Capital Gains Taxation in India | History, Evolution, and Legislative Measures

Table of Contents

1. Introduction
2. Brief History of Capital Gains Taxation in India
3. The Evolution of Capital Gains Taxation in India
4. Legislative Measures to Improve Capital Gains Taxation

1. Introduction

A taxpayer, in many instances, has the following questions when he intend to dispose of any immovable property and claim the benefit of exemption by utilising the sale consideration for acquiring or constructing a new residential house:

• How can he legitimately save tax on the sale of immovable property held for over three years?
• What if he sold the property below the circle rate/stamp duty value?
• What are the various rollover benefits or exemptions available under provisions of the Income-tax Act, 1961?
• What are the eligibility conditions for availing exemptions?
• What is the procedure laid down under the Act for claiming such exemptions?
• Whether he can invest the sale proceeds in buying more than one residential house?
• Whether the new residential house can be purchased in joint names with other members of the family?

Those interested in making investments in equity markets or Mutual Funds are also keen to know the relevant tax rules and their implications to minimise the tax arising on the sale of such investments. It is in this background that the idea of dealing with the subject of taxation of capital gains in a question-answer or query-response format was conceived.

2. Brief History of Capital Gains Taxation in India

The history of capital gains taxation goes back to the Budget of 1947 when capital gains tax was introduced by inserting section 12B in the then Indian Income-tax Act, 1922 with effect from AY 1947-48 to curb the speculative activity of buying and selling assets in an inflationary environment in the wake of World War II. This levy was, however, short-lived and was abolished after two years as it was considered to be hampering the growth of the stock market.

On the recommendation of Prof. Nicholas Kaldor, based on the principle of equity in taxation and with a view to augmenting tax revenue, capital gains tax was re-introduced by the Finance (No. 3) Act of 1956 in respect of sale, exchange, relinquishment or transfer of capital asset effected after 31-03-1956. Since then, levy of tax on capital gains became a permanent feature of the Indian tax structure. During the period of last over six decades, India has come a long way in the field of capital gains taxation.

3. The Evolution of Capital Gains Taxation in India

From levy of special tax rate of 20% on Long-Term Capital Gains (LTCG) after indexation in 1992 to grant of exemption on LTCG earned from listed securities in 2004 [subject to levy of a nominal Securities Transaction Tax (STT)] till re-introduction of LTCG tax on equities by the Finance Act, 2018, the capital gains taxation of listed securities has witnessed remarkable changes over past three decades paving the way for increased participation of investors in the stock market and consequent deepening of the equity markets in India.

The history of taxation of capital gains has by and large been one of constant evolution. The process of evolution has broadly been two-fold: first, by rationalising and streamlining the statutory provisions by way of filling the gaps and plugging the loopholes in capital gains taxation and secondly, by removing the difficulties and mitigating the genuine hardship of taxpayers by way of relaxing the rigour of tax law from time to time. All this has resulted in expanding and widening the horizons of capital gains taxation in India in tune with the changing times and the requirements of a fast-growing economy. Besides, capital gains taxation has been used as an effective tool for facilitating economic growth and development by incentivising channelisation of investment of capital gains into priority sectors of the economy like agriculture, rural electrification, housing, infrastructure, Small and Medium Enterprises (SMEs), etc.

4. Legislative Measures to Improve Capital Gains Taxation

The Legislature has been taking necessary steps from time to time for removing the lacunae and plugging the loopholes in existing provisions and thereby suppressing the mischief by bringing in appropriate corrective measures to check tax evasion. For example, based on recommendations of the Chelliah Committee to rationalise the system of LTCG taxation, Section 48 was substituted by the Finance Act, 1992 w.e.f. AY 1993-94 and onwards granting benefit of indexation of cost of acquisition and cost of improvement on transfer of long-term capital assets so as to neutralise the effect of price inflation over the period during which LTCG had arisen. Again, section 50C was brought on the statute book w.e.f. AY 2003-04 with a view to checking large-scale evasion of tax by understatement of sale consideration of immovable properties at the time of transfer. Recently, the Finance Act, 2023 made amendments of sub-sections (1) and (2) of section 55 in order to provide that cost of acquisition and cost of improvement of a capital asset being any intangible asset or any other right [other than those already mentioned in section 55(1)(b)(1) and section 55(2)(a)] shall be taken as Nil.

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[FAQs] Income Tax Returns (ITR) | Capital Gains

The Legislature has also been taking various measures over the years with a view to removing difficulties and alleviating the genuine hardship caused to the taxpayers on account of the rigour of certain provisions of the Act. A few important examples in this regard include insertion of new section 45(5) by the Finance Act, 1987 w.e.f. 01-04-1988 to provide for taxation of initial as well as additional compensation in the year of receipt rather than the year of transfer of capital asset by way of compulsory acquisition in view of the considerable gap between the date of transfer and the date of payment of compensation; insertion of another new section 54H by the Finance (No. 2) Act, 1991 w.e.f. 01-10-1991 to the effect that the period for depositing or investing the capital gain in acquiring the new asset under sections 54, 54B, 54D, 54EC and 54F shall be reckoned from the date of receipt of such compensation and the insertion of third proviso to section 50C(1) prescribing tolerance limit of 5% w.e.f. 01-04-2019 and 10% w.e.f. 01-04-2021 for avoiding the substitution of stamp duty value for the declared sale consideration.

However, complexity of direct tax laws in India has been a subject of perpetual lament and despair on the part of tax policy commentators and experts. There has been a growing demand for the simplification and rationalisation of current income tax regime in general and capital gains structure in particular. Capital gains taxation in India covering diverse asset classes (viz., equity, real estate and gold) and prescribing different periods of holding, different rules of indexation of cost and different tax rates for each class has recently been called “a complex maze”.