Capital Gains (ss.45–55); Capital vs Revenue Receipt — Law of Taxation Notes

Capital Gains (ss.45–55); Capital vs Revenue Receipt

‘A’ sells the house he bought four years ago for ₹25 lakh, now for ₹60 lakh. Is the ₹35 lakh “profit” taxable, and how? Meanwhile, another ‘A’ receives ₹10,000 as compensation for an accident injury on a bus. One is a taxable capital gain; the other is not income at all. The head of Capital Gains, and the capital-versus-revenue line, decide both.

The scheme of the head “Capital Gains”

Section 45 — the charge. Any profit or gain arising from the transfer of a capital asset is chargeable as “capital gains” in the year of transfer. Four elements must all exist: (i) a capital asset; (ii) a transfer; (iii) in the previous year; (iv) a resulting profit or gain.

Capital asset (s.2(14)) — property of any kind held by the assessee, whether or not connected with his business. But it excludes: stock-in-trade (that is business income), personal effects (movable articles for personal use — but not jewellery, paintings, etc., which are capital assets), and rural agricultural land.

Transfer (s.2(47)) — widely defined: sale, exchange, relinquishment, extinguishment of rights, compulsory acquisition, and conversion of a capital asset into stock-in-trade.

Short-term vs Long-term (s.2(42A)/(29A)):

• Short-term capital asset — held for not more than 36 months before transfer (24 months for immovable property and unlisted shares; 12 months for listed securities/units).
• Long-term capital asset — held longer than that period. Long-term gains enjoy indexation (adjusting cost for inflation via the Cost Inflation Index) and concessional rates.

Computation of capital gain (s.48):

• Sale consideration (full value of consideration)
• Less: cost of acquisition (indexed for long-term assets)
• Less: cost of improvement (indexed for long-term)
• Less: expenses on transfer (brokerage, legal fees)
• = Capital Gain (then subtract any exemption under ss.54–54F for reinvestment).

Capital vs Revenue receipt (the classic distinction):

• A capital receipt arises from the sale/loss of a source (a fixed asset, the “tree”); it is generally not income, except where the Act specifically taxes it (capital gains).
• A revenue receipt arises from the use of a source (the “fruit” — rent, interest, sale of stock); it is income and taxable.
• Tests: is the receipt for parting with a source or for its produce? Compensation for loss of a capital asset is capital; compensation for loss of profits/trading is revenue.

⚠️ DON’T CONFUSE — Capital receipt vs Revenue receipt

A capital receipt is money from selling or losing the source itself — the tree (sale of a building, a one-time compensation for a capital asset). It is generally not taxable as income (only as capital gains, if the Act says so). A revenue receipt is money from using the source — the fruit (rent, interest, sale of stock-in-trade) — and is taxable income. Ask: did the assessee part with a source or earn from its use?

The Format (pro-forma)

Learn this skeleton first, then see it applied below. XXXX stands for a figure; amounts in brackets (XXXX) are subtracted. For a long-term asset, cost of acquisition and improvement are the indexed figures.

Format — Computation of Capital Gains (ss.45–48)

🧩 WORKED EXAMPLE — Sale of a residential house

Facts. ‘A’ sells for ₹60,00,000 a residential house purchased 4 years ago for ₹25,00,000; brokerage ₹60,000; assume indexed cost of acquisition works out to ₹32,00,000.

Rule. Held over 24 months (immovable) → long-term capital asset; gain = sale consideration − indexed cost − transfer expenses (s.48); rate is the concessional LTCG rate, and reinvestment relief under s.54 may apply.

Apply.

• Sale consideration 60,00,000
• Less indexed cost of acquisition 32,00,000
• Less transfer expenses (brokerage) 60,000
• Long-term capital gain = ₹27,40,000

Conclusion. The gain is a long-term capital gain, taxable at the concessional rate — but ‘A’ can claim exemption under s.54 if he reinvests the gain in another residential house within the prescribed time. (An accident compensation like the ₹10,000 KSRTC payment, by contrast, is a capital/personal receipt and not taxable at all.)

Section 45(1): “Any profits or gains arising from the transfer of a capital asset effected in the previous year shall, save as otherwise provided …, 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.”

In Simple Terms: Sell a capital asset for more than it cost you, and the profit is a “capital gain” (s.45). Hold it long enough and it is long-term (indexation + lower rate); shorter and it is short-term. A capital receipt (selling the source) is not ordinary income; a revenue receipt (income from using the source) is.

⚠️ Currency note — Finance (No. 2) Act, 2024. For transfers made on or after 23 July 2024, long-term capital gains are taxed at a flat 12.5% and indexation has been withdrawn for most assets (a limited grandfathering lets resident individuals/HUFs still choose indexation for land or buildings acquired before that date, paying the lower of the two). The worked examples in this topic use the pre-2024 indexation method for illustration; in the exam, apply the method and rate in force for the relevant assessment year.

flowchart TD
    ROOT["Capital Gains s.45"]:::root
    ROOT --> A["Capital asset s.2(14)<br/>(not stock, not personal effects, not rural agri land)"]:::leaf
    ROOT --> B["Transfer s.2(47)<br/>sale, exchange, relinquishment"]:::leaf
    ROOT --> C{"Holding period?"}:::leaf
    C -->|"Short"| ST["Short-term: normal rate"]:::sub
    C -->|"Long"| LT["Long-term: indexation + concessional rate"]:::sub
    ROOT --> D["Gain s.48 = consideration - cost - improvement - expenses"]:::leaf
    classDef root fill:#FFF8DC,stroke:#000,stroke-width:1px,color:#000;
    classDef leaf fill:#E6F3FF,stroke:#1E3A8A,color:#000;
    classDef sub fill:#F2F2F2,stroke:#555,color:#000;
    linkStyle default stroke:#888,stroke-width:1px;

Case Laws

• CIT v B.C. Srinivasa Setty (1981) — if the cost of acquisition cannot be conceived (self-generated goodwill), the capital-gains charge fails; the machinery must work.
• Vodafone International Holdings v Union of India (2012) — the meaning of “transfer” of a capital asset and its Indian situs.

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