a research conducted by the ADBI- Asian Development Bank Institution10 Section 54EE provided a meaningful method for startups to save on capital gains tax by investing through a fund that the government has notified. Further its observed the dual role played by the section by highlighting its role in ease of fundraising, especially in their early stages, this section provided an additional avenue for startups to raise capital, making it more attractive for investors to put their money into the specified funds.
These specified funds have additional advantages such as investment in a portfolio of startups rather than a single entity, then reducing the risk of investors.
Therefore section 54EE has been a success and compensate for other benefits which were less impactful such as the minimum alternate tax and misalignment in rules framed by SEBI versus rules framed by DIPP (Department for Promotion of industry and internal Trade)11
6) Section 54F: Capital gains on transfer of a long term capital asset other than a long term capital asset other than a house property
• Assessee: Following exemption is available only to an HUF or Individual.
• Asset: Any long term capital asset Other than a residential house property. Provided, the assessee does not own more than one house property.
• Condition: Assessee is required to purchase a residential house property out of the capital gains that occurs.
• Time limit: purchase must have been made 1 year prior to transfer or 2 year after transfer. In case of construction the limit is 3 years from date of transfer.
• Exemption limit: cost of new house into capital gains divided by net sale consideration.
• Denial of exemption: if the new asset is transformed within 3 years of construction or acquisition or assessee purchases another residential house property within 2 years of availing said exemption.
• Rational Involved herein: The rationale underlying Section 54F is largely similar to that of Section 54, as both provisions seek to promote the housing sector. However, Section 54F further strengthens the rationale of Section 54 by emphasizing the role of housing in contributing to GDP growth. It is contended that this is the reason why the Income Tax Act contains two separate provisions granting exemption through the purchase or construction of residential house property. While Section 54 is primarily aimed at stimulating economic activity through the construction of residential houses, Section 54F adopts a broader objective by encouraging urbanisation and, indirectly, contributing to the eradication of slums.
7) Section 54G: capital gains on transfer of assets in cases of shifting of industrial undertakings
• Assessee: can be claimed by any person.
• Assets: any land, building or plat, machinery being shifted from urban to rural area.
• The Limit: Purchase to be made within 3years from date of transfer or 1year before date of transfer.
• Exemption limit: Amount invested or capital gains whichever is lower.
• Restriction: New asset cannot be transferred for a period of 3years from date of transfer, acquisition.
• Scheme: Capital gain deposit account may be opened with any scheduled bank for safekeeping until utilization
• Rational: Concentration of economic growth poses several challenges such as the issue of agreement labourers who cannot find jobs in their home town in rural areas further for the growth of economic activity organically it requires the shifting of businesses to their areas which bare relatively unpopular. This section carries with it the purpose of dealing with both vagrant workers as will as fuelling organised growth of the economy.
8) Section 54GA: Capital gains on transfer of assets in cases of shifting of industrial undertakings from urban area to any SEZ
Similar to section 54G which focus on rural areas section 54GA focus on SEZ or special economic zones setup by the government of India. These areas are primarily focused on exporting activity rather than domestic uses therefore giving a huge boost to the economy thus deserving the exemption allowed.
9) Section 54GB: deduction from capital gain on transfer of residential property for investment in eligible company.
One of the unique exemption available for individual and HIUF wherein the capital gains that arise from selling of house property may be invested into equity shares of eligible companies.
However it is to be noted that such transfer should have taken place between 1/4/2013 to 31/3/2021 therefore it is no longer relevant for current FY.
CONCLUSION
The manner in which taxes are collected, which events are taxed and which events are exempted all have a significant impact on the direction in which credit flows in the economy. Therefore taxing laws are a powerful governance mechanism of a state which determine where investment are need to be made due to this sensitive nature of the subject it requires lots of planning to determine which exemption should be allowed.
A careful analysis of the exemption available under head income from capital gains special emphasis on role of housing sector in bosting the GDP with two independent provision hinting towards the same. Furthermore provision bosting the growth of start-ups and their disbursement into the rural and SEZ location have been emphasized for better greater business are deterred from entering are entered through public sector undertakings and they are being supported by bonds which are tax savings in nature, the above provision indirectly solve various societal problems such as issue of migrant labourers and reduction of slums houses being converted to residential houses. The provision are a step in the right direction and will reap fruitful results in the years to come.
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Footnotes
1. Tanima Bhattacharya & Meenakshi Rajeev, Measuring Linkages to Identify Key Sectors of the Indian Economy, 68 RESERVE BANK INDIA BULL. 1, 3 (2013), https://www.rbi.org.in/scripts/BS_ViewBulletin.aspx?Id=14664.
2. NAT’L ASS’N OF REALTORS, ECON. IMPACT OF HOUS. SECTOR 12 (2003), https://www.creb.org/publications/urban-economic-impact.pdf.
3. Ananda Kumar & Neelam Chaudhary, Impact of Housing Investment on India, 10 INT’L J. SOC. & ECON. STUD. 45, 47 (2020).
4. Press Information Bureau, Govt. of India, Contribution of Various Sectors to GDP (Mar. 12, 2024), https://pib.gov.in/PressReleasePage.aspx?PRID=1864183.
5. Patrik Sundqvist & Lisa Andersson, A Study on Impacts of Land Fragmentation 22 (2019), https://www.diva-portal.org/smash/get/diva2:131275/FULLTEXT01.pdf.
6. Press Information Bureau, Govt. of India, Year End Review 2019 – Ministry of Road Transport and Highways (Dec. 31, 2019), https://www.pib.gov.in.
7. State of West Bengal v. Bela Banerjee, AIR 1954 SC 170 (India).
8. CIT v. Modern Translators Ltd., (2008) 170 Taxman 328 (Delhi).
9. Union of India v. Tulsyan NEC Ltd., (2014) 1 SCC 254 (India).
10. Vijay Kumar Singh, Policy and Regulation Changes for a Successful Startups Revolution: Experience from Startups Action Plan in India, ASIAN DEV. BANK INST. 15 (2018), https://www.adb.org/sites/default/files/publication/477631/adbi-wp904.pdf.
11. Kalyani Karnad & Shubham Bhargava, Taxation on Startups in India, 4 J. COMP. INT’L L. 112, 118 (2018).