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

Section 55(2) of the Income Tax Act, 1961, provides crucial rules for determining the cost of acquisition of capital assets when computing capital gains. This provision is essential for calculating taxable gains accurately, especially in scenarios involving gifts, inheritance, or specific types of assets like goodwill, shares, or depreciable property. Below is a detailed breakdown of the key aspects of Section 55(2):

1. General Definition of Cost of Acquisition

The cost of acquisition refers to the amount paid to acquire the asset, including expenses like stamp duty, registration fees, and other capital expenditures incurred to complete the title 513. For assets acquired before April 1, 2001, taxpayers can choose between:

• The actual costpaid, or
• The fair market value (FMV)as of April 1, 2001.

2. Special Cases Under Section 55(2)

(a) Assets Acquired via Gift, Will, or Inheritance [Section 55(2)(ac)]

• The cost of acquisition is deemed to be the cost to the previous owner(adjusted for inflation).
• Exceptions:
  • If the asset was self-generated (e.g., goodwill), the cost is nil.
  • For inherited assets, the holding period includes the previous owner’s tenure .

(b) Goodwill, Trademarks, and Business Rights [Section 55(2)(a)]

• Purchased: Cost = purchase price.
• Self-generated or inherited: Cost = nilunless the previous owner paid for it.

(c) Bonus Shares or Financial Assets [Section 55(2)(aa)]

• Allotted after April 1, 2001: Cost = nil.
• Allotted before April 1, 2001: FMV as of April 1, 2001, can be used.

(d) Equity Shares (Section 55(2)(ac) – “Grandfathering Clause”)

For shares acquired before February 1, 2018, the cost is the higher of:

1. Actual cost, or
2. The lower of:

• • FMV as of January 31, 2018, or
  • Sale consideration.
  • Unlisted shares later listed: FMV is computed using the Cost Inflation Index (CII).

(e) Depreciable Assets [Section 50]

• Cost = written down value (WDV)of the asset block at the year’s start + any additions during the year.
• Gains from such transfers are always treated as short-term capital gains.

3. Key Adjustments and Exceptions

• Indexation Benefit: Adjusts the cost for inflation using CII for long-term assets.
• Mortgage Discharge: If a inheritor clears a mortgage on inherited property, the payment is added to the cost.
• Conversion of Inventory to Capital Asset: Cost = FMV at the conversion date

(A)  Cost of Acquisition of Assets acquired before 1.4.2001 [Section 55(2)(b)]

Section 55(2)(b) of the Income Tax Act, 1961, provides special rules for determining the cost of acquisition of capital assets purchased before April 1, 2001. This provision is crucial for calculating capital gains tax, especially for long-held assets like property, where inflation significantly impacts the original purchase price.

Key Provisions Under Section 55(2)(b)

1.  Option to Choose Between Actual Cost or FMV (April 1, 2001)

• Taxpayers can select the higherof:
  • Actual costpaid for the asset, or
  • Fair Market Value (FMV)as of April 1, 2001.

• Example:
  • If a property was bought in 1990 for ₹5 lakhand its FMV on April 1, 2001, was ₹12 lakh, the taxpayer can use ₹12 lakh as the cost basis (if higher than the original cost).

2.  FMV Cannot Exceed Stamp Duty Value

• If the FMV exceeds the stamp duty value(government-assessed value), the lower of the two must be taken.
• Example:
  • FMV (2001) = ₹12 lakh
  • Stamp duty value (2001) = ₹10 lakh
  • Adopted cost= ₹10 lakh (since it is lower than FMV).

3.  Indexation Benefit (If Applicable)

• For long-term capital gains (LTCG), the chosen cost (actual or FMV) can be adjusted for inflation using the Cost Inflation Index (CII)from 2001-02 onwards.
• Formula:
• Example:
  • FMV (2001) = ₹10 lakh
  • CII (2024-25) = 348
  • Indexed Cost= ₹10 lakh × (348/100) = ₹34.8 lakh.

4.  Applicability to Inherited/Gifted Assets

• If the asset was acquired via inheritance, gift, or will, the previous owner’s cost(or FMV as of 2001) applies.

5.  No Indexation Under New Tax Regime (Post-July 2024 Changes)

• The Finance Act 2024introduced a 5% flat tax rate on LTCG (for immovable property) without indexation.
• However, taxpayers can still use FMV (2001)as the base cost (but cannot adjust it further for inflation).

Practical Implications & Tax Planning

• Choosing Between Actual Cost vs. FMV (2001):
  • If the FMV (2001) > Original Cost, opting for FMV reduces taxable gains.
  • If the asset was self-constructed before 2001, professional valuation may be needed to determine FMV.
• Impact of New vs. Old Tax Regime:
  • Under the old regime (20% with indexation), indexed cost reduces tax liability.
  • Under the new regime (12.5% without indexation), the tax may be lower for some transactions.

(B)   Cost of Acquisition for Goodwill, Trademarks, Business Rights, etc. [Section 55(2)(a)]

Section 55(2)(a) of the Income Tax Act, 1961, specifies the cost of acquisition for self-generated intangible assets like goodwill, trademarks, business rights, tenancy rights, permits, etc., when computing capital gains.

Key Rules Under Section 55(2)(a)

1.  Self-Generated vs. Purchased Assets

TYPE OF ASSET	COST OF ACQUISITION	TAX IMPLICATION
Self-generated (e.g., goodwill built over time, brand value, tenancy rights obtained without payment)	Nil	Entire sale consideration is taxable as capital gains.
Purchased (e.g., goodwill acquired when buying a business, trademark purchased from another entity)	Actual purchase price	Only the difference between sale price and purchase cost is taxable.

2.  Applicable Assets

This section covers:

• Goodwillof a business/profession
• Trademarks/brand namesassociated with a business
• Right to manufacture/produce/processgoods
• Right to carry on any business/profession
• Tenancy rights(e.g., leasehold rights)
• State carriage permits, loom hours, etc.

Practical Examples

Case 1: Self-Generated Goodwill (Cost = Nil)

• You run a law firmfor 20 years and sell it for ₹2 crore, including goodwill.
• Since goodwill was self-created, its cost = Nil.
• Taxable Capital Gain= ₹2 crore (full sale value).

Case 2: Purchased Goodwill (Cost = Actual Payment)

• You buy a restaurant businessfor ₹50 lakh, including ₹20 lakh for goodwill.
• Later, you sell the business for ₹1 crore.
• Taxable Gain= ₹1 crore – ₹50 lakh = ₹50 lakh.

Case 3: Tenancy Rights (Self-Acquired vs. Purchased)

• Self-acquired(no payment): Cost = Nil → Full sale value taxable.
• Purchased(e.g., premium paid for lease rights): Cost = Actual payment → Only profit taxed.

Exceptions & Special Cases

1.  Goodwill on Incorporation of a Firm into a Company [Section 47(xiii)]

• If a partnership firm converts into a company, the cost of goodwillis taken as per the books of the firm (not Nil).
• Example: If the firm’s books show goodwill at ₹10 lakh, this becomes the cost for the company.

2.  Indexation Benefit (For Purchased Intangibles)

• If the asset was purchased, indexation applies for long-term capital gains (LTCG).
• Formula:

3.  Amortization vs. Capital Gains (For Depreciable Intangibles)

• Depreciable assets(e.g., purchased patents) follow Section 50 (taxed as short-term gains).
• Non-depreciable assets(e.g., goodwill) follow Section 55(2)(a).

Tax Planning Considerations

✔ For self-generated assets, since cost is Nil, tax liability is higher – plan for deductions under other sections.

✔ For purchased intangibles, maintain proper purchase records to claim cost and indexation.

✔ If converting a business into a company, ensure proper valuation to avoid disputes.

(C)  Cost of Acquisition of Right Shares [Section 55(2)(aa)]

Section 55(2)(aa) of the Income Tax Act, 1961, governs the cost of acquisition for right shares (additional shares offered to existing shareholders) and the tax treatment of renounced rights. Below is a detailed breakdown of the rules and their implications:

1. Cost of Original Shares

• Remains unchanged: The cost of the original shares(based on which rights are offered) continues to be the actual purchase price paid by the shareholder.
  • Example: If you bought 100 shares at ₹10/share in 2010, their cost basis remains ₹10/share even after receiving rights.

2. Cost of Right Shares (If Subscribed)

• Actual payment: The cost of right shares subscribed by the shareholder is the amount paid to the companyfor acquiring them.
  • Example: If you subscribe to 50 right shares at ₹20/share, your cost basis for these shares = ₹20/share.

3. Tax Treatment of Renounced Rights

• For the renouncer (original shareholder):
  • The amount receivedfor renouncing the rights is treated as capital gains (short-term or long-term based on holding period of original shares).
  • Cost of acquisition of the right = Nil.
  • Example: If you renounce rights to 50 shares for ₹5,000, the entire ₹5,000 is taxable as capital gains.
• For the renouncee (new buyer):
  • The cost includes:
    1. Payment to the companyfor subscribing to shares.
    2. Payment to the renouncerfor acquiring the rights.
  • Example: If the renouncee pays ₹20/share to the company + ₹10/share to the renouncer, the total cost = ₹30/share.

4. Holding Period Calculation

• Right shares: The holding period is calculated from the date of allotment(not the date of original shares).
• Renounced rights: Gains are classified based on the holding period of the original shares(if held >12 months, long-term; else short-term).

5. Key Exceptions & Special Cases

• Bonus vs. Rights Shares: Unlike bonus shares (cost = Nil), right shares have a cost basis.
• Indexation Benefit: For long-term right shares, indexation applies from the allotment date.

Practical Example

SCENARIO	COST CALCULATION	TAXABLE GAIN
Subscribed Rights (50 shares @ ₹20)	₹20/share	Gains = Sale price – ₹20
Renounced Rights (Received ₹5,000)	Nil	Entire ₹5,000 taxable
Renouncee’s Cost (Paid ₹10/share to renouncer + ₹20 to company)	₹30/share	Gains = Sale price – ₹30

(D)  Cost of Acquisition of Bonus Shares or Financial Assets Allotted Without Payment [Section 55(2)(ac)(iiia)]

Section 55(2)(ac)(iiia) of the Income Tax Act, 1961, governs the cost basis for bonus shares (or other financial assets) issued without any payment by the company. This provision ensures proper tax treatment when such shares are later sold.

Key Rules Under Section 55(2)(ac)(iiia)

1.   General Rule for Bonus Shares (Allotted After 1st April 2001)

• Cost of acquisition = Nil(since no payment is made).
• Tax Implication: The entire sale proceedsare taxable as capital gains.

Example:

• You hold 100 shares of XYZ Ltd.
• Company issues 1:1 bonus shares(100 additional shares).
• When you sell the bonus shares, your cost = ₹0.
• If sold for ₹200/share, taxable gain = ₹20,000 (100 × ₹200).

2.  Bonus Shares Issued Before 1st April 2001

• Taxpayer can choose between:
  • Actual cost = Nil, or
  • Fair Market Value (FMV) as of 1st April 2001(if higher).
• Indexation benefitapplies if FMV is chosen.

Example:

• You received 100 bonus shares in 1998.
• FMV on 1st April 2001 = ₹50/share.
• You can take ₹5,000 (100 × ₹50)as cost (indexed for inflation).

3.  Holding Period for Capital Gains Classification

• Bonus sharesare considered held from the date of allotment of original shares.
• If original shares were held for >12 months, bonus shares qualify for long-term capital gains (LTCG).

Example:

• Original shares bought on 1st Jan 2020.
• Bonus shares allotted on 1st Jan 2023.
• If sold on 1st Jan 2024, holding period = 4 years (LTCG applies).

4.  Special Cases

(a) Bonus Shares on Pre-2001 Shares

• If original shares were acquired before 1st April 2001, the taxpayer can choose:
  • FMV as of 1st April 2001(for bonus shares).
  • Indexation benefitfrom 2001-02 onwards.

(b) Bonus Shares in Demergers/Amalgamations

• If bonus shares arise due to corporate restructuring, the cost is determined under Section 49(2)(based on original cost).

Tax Implications & Planning

SCENARIO	COST OF ACQUISITION	TAX TREATMENT
Bonus shares (post-2001)	Nil	Full sale value taxable
Bonus shares (pre-2001)	FMV (1st April 2001)	Indexation benefit available
Bonus on inherited shares	Same as original owner’s cost	LTCG if original holding >12 months

TIPS :

✔ Bonus shares allotted after 1st April 2001 → Cost = Nil → Entire sale proceeds taxable.

✔ Pre-2001 bonus shares → Can use FMV (2001) + indexation benefit.

✔ Holding period includes the original shares’ tenure.

(E)  Cost of Acquisition for Computing Long-Term Capital Gains (LTCG) under Section 112A [Section 55(2) (ac)]

Section 55(2)(ac) of the Income Tax Act, 1961, provides the cost basis for calculating long-term capital gains (LTCG) on listed equity shares, equity-oriented mutual funds, and business trusts sold after 1st April 2018, as per Section 112A.

Key Rules Under Section 55(2)(ac) for Section 112A

1.   Grandfathering Benefit (For Shares Acquired Before 31st Jan 2018)

• If shares were purchased before 1st Feb 2018, the cost of acquisitionis the higher of:
  • Actual purchase price, or
  • Lower of:
    • Fair Market Value (FMV) as of 31st Jan 2018, or
    • Sale consideration.
  • Indexation benefit is NOT allowed(since Section 112A imposes a flat 10% tax).

Example:

• Bought 100 shares in 2015 at ₹500/share.
• FMV on 31st Jan 2018 = ₹800/share.
• Sold in 2024 at ₹1,200/share.
• Cost for LTCG = Higher of:
  • Actual cost (₹500) orLower of (₹800 FMV or ₹1,200 sale price) → ₹800.
• Taxable LTCG = (1,200 – 800) × 100 = ₹40,000.

2.  Shares Acquired On or After 1st Feb 2018

• Cost = Actual purchase price(no grandfathering benefit).
• LTCG tax = 10% (above ₹1 lakh exemption per financial year).

Example:

• Bought shares in 2020 at ₹1,000.
• Sold in 2024 at ₹1,500.
• Taxable LTCG = ₹500/share (10% tax if gains exceed ₹1 lakh in a year).

3.  Bonus Shares, Rights Issues, and Mergers

TYPE OF SHARE	COST OF ACQUISITION	TAX TREATMENT
Bonus shares (issued after 1st April 2001)	Nil	Full sale value taxable
Rights shares (subscribed)	Actual payment	Normal LTCG rules apply
Shares from demerger/amalgamation	As per Section 49	Original cost applies

Exceptions & Special Cases

• Non-equity funds (debt/hybrid mutual funds)→ Section 112A does not apply (use normal LTCG rules).
• Shares sold before 12 months→ Short-term capital gains (STCG) at 15%.
• Business Trusts (REITs/InvITs)→ Same rules as equity shares.

Tax Calculation Example (Grandfathering Benefit)

PARTICULARS	AMOUNT (₹)
Purchase price (2015)	50,000
FMV (31st Jan 2018)	80,000
Sale price (2024)	1,20,000
Cost (higher of actual or FMV)	80,000
Taxable LTCG	40,000
Tax @10% (after ₹1 lakh exemption)	4,000

Tips :

✔ Pre-2018 shares: Get grandfathering benefit (higher of cost or FMV as of 31st Jan 2018).

✔ Post-2018 shares: Actual cost applies.

✔ No indexation under Section 112A (flat 10% tax).

✔ Bonus shares cost = Nil (if issued after 2001).

(F)  Cost of Acquisition for Depreciable Assets [Section 50]

Section 50 of the Income Tax Act, 1961, provides special rules for calculating capital gains on depreciable assets (assets eligible for depreciation under the Income Tax Act). Since these assets are part of a “block of assets,” their tax treatment differs from other capital assets.

Key Rules Under Section 50

1.   Depreciable Assets are Always Treated as Short-Term (STCG)

• No long-term capital gains (LTCG): Even if held for years, gains from the sale of depreciable assets are always taxed as short-term capital gains (STCG).
• Tax rate: Normal slab rates apply (not the flat 15% or 20% for other assets).

2.  Calculation of Cost of Acquisition

The written down value (WDV) of the block of assets is used instead of individual asset cost:

• Cost = Opening WDV of the block (1st April) + Additions during the year – Assets sold.
• No separate cost allocation: Individual asset costs are irrelevant—only the block’s net WDV

Example:

• Block of Machinery (Rate: 15%):
  • Opening WDV (1st April 2023) = ₹10 lakh
  • New machine bought in 2023-24 = ₹2 lakh
  • Machine sold for ₹5 lakh (WDV = ₹3 lakh)
• Adjusted WDV= ₹10 lakh + ₹2 lakh – ₹3 lakh = ₹9 lakh
• Taxable STCG= Sale price (₹5 lakh) – WDV (₹3 lakh) = ₹2 lakh

3.  No Indexation Benefit

• Since gains are always short-term, indexation does not apply.

4.  Full Block Sale (No Assets Left in the Block)

If all assets in a block are sold:

• STCG = Sale price – (Opening WDV + Additions).
• If sale price < WDV: The difference is a short-term capital loss (STCL).

Example:

• Opening WDV = ₹10 lakh
• Additions = ₹2 lakh
• All assets sold for ₹15 lakh
• STCG = ₹15 lakh – (₹10 lakh + ₹2 lakh) = ₹3 lakh

Exceptions & Special Cases

1.  Assets Purchased but Not Used for Business

• If a depreciable asset is never used for business, it is not part of the block→ Normal capital gains rules apply (Section 45).

2.  Conversion from Business to Personal Use

• If a depreciable asset is converted to personal use, its WDV at the time of conversionbecomes the cost for future capital gains.

3.  Assets Eligible for Higher Depreciation

• Some assets (e.g., EVs, renewable energy equipment) have higher depreciation rates (40-80%)→ Faster WDV reduction → Lower capital gains on sale.

Comparison: Depreciable vs. Non-Depreciable Assets

ASPECT	DEPRECIABLE ASSETS (SECTION 50)	NON-DEPRECIABLE ASSETS (SECTION 45/48)
Tax Treatment	Always STCG (normal slab rates)	LTCG (20% with indexation) or STCG (15%)
Cost Basis	Block’s WDV (not individual cost)	Actual purchase price + indexation
Indexation	Not allowed	Allowed for LTCG
Sale of Entire Block	STCG = Sale price – (WDV + additions)	Normal capital gains calculation

Practical Example

Scenario:

• A business owns a block of computers(15% depreciation rate).
• Opening WDV (1st April 2023): ₹5 lakh
• New computers purchased (2023-24): ₹1 lakh
• Old computers sold (2023-24): Sale price = ₹3 lakh (WDV = ₹2 lakh)

Calculation:

1. Adjusted WDV= ₹5 lakh (opening) + ₹1 lakh (new) – ₹2 lakh (sold) = ₹4 lakh
2. STCG= ₹3 lakh (sale) – ₹2 lakh (WDV) = ₹1 lakh (taxed at normal slab rates).

Key Takeaways

✔ Depreciable assets → Always STCG (no LTCG benefit).
✔ Cost = Block’s WDV (not individual asset cost).
✔ No indexation (since gains are short-term).
✔ Full block sale? Compare sale price with (Opening WDV + Additions).

Tax Tip:

• Plan asset sales to minimize WDV adjustmentsand optimize tax liability.
• Maintain detailed depreciation recordsfor ITR filing.