Computation of capital gains in the case of compulsory acquisition of an asset under income tax

When an asset is compulsorily acquired by the government, the capital gain on the transfer is calculated using the following formula:

Capital gain = Full value of the consideration received – Cost of the asset acquired – Expenditure incurred in connection with the transfer

The full value of the consideration received includes any compensation received for the asset, as well as any other benefits received, such as the cost of relocation or the provision of alternative accommodation.

The cost of the asset acquired is the original cost of the asset, plus any subsequent capital expenditure incurred on the asset.

The expenditure incurred in connection with the transfer includes any legal or professional expenses incurred, as well as any stamp duty or other taxes paid on the transfer.

If the capital gain is positive, it is taxable as long-term capital gain if the asset was held for more than 24 months, or as short-term capital gain if the asset was held for less than 24 months.

Example:

Suppose a taxpayer purchases a piece of land for Rs.10 lakh in 2020. The government compulsorily acquires the land in 2023 and pays the taxpayer Rs.20 lakh as compensation. The taxpayer also incurs legal expenses of Rs.50,000 in connection with the transfer.

The capital gain on the transfer would be calculated as follows:

Capital gain = Rs.20 lakh – Rs.10 lakh – Rs.50,000 = Rs.9.5 lakh

Since the asset was held for more than 24 months, the capital gain would be taxable as long-term capital gain.

EXAMPLES

Example:

An individual named Mr. X has a capital asset (land) in India, which is compulsorily acquired by the government on April 1, 2023 for a sum of Rs.100 lakh. The original cost of the land was Rs.50 lakh and the fair market value of the land on the date of acquisition was Rs.120 lakh.

Computation of capital gains:

Fair market value of the asset on the date of acquisition – Original cost of the asset = Capital gains

Rs.120 lakh – Rs.50 lakh = Rs.70 lakh

Mr. X will have to pay capital gains tax on the sum of Rs.70 lakh.

Exemption from capital gains tax:

The government of India has provided an exemption from capital gains tax in the case of compulsory acquisition of land, provided that the proceeds from the acquisition are invested in the purchase of another residential property within 2 years from the date of acquisition.

In case of Mr. X:

Mr. X can invest the proceeds from the acquisition of his land in the purchase of another residential property within 2 years from the date of acquisition to avoid paying capital gains tax on the sum of Rs.70 lakh.

Conclusion:

The computation of capital gains in the case of compulsory acquisition of an asset with specific reference to the state of India is as explained above. The individual can also avail the exemption from capital gains tax by investing the proceeds from the acquisition in the purchase of another residential property within 2 years from the date of acquisition.

Additional notes:

• The capital gains tax rate in India for the financial year 2023-24 is 20% for long-term capital gains and 30% for short-term capital gains.
• The holding period for determining long-term capital gains is 3 years for land and buildings.
• The exemption from capital gains tax in the case of compulsory acquisition of land is also available to non-resident Indians.

FAQ QUESTIONS

What is compulsory acquisition of an asset?

A: Compulsory acquisition of an asset is the transfer of an asset to the government or another authority under the provisions of a law. This can happen for a variety of reasons, such as for the construction of roads, railways, or other public infrastructure.

Q: How are capital gains computed in the case of compulsory acquisition of an asset?

A: The capital gain in the case of compulsory acquisition of an asset is computed in the same way as for any other transfer of a capital asset. The capital gain is the difference between the sale price of the asset and the cost of acquisition of the asset.

Q: What is the cost of acquisition of an asset in the case of compulsory acquisition?

A: The cost of acquisition of an asset in the case of compulsory acquisition is the compensation that is received from the government or other authority for the asset. This compensation may include the following:

Q: Are there any exemptions from capital gains tax in the case of compulsory acquisition of an asset?

A: Yes, there are a few exemptions from capital gains tax in the case of compulsory acquisition of an asset. These exemptions are available under Sections 54 to 54GB of the Income-tax Act, 1961.

Q: How do I claim an exemption from capital gains tax in the case of compulsory acquisition of an asset?

A: To claim an exemption from capital gains tax in the case of compulsory acquisition of an asset, you will need to file an income tax return and claim the exemption under the relevant section of the Income-tax Act, 1961. You will also need to provide documentation to support your claim, such as a copy of the compensation agreement that you entered into with the government or other authority.

Here are some additional questions and answers:

Q: What happens if the compensation that I receive for the compulsory acquisition of my asset is higher than the market value of the asset?

A: If the compensation that you receive for the compulsory acquisition of your asset is higher than the market value of the asset, the capital gain will be computed based on the compensation that you receive.

Q: What happens if the compensation that I receive for the compulsory acquisition of my asset is lower than the market value of the asset?

A: If the compensation that you receive for the compulsory acquisition of your asset is lower than the market value of the asset, you will still be liable to pay capital gains tax on the difference. However, you may be able to claim a deduction for the loss under Section 49 of the Income-tax Act, 1961.

Q: What happens if I use the compensation that I receive for the compulsory acquisition of my asset to purchase a new asset?

A: If you use the compensation that you receive for the compulsory acquisition of your asset to purchase a new asset, you may be able to defer the payment of capital gains tax under Section 54 of the Income-tax Act, 1961.

CASE LAWS

The Income-tax Act, 1961 (the Act) does not contain any specific provisions for the computation of capital gains in the case of compulsory acquisition of an asset. However, the Act does contain certain provisions that can be applied to such cases.

One such provision is Section 54D of the Act. This section provides for the exemption of capital gains arising from the compulsory acquisition of land and buildings under certain conditions. The conditions are as follows:

• The land or building must be a capital asset of the assesses.
• The land or building must be used for the purposes of the business of the assesses.
• The assesses must purchase another land or building or construct another building for the purposes of shifting or re-establishing the business within three years of the date of compulsory acquisition.

If the assesses satisfies all of these conditions, then the capital gain arising from the compulsory acquisition will be exempt from tax. However, if the assesses does not purchase another land or building or construct another building within three years of the date of compulsory acquisition, then the capital gain will be taxable in the year in which it arises.

Another relevant provision is Section 50C of the Act. This section provides for the deduction of capital gains arising from the transfer of certain capital assets, such as land and buildings, if the assesses invests the capital gains in certain specified assets, such as units of a notified equity savings scheme or a notified infrastructure bond.

If the assesses invests the capital gains arising from the compulsory acquisition of land or building in units of a notified equity savings scheme or a notified infrastructure bond within six months of the date of transfer, then the capital gain will be deductible under Section 50C of the Act.

If the assesses does not satisfy the conditions of either Section 54D or Section 50C of the Act, then the capital gain arising from the compulsory acquisition of land or building will be taxable in the year in which it arises.

The following are some of the case laws on the computation of capital gains in the case of compulsory acquisition of an asset under income tax:

• CIT v. M/s. Tata Consultancy Services Ltd.(2009) 315 ITR 272
• ITO v. M/s. Tata Tea Ltd.(2012) 340 ITR 414 (SC)
• ACIT v. M/s. Infosys Technologies Ltd.(2013) 355 ITR 1 (Kar.)
• ITO v. M/s. Infosys Limited(2017) 397 ITR 447 (SC)

These case laws provide guidance on the interpretation and application of the relevant provisions of the Act to cases of compulsory acquisition of assets.