Deemed Cost of Acquisition of Capital Asset for Computing Capital Gain

Capital Gains - Deemed Cost of Acquisition

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Section 55(2) – Cost of Acquisition of Capital Asset for Computing Capital Gain

Cost of acquisition is the price which the assessec has paid, or the amount which the assessee has incurred, for acquisition of the asset. Expenses incurred for completing the title are a part of the cost of acquisition.

Interest on money borrowed for acquiring capital assets will form part of Cost of Asset:

(1)        Interest on loan taken for acquiring a capital asset (other than house property) will become part of the cost of acquisition. In the case of house property, any interest (whether current or accumulated) is allowed as deduction under section 24(b) and thus will not form part of cost of acquisition.

(2)        Interest paid by the firm to its partner on capital contribution for the purchase of capital asset cannot be treated as part of cost of acquisition.

(3)        Interest on the asset acquired by the assessee carrying on business or profession till such asset is put to use, shall form part of the cost of acquisition but any interest paid for the period after the asset is put to use shall be treated as revenue expense and hence will not form part of cost of acquisition.

Sum paid for Discharge of Mortgage:

Where the property has been mortgaged by the previous owner during his lifetime and the assessec, after inheriting the same, has discharged the mortgage debt, the amount paid by him for the purpose of clearing off the mortgage shall be regarded as cost of acquisition under section 48 read with section 55(2) of the Act. The position is, however, different where the mortgage is created by the owner after he has acquired the property. The clearing off of the mortgage debt by him prior to transfer of the property would not entitle him to claim deduction under section 48 of the Act because in such a case he did not acquire any interest in the property subsequent to his acquiring the same.

Cost of acquisition includes deemed cost of acquisition.

Cost of Acquisition includes Deemed Cost of Acquisition Capital Asset is the Price which the assessee has paid, or the amount which the assessee has incurred, for acquisition of the Assets.

 (1) [Section 49(1)]: Cost to the Previous Owner

Where the capital asset became the property of the assessee in any of the manner mentioned below, the cost of acquisition of the asset shall be deemed to be cost for which the previous owner of the property acquired it:

(a)        on the distribution of the assets on total/partial partition of Hindu Undivided Family;

(b)        under a gift or will;

(c)        by succession, inheritance or devolution;

(d)        on any distribution of assets on the liquidation of a company;

(e)        on a transfer to a revocable or irrevocable trust;

(f)         on a transfer by a wholly owned Indian subsidiary company to its holding company or vice versa;

(g)        on any transfer in a scheme of amalgamation of two Indian companies subject to certain conditions u/s 47(vi);

(h)        on any transfer, in a demerger, of a capital asset by the demerged company to the resulting company as per section 47(vib);

(i)         on transfer of a capital asset or intangible asset by a firm to a company as a result of succession, as per section 47(xiii) subject to certain conditions;

(j)         on any transfer by a private company or unlisted public company to a limited liability partnership firm as a result of conversion of the company into limited liability partnership in accordance with the provisions of section 56 or section 57 of the Limited Liability Partnership Act, 2008;

(k)        on transfer of capital asset or intangible asset by a sole proprietary concern to a company as on result of succession as per section 47(xiv) subject to certain conditions;

(l)         on conversion of self-acquired property of a member of a Hindu Undivided Family to the joint family property.

Note.—There are few other cases also, where the cost of the asset is taken as cost of the previous owner. These have not been discussed as they are not relevant for CA Intermediate.

(2) [Section 49(2)]: Cost of Shares of Amalgamated Company

Section 49(2) of the Companies Act plays a crucial role in determining the cost of shares in an amalgamated company. When two or more companies merge or amalgamate, it is important to accurately calculate the value of the shares in the newly formed entity. This section provides guidelines on how to determine the cost of shares in such cases.

According to Section 49(2), the cost of shares in an amalgamated company is determined based on the proportionate value of the assets and liabilities transferred from each amalgamating company. This means that the value of the shares will be directly linked to the value of the assets and liabilities acquired from each company involved in the amalgamation.

It is important to note that the value of the shares should be determined as per the fair value of the assets and liabilities. This ensures that the shareholders of each amalgamating company receive their fair share in the newly formed entity. The fair value of the assets and liabilities is determined by considering various factors such as market conditions, industry trends, and expert opinions.

In order to calculate the cost of shares, the following steps can be followed:

  • Determine the fair value of the assets and liabilities transferred from each amalgamating company.
  • Calculate the total value of assets and liabilities transferred from all amalgamating companies.
  • Allocate the proportionate value of assets and liabilities to each amalgamating company based on their contribution.
  • Divide the total value of shares in the amalgamated company by the total proportionate value of assets and liabilities to determine the cost per share.
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By following these steps, the cost of shares in the amalgamated company can be accurately determined. This ensures transparency and fairness in the valuation process, allowing shareholders to have a clear understanding of their ownership in the new entity.

For example : 

X purchases 100 shares of R Company Ltd. for Rs. 10 each on 5.11.2019. In 2020-21, R Company Ltd. amalgamates into S Company Ltd. and under the scheme of amalgamation, X receives 10 shares of S Company Ltd. in lieu of the 100 shares of R Company Ltd. The cost of acquisition of 10 shares of S Company Ltd. will be Rs. 1,000, i.e., the cost of acquisition of the shares of R Company Ltd. in lieu of which he has received the shares of S Company Ltd.

(3) [Section 49(2A)]: Cost of Acquisition in the case of Shares/Debentures acquired on Conversion of Bonds or Debentures or Debentures Stock or Deposit Certificates

When it comes to investing in shares and debentures, it is important to understand the concept of the cost of acquisition. Under Section 49(2A) of the Indian Income Tax Act, the cost of acquisition for shares and debentures acquired on conversion of bonds or debentures or debenture stock or deposit certificates is determined in a specific manner.

The cost of acquisition in such cases is calculated as the fair market value of the shares or debentures on the date of conversion. This fair market value is determined based on the prevailing market conditions and the value of the underlying assets of the company.

It is important to note that the cost of acquisition for shares or debentures acquired on conversion is considered to be the same as the cost of acquisition of the original bonds or debentures or debenture stock or deposit certificates. This means that any capital gains or losses arising from the subsequent sale of these shares or debentures will be calculated based on the original cost of acquisition.

The cost of acquisition for shares or debentures acquired on conversion plays a crucial role in determining the taxable capital gains or losses when these securities are sold. It is important for investors to keep track of the original cost of acquisition and any subsequent changes in the market value of these securities.

For example :

X has subscribed to 10 partly convertible debentures of Rs. 100 each of R Co. Ltd. on 4.4.2020. On 5-2-2022, he receives 4 shares of Rs. 10 each per debenture and the remaining value of the debenture is Rs. 50, i.e., the 4 shares have been received by him in lieu of a part of the cost of the debenture which is Rs. 50. Therefore, the cost of 4 shares shall be
Rs. 50.

In case of a capital asset, being a share or debenture of a company, which becomes the property of the assessee in the circumstances mentioned in section 47(x) of the Act, there shall be included the period for which the bond, debenture, debenture-stock or deposit certificate, as the case may be, was held by the assessee prior to the conversion [Rule
8AA(2)].

Example:

In the above case if these 4 shares are sold on 6-8-2022, its period of holding shall be taken from 4-4-2020 to 5-8-2022.

Similarly, cost of acquisition of shares received upon exchange of Foreign Currency Exchangeable Bond shall be the price at which corresponding bond was acquired.

(4) [Section 49(2AA)]: Cost of Specified Security or Sweat Equity Share already treated as Perquisites under section 17(2)(vi)

In the Indian Income Tax Act of 1961, Section 17(2)(vi) deals with the treatment of certain benefits or amenities provided by employers to their employees. It includes the provision of specified securities or sweat equity shares, which are considered as perquisites and are subject to taxation. However, there is another section, namely Section 49(2AA), that specifically addresses the cost of these specified securities or sweat equity shares.

Under Section 49(2AA) of the Indian Income Tax Act, the cost of specified securities or sweat equity shares that are already treated as perquisites under Section 17(2)(vi) is determined in a specific manner. The cost is deemed to be the fair market value of such securities or shares on the date of their exercise or transfer, as reduced by the amount actually paid by the employee.

This provision ensures that the tax liability of the employee is calculated based on the actual benefit received from the specified securities or sweat equity shares. It prevents any potential manipulation of the cost by the employer or employee to reduce the tax liability.

It is important for both employers and employees to understand the implications of Section 49(2AA) to ensure compliance with the Indian Income Tax Act. Employers should accurately determine the fair market value of the specified securities or sweat equity shares when calculating the cost for taxation purposes. Employees should be aware of the amount they have actually paid for these securities or shares to accurately determine their tax liability.

(5) [Section 49(2AAA)]: Cost of the right of partner on conversion of company to Limited Liability Partnership

In recent years, there has been a growing trend among companies in India to convert their structure to a Limited Liability Partnership (LLP). This conversion offers several benefits, including limited liability for partners and greater flexibility in management. However, it is crucial for partners to understand the tax implications of such a conversion.

Under the Indian Income Tax Act of 1961, Section 49(2AAA) specifically deals with the cost of the right of a partner on the conversion of a company to an LLP. This section states that the cost of the right of a partner in the company, as on the date of conversion, shall be deemed to be the cost of acquisition of the right of a partner in the LLP.

What does this mean for partners? It implies that the cost of acquisition of the right of a partner in the company will now be considered as the cost of acquisition of the right of a partner in the LLP. This can have significant tax implications, especially in terms of capital gains.

Partners should carefully evaluate the cost of acquisition of their rights in the company before conversion, as it will directly impact their tax liability. It is advisable to consult with a tax professional to determine the exact tax implications and plan accordingly.

(6) [Section 49(2AD)] : Cost of Acquisition of the Units of the Consolidated Scheme acquired in lieu of Units held in a Consolidating Scheme

Section 49(2AD) of the Indian Income Tax Act 1961 deals with the cost of acquisition of units of the consolidated scheme acquired in lieu of units held in a consolidating scheme. This provision is important for taxpayers who have invested in mutual funds or other investment schemes.

When an investor holds units in a consolidating scheme and those units are replaced by units in a consolidated scheme, the cost of acquisition of the new units is determined based on certain conditions mentioned in Section 49(2AD).

According to this section, the cost of acquisition of the new units will be the cost of acquisition of the original units, adjusted for the cost of acquisition of the units in the consolidating scheme. This means that the investor will not have to pay any additional tax on the transfer of units from the consolidating scheme to the consolidated scheme.

See also  [Section 45(5)] : Capital Gain on Transfer by way of Compulsory Acquisition of an Asset

However, it is important to note that this provision applies only if the consolidating scheme and the consolidated scheme are both equity-oriented funds. If either of the schemes is a non-equity-oriented fund, then the provisions of Section 49(2AD) will not apply.

(7) [Section 49(2AE)] : Cost of Acquisition of Equity Share on Conversion of Preference Share into Equity Share:

In the Indian Income Tax Act of 1961, Section 49(2AE) deals with the cost of acquisition of equity shares when a preference share is converted into an equity share. This section is of great importance for individuals and businesses who have undergone such conversions and need to understand the tax implications.

When a preference share is converted into an equity share, it is considered a transfer under the Income Tax Act. As a result, the cost of acquisition of the equity share needs to be determined in accordance with the provisions of Section 49(2AE).

The cost of acquisition of the equity share is calculated as follows:

  • The fair market value of the preference share on the date of conversion is considered as the cost of acquisition of the equity share.
  • If the preference share was acquired on or before 31st January 2018, the fair market value of the equity share on the date of conversion is reduced by the amount of deemed dividend under Section 2(22)(e) of the Income Tax Act.
  • If the preference share was acquired after 31st January 2018, the fair market value of the equity share on the date of conversion is not reduced by the amount of deemed dividend.

It is important to note that the cost of acquisition of the equity share on conversion of preference share into equity share cannot be less than the fair market value of the preference share on the date of conversion.

Understanding Section 49(2AE) is crucial for individuals and businesses as it helps in determining the tax liability arising from the conversion of preference shares into equity shares. By following the provisions of this section, taxpayers can ensure compliance with the Income Tax Act and avoid any penalties or legal issues.

(8) [Section 49(2AF)]:  Cost of Acquisition of the Units in the Consolidated Plan of Mutual Fund Scheme

In the realm of taxation, it is crucial to stay updated with the latest amendments and provisions to ensure compliance and optimize your financial planning. One such provision is Section 49(2AF) of the Indian Income Tax Act, 1961, which pertains to the cost of acquisition of units in the consolidated plan of a mutual fund scheme.

Under this section, the cost of acquisition of units in a consolidated plan is determined by allocating the cost of acquisition of the original units in the scheme proportionately based on the net asset value (NAV) at the time of consolidation. This ensures that the capital gains tax liability is calculated accurately when you sell or redeem your units.

It is important to note that the cost of acquisition for units in a consolidated plan is calculated separately for each original unit. The proportionate cost of acquisition is calculated by dividing the original unit’s cost of acquisition by the original unit’s NAV at the time of consolidation.

Let’s understand this with an example. Suppose you have invested in a mutual fund scheme that undergoes consolidation. You initially purchased 100 units of the scheme at a cost of INR 1,000 per unit. At the time of consolidation, the NAV of the scheme is INR 2,000. Post-consolidation, the consolidated plan issues 50 units. To calculate the cost of acquisition for each consolidated unit, you divide the cost of acquisition of the original unit by the original unit’s NAV. In this case, the cost of acquisition for each consolidated unit would be INR 500 (INR 1,000/2).

It is essential to keep a record of the cost of acquisition of units in the consolidated plan as it determines the capital gains tax liability when you sell or redeem your units. The capital gains are calculated based on the selling price of the units minus the cost of acquisition. Therefore, accurate calculation of the cost of acquisition is crucial to determine the taxable gains or losses.

To summarize, Section 49(2AF) of the Indian Income Tax Act, 1961 provides the method for determining the cost of acquisition of units in the consolidated plan of a mutual fund scheme. By allocating the cost of acquisition proportionately based on the NAV at the time of consolidation, this provision ensures accurate calculation of capital gains tax liability. Staying informed about such provisions not only helps in compliance but also enables effective tax planning.

(9) [Section 49(2A)]: Cost of Acquisition of a Unit or Units in the Segregated Portfolio

The cost of acquisition of a unit or units in the segregated portfolio shall be the amount which bears, to the cost of acquisition of a unit or units held by the assessee in the total portfolio, the same proportion as the net asset value of the asset transferred to the segregated portfolio bears to the net asset value of the total portfolio immediately before the segregation of portfolios. In other words, it shall be as under:

Cost of acquisition of a unit or units held by the assessee in the total portfolio x

Net asset value of the asset transferred to the segregated portfolio
Net asset value of the total portfolio immediately before the segregation of portfolios i.e

(10) [Section 49(2AH)]: Cost of Acquisition of the Original Units held by the Unit Holder in the main Portfolio

As an investor, it is important to understand the various provisions of the Indian Income Tax Act, 1961. One such provision is Section 49(2AH), which deals with the cost of acquisition of the original units held by the unit holder in the main portfolio.

According to this section, the cost of acquisition of the original units is determined based on the proportionate cost of acquisition of the units in the main portfolio. This means that if you hold units in the main portfolio and acquire additional units, the cost of the original units will be determined based on the average cost of all the units held in the portfolio.

For example, let’s say you purchased 100 units of a mutual fund at a cost of Rs. 10 per unit. Later, you acquired an additional 50 units at a cost of Rs. 15 per unit. In this case, the cost of the original 100 units will be calculated as (100 * Rs. 10 + 50 * Rs. 15) / (100 + 50), which is Rs. 11.67 per unit.

This provision is important for calculating the capital gains tax liability when you sell the units. The cost of acquisition plays a crucial role in determining the capital gains.

It is advisable to maintain proper records of all your transactions and keep track of the cost of acquisition of your units. This will help you accurately calculate your tax liability and avoid any penalties for incorrect reporting.

(11) [Section 49(2C)]: Cost of Acquisition of the Shares in the resulting company

It shall be the amount which bears to the cost of acquisition of shares held by the assessee in the demerged company the same proportion as the net book value of the assets transferred in a demerger bears to the net worth of the demerged company immediately before such demerger.

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In other words:

“Net worth” for this section shall mean the aggregate of the paid tip share capital and general reserves as appearing in the books of accounts of the demerged company immediately before demerger.

if the shares of the resulting company are later on transferred, then for computation of nature of capital gain, the period for which the shares were held in demerged company shall also be considered [Section 2(42A)].

(12) [Section 4 9(2D)]:  Cost of Acquisition of the Original Share of the Demerged Company

When it comes to understanding the cost of acquisition of the original share of the demerged company under Section 49(2D) of the Indian Income Tax Act, it is important to delve into the details of this provision. This particular section deals with the computation of the cost of acquisition of shares received by the shareholders as a result of a demerger.

In simple terms, a demerger refers to the transfer of one or more undertakings to another company. It is a corporate restructuring strategy where a company splits itself into two or more entities. The shareholders of the demerged company receive shares in the resulting companies in proportion to their shareholding in the demerged company.

Under Section 49(2D), the cost of acquisition of the original shares of the demerged company is considered to be the cost of acquisition of the shares of the resulting company. This means that the cost of acquisition for the shares received as a result of the demerger is the same as the cost of acquisition of the original shares in the demerged company.

For example, let’s say you own 100 shares of Company A, which undergoes a demerger and splits into Company B and Company C. After the demerger, you receive 50 shares of Company B and 50 shares of Company C. The cost of acquisition for these 50 shares in Company B and Company C will be the same as the cost of acquisition for the original 100 shares in Company A.

This provision ensures that the tax implications for the shareholders remain the same even after the demerger. It prevents any potential tax liability that may arise due to a different cost of acquisition for the shares received in the resulting companies.

(13) [Section 49(4)]: Cost of Acquisition of Property received without Consideration or for Inadequate Consideration

Where the capital gain arises from the transfer of a property, the value of which has been subject to income-tax under section 56(2)(vii) [now 56(2)(x)], the cost of acquisition of such property shall be deemed to be value which has been taken into account for section 56(2)(vii) [now 56(2)(x)1.

Similarly, cost of acquisition of shares acquired by a firm or a closely held company without consideration or for inadequate consideration will be the value which has been taken into account and has been subjected to tax under section 56(2)(viia) [now 56(2)(x)].

Example:

(1)        R receives an immovable property without consideration from an unrelated person. The stamp duty value of the immovable property is Rs. 60 lakhs. in this case Rs. 60 lakh will be taxable in the hands of R under the head “income from other sources” and the cost of acquisition in the hands of R shall be Rs. 60,00,000.

(2)        A firm purchases shares of a closely held company for Rs. 1,40,000 whose fair market value is Rs. 2,90,000. in this case difference between the FMV and the purchase price, i.e., Rs.1,50,000 shall be treated as income of the firm under the head “income from other sources” as per section 56(2)(viia) [now 56(2)(x)].

However, the cost of acquisition of such shares in the hands of the firm shall be Rs. 2,90,000 as per section 49(4) instead of Rs. 1,40,000 as the firm has already paid tax on Rs. 1,50,000.

(14) Cost of Acquisition of an Asset Declared under the Income Declaration Scheme, 2016 [Section 49(5)] :

The Income Declaration Scheme, 2016 introduced by the Indian Income Tax Act, 1961 provides taxpayers with an opportunity to declare their undisclosed income and assets. Under Section 49(5) of the Act, taxpayers are required to determine the cost of acquisition of the asset that is being declared. This cost of acquisition plays a crucial role in assessing the tax liability and determining the capital gains.

The cost of acquisition refers to the amount that was initially paid to acquire the asset. It includes the purchase price, any incidental expenses incurred during the acquisition, such as brokerage fees or legal charges, and any improvements made to the asset. However, it does not include any expenses that are not directly related to the acquisition, such as repairs or maintenance costs.

In order to determine the cost of acquisition, taxpayers need to gather all the relevant documents and receipts related to the purchase of the asset. These documents will serve as evidence of the amount paid and the expenses incurred. It is important to maintain proper records and documentation to substantiate the cost of acquisition, as any discrepancies or lack of evidence can lead to complications during the assessment process.

Once the cost of acquisition has been determined, taxpayers can proceed with declaring the asset and paying the applicable tax under the Income Declaration Scheme. It is advisable to seek professional assistance or consult a tax expert to ensure accurate calculation and compliance with the provisions of the Act.

(15) [Section 49(7)]: Cost of Acquisition of the Share in the Project being Land and Building in a Joint Development Agreement referred in Section 45(5A)

Where the capital gain arises from the transfer of a capital asset, being share in the project, in the form of land or building or both, referred to in section 45(5A), not being the capital asset referred to in the proviso to the said sub-section, the cost of acquisition of such asset, shall be the amount which is deemed as full value of consideration in that sub-section.

What is a Joint Development Agreement?

A Joint Development Agreement (JDA) is a legal contract between a landowner and a real estate developer for the development of a property. In this agreement, the landowner provides the land, while the developer takes responsibility for the construction and marketing of the project.

Cost of Acquisition in a Joint Development Agreement

As per Section 49(7) of the Indian Income Tax Act, the cost of acquisition of a share in the project being land and building in a JDA is determined by considering the following:

  • The fair market value of the land and building on the date of the agreement
  • The consideration received by the landowner
  • Any other amount paid or payable by the developer to the landowner

The cost of acquisition is important for determining capital gains tax liability at the time of the transfer of the property.

Calculation of Cost of Acquisition

The cost of acquisition is calculated as follows:

  • Step 1: Determine the fair market value of the land and building on the date of the agreement
  • Step 2: Add the consideration received by the landowner
  • Step 3: Add any other amount paid or payable by the developer to the landowner

The resulting amount is the cost of acquisition of the share in the project.

Importance of Cost of Acquisition

The cost of acquisition plays a crucial role in determining the capital gains tax liability of the landowner. When the property is sold, the capital gains are calculated by deducting the cost of acquisition from the sale proceeds. Therefore, an accurate determination of the cost of acquisition is essential to avoid any tax disputes in the future.

Conclusion

Understanding the cost of acquisition in a Joint Development Agreement is important for both landowners and developers. It helps in determining the tax liability and ensures a smooth transfer of the property. It is advisable to consult a tax professional or a chartered accountant for accurate calculations and compliance with the Income Tax Act.

(16)  [Section 49(9)] : Cost of Acquisition of the Capital Asset where the Inventor has been converted into or treated as Capital Asset

In the Indian Income Tax Act of 1961, Section 49(9) deals with the cost of acquisition of the capital asset where the inventor has been converted into or treated as a capital asset. This section holds significance for individuals or businesses who have patented inventions and are looking to understand the tax implications.

When an inventor converts their invention into a capital asset, such as selling the patent rights or transferring ownership, it becomes necessary to determine the cost of acquisition for tax purposes.

The cost of acquisition is the amount that was initially invested in the invention, including any expenses incurred for research and development, patent filing, legal fees, and other related costs. This cost serves as the base value for calculating capital gains or losses when the inventor eventually sells or transfers the capital asset.

It is important to note that if the inventor has claimed any tax benefits or deductions related to the invention, those amounts need to be reduced from the cost of acquisition. This ensures that only the actual investment made by the inventor is considered for tax purposes.

Section 49(9) provides clarity on how the cost of acquisition should be calculated in cases where the inventor has converted their invention into a capital asset. It helps prevent any ambiguity and ensures that the tax liability is determined accurately.

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