TAXATION OF CAPITAL GAINS : A COMPARATIVE STUDY

Gagan Kumar Kwatra*

I Nature of capital gains : some important questions
ALTHOUGH THE concept of income has been developed at length by
economists, its definition by Haig as "the money value of the net
accretion to economic power between two points of time"1 may be
regarded as a very satisfactory theoretical one. India, by including
capital gains in income, has come closer to this definition. However,
countries like Singapore and Hong Kong follow the accounting concept
of income which excludes capital gains from taxation.
The effective legal definition of capital gains varies in different coun-
tries. Xa In Hong Kong and Singapore capital gains are altogether exclu-
ded from taxable income, while in Argentina, Brazil, Chile, Peru, Taiwan,
Thailand, Uruguay and Venezuela, they are generally taxed as ordinary
income. In Australia, New Zealand and South Africa, such gains are
exempt from tax unless arising in the ordinary course of business.
This different treatment of capital gains in various countries raises
the basic question whether they should at all be taxed. Some argue that
they be completely exempted from taxation on grounds of, (/) economic
expediency; Hi) illusory nature of such gains during inflation; (iii) irre-
gular, unexpected nature; and (iv) stimulating tax avoidance. At the
outset these arguments do not seem to have much force. It is true that
their exemption mitigates to some extent the evil effects of taxation of in-
come on savings and investment. But in this manner any device which
enables the tax-payer to avoid taxation would have a similar effect. Avoid-
ance of tax can, by no means, be justified.
(1) Are capital gains illusory in nature?
It is argued that there is no real increase in the taxable capacity of
the tax-payer because the gains are of an illusory nature, mainly due to
the continuous decline in the value of money, i.e., inflation. This happens
particularly in the case of immoveable property. But this argument does

*LL.M. (Delhi), LL.M. (Harvard); International Tax Program, Harvard; Senior

Executive, Federation of Indian Chambers of Commerce and Industry, New Delhi;
Hony. Secretary, International Fiscal Association—India Branch.
1. RM. Haig, "Concept of Income—Economic and Legal Aspects", The Federal
Income Tax (1921), reprinted in R.A. Musgrave and C.S, Shoup (ed.), Readings in the
Economics of Taxation (1970).
ia. The position regarding capital gains taxation in various countries is given in
the appendix.
1988J TAXATION OF CAPITAL GAINS J 39

not appear to be correct. In fact, it is felt that application in the capital

value of a capital asset may occur on account of a number of other factors
like accumulation of interest, fall in interest rates, revaluation or revision
of prospects, etc. It is not feasible to isolate the contribution of each of
these factors to capital appreciation. Even if such appreciation exactly
matches the change in the general price level, "at the practical level, it
seems very doubtful whether any correction for price changes is really
workable, as it would involve taxing those whose capital assets appreciate
more than the rise in prices, and presumably subsidising those whose capital
assets appreciate less."2 Hence, the argument may have some validity
against the choice of income as the base of taxation, but not against the in-
clusion of capital profits in the concept of income.3

(2) Should gains which are non-recurrent and casual be taxed as income ?
The argument that capital gains do not constitute income as they
are non-recurrent a^d casual is not correct. It may be noted that although
irregular, they do increase taxable capacity of the tax-payer. When pos-
session of wealth, even if it yields no income, increases such capacity and
is, therefore, taxed, capital gains which reflect increased flow of income,
would also increase their taxable capacity and should be taxed.

(3) Does taxation of capital gains stimulate tax avoidance ?

It is argued that taxation of capital gains stimulate tax avoidance.
This argument in fact overlooks the fact that their complete exemption
would, (0 afford a much stronger stimulus to tax avoidance than the re-
duction of liability arising out of differential treatment; and (//) encourage
people to acquire capital assets out of their savings, earn capital gains
rather than incomes and thus avoid the payment of tax.
The taxation of capital gains, on the contrary, is justified on various
other considerations. The failure to include them in the tax base would
mean that some tax-payers are receiving a gift at the expense of the rest
of the community. It is generally seen that gains accrue in the main to
a wealthy minority and unequal distribution of wealth is perpetuated.
Thus a minority of the community which, often by virtue of their capital,
are already enjoying high income, receive further tax-free increments.
Seltzer's4 researches into the American tax system have revealed that capital
gains are concentrated in the upper income groups and that many indi-
viduals reach higher income levels mainly on account of them. Hence,
6
'their continued exemption from tax would not merely favour the well-to-
do and discriminate against the lower income groups, but also discriminate

2. A.R. Prest, Public Finance in Theory and Practice 300 (1970).

3. Nicholas Kaldor, Indian Tax Reform : Report of a Survey (1956).
4. L.H. Seltzer, The Nature and Tax Treatment of Capital Gains 122 (1951).
140 JOURNAL OF THE INDIAN LAW INSTITUTE [Vol. 30 : 2

against the tax-payer with a given income which contained no, or only a
small, element of capital gains, compared with the tax-payer with the same
total income which contained a large capital gain element."5 While dealing
with the issue, Cutt observed :
[I]f such gains remain untaxed or are taxed at sufficiently lower
rates, effectiveness of progressive taxation as a means of reduc-
ing inequalities of income would be seriously curtailed.6
It is also said that tax on capital gains hampers the free mobility
of capital and thereby disturbs the equilibrating adjustments in a dyna-
mic economy, But it is not always that the capital shifts from one sector
to another purely due to the economic and social adjustments. The shift-
ing may be guided by speculative propensity. These speculative trans-
actions need to be curbed and capital gains taxation is one ofthe means to
achieve it.
Moreover, capital gains taxation has a stabilising effect on the eco-
nomy. With the existence of provision for carry forward of capital loss,
such inequity of discrimination against fluctuating income would be avoided
to a large extent. That is the reason why most of the countries which
tax capital gains have provision for carrying forward the capital losses.
Further, under a progressive tax system without averaging, this tax would
substantially enhance the built-in-flexibility of the income-tax system in
that it would withdraw into the exchequer much larger funds from active
circulation in a period of upswing than during the recession or depression.
This point has also been advocated by Head7 who emphasises not only the
contribution of this tax to automatic stability but also the role of such taxa-
tion in discretionary stabilisation policy in booms sustained by capital
gains in real estates and stock values.

II Legislative changes and administrative complexities

In India, tax on capital gains was imposed for the first time in 1947.
While justifying its imposition, the finance minister observed that "there
is a stronger justification for taxing these profits than is for taxing ordinary
income, since they represent what is properly described as unearned incre-
ment."8 The tax was short-lived and discontinued after two years. Capital
gains between 1 April 1946 and 31 March 1948 were liable to tax. The
non-taxable maximum limit was fixed at Rs. 15,000. In computing them
the tax-payer was given the option to adopt, instead of the actual cost of
the asset, its fair market value as on 1 April 1939. In the case of non-
company tax-payers, special rates of tax were prescribed ranging from

5. A.R. Ilersic, The Taxation of Capital Gains 17-18 (1982).

6. James Cutt, Taxation and Economic Development in India 118 (1969).
7. J.G. Head, The Case for a Capital Gains Tax : Public Finance 220-249 (1963).
8. Finance Minister's Budget Speech, Government of India (1947-48).
1988] TAXATION OF CAPITAL GAINS 141

one anna in the rupee (6.25 per cent) on capital gains upto Rs. 50,000 to
five anna (31,25 per cent) in the rupee on gains above Rs. 10 lakhs. In
the case of companies the tax was not to be charged if the amount of capital
gains did not exceed Rs. 15,000. But where the gains exceeded this amount
the whole of it was taxed. The rate of tax for companies was the ordi-
nary income-tax rate applicable to them. In order to remove the appre-
hension that "losses claimed may exceed the profits declared," 9 it was
provided that capital loss could be set-off only against capital gain and such
loss could be carried forward for six years only if it exceeded Rs, 15.000
in any year for non-corporate tax-payers.
Although imposition of tax on capital gains was justified, it was abolish-
ed in the year 1949 on account of its unpopularity, low yield of revenue
and adverse effect on the investment and movement of capital. While
explaining its abolition, the finance minister stated in his budget speech
that "its psychological effect on investment has, however, been markedly
adverse and it has had the effect of hampering the free movement of stocks
and shares without which it is hardly possible to maintain a high level of
industrial development".10
In the year 1955, Kaldor was invited to recommend tax reforms after
studying the existing system of taxation in India. While commenting on
the reasons for withdrawal of capital gains tax in 1949, he stated:
[T]hese arguments did not justify the withdrawal of the tax
so soon. The yield of the tax of Rs. 60 million for the two
years related to 1824 assessments only. It is not clear how the
Government could have had the information or experience at its
disposal to be able to conclude that the tax had important ad-
verse effects on investment, or hindered the interchange of secu-
rities. There is also a logical contradiction involved in arguing
both that the tax has only a negligible yield, and at the same
time has important adverse repercussions on the economy.11

Kaldor held that capital gains were beneficial receipts forming part
of the surplus in the hands of individuals and could be used by them for
consumption as well as investment, thus adding to their taxable capacity.
He further observed that taxation of such gains would not only ensure
horizontal equity, but also help in plugging one of the well known loop-
holes of tax avoidance. Commenting on the system of levying additional
tax on companies on their undistributed profits, he pointed out:

[T]he benefits which shareholders derive from the accumulation

of capital reserves can only be equitably taxed by taxing the

9. Ibid.
10. Finance Minister's Budget Speech, Government of Tndia, (1949-50),
11. Nicholas Kaldor, supra note 3*
142 JOURNAL OF THE INDIAN LAW INSTITUTE [Vol. 30 : 2

capital gains of individual shareholders and not by taxing

the company savings as such.12
Following Kaldor's recommendation, capital gains tax was reimpo-
sed in the year 1956. The non-taxable limit was fixed at Rs. 5,000 for
non-company tax-payers, with no liability to pay tax if the total income,
including the capital gains, did not exceed Rs. 10,000. One-third of such
gains would be added to the other income, and the income-tax rate appli-
cable to the sum so arrived at would be the rate at which the whole of these
gains would be taxed. In the case of registered firms, to attract tax, capi-
tal gains must exceed Rs. 5,000 and total income, Rs. 40,000. As regards
companies, the full amount of such gains was taxable as income. Losses
could be set-off, as before, only against capital gains, but, could now be
carried forward indefinitely provided the capital loss sustained in any 'pre-
vious year' exceeded Rs. 5,000.
Since 1956 the tax treatment of capital gains has been the subject
matter of investigation by various individuals and committees such as S.
Bhoothalingam in 1968, the Direct Taxes Enquiry Committee in 1971,
the Direct Tax Laws Committee in 1978 and Economic Administration
Reforms Commission in 1983 who have studied the taxation of capital
gains and made some recommendations. Consequently, almost every
Finance Act contains some provision/change in laws relating to capital
gains taxation.
Over the last three decades the law on capital gains taxation has been
overhauled and refashioned a number of times. But these frequent changes
in the provisions and rules have made the law very complex to administer.
The provisions have been amended, added, substituted and omitted for
more than fifty times during this period, sometimes with a view to granting
more concessions and exemptions so as to remove the hardships to tax-
payers as a result of inflation, sometimes to check tax evasion through
understatement of consideration on transfer of a capital asset, etc. Thus
in an attempt to reconcile equity with incentives to capital formation for
economic growth, the capital gains tax has largely ignored an important
canon of taxation, viz., simplicity. Drafting of the provisions is so com-
plicated that even a highly educated man has to read the passages slowly
several times to understand the meaning and still cannot keep himself
abreast ofthe current provisions. A tax system should be sufficiently simple
in content and terminology for a tax-payer of average intelligence to com-
prehend at least its main principles. Tf that is so, it will result in a greater
degree of voluntary compliance and the tax will be relatively inexpensive
to assess and collect.
A number of concessions halve been allowed and withdrawn to achieve
certain objectives. The frequent changes in these provisions creates un-
certainty in the minds of tax-payers. It is high time that this is removed

12. Ibid.
1988] TAXATION OF CAPITAL GAINS 143

and concessions, once allowed, should continue for a long period of time,
unless the circumstances warrant their earlier withdrawal, so that tax-payers
may take full advantage.
Generally changes in the various provisions are made through the
Annual Finance Bills. As the Finance Bill is not referred to the Select
Committee and members of Parliament do not have adequate opportunity
of studying the various provisions, total effect of the amendments cannot
be ascertained, since at times they are made retrospectively merely to get
around an adverse decision of the Supreme Court.
With a view to having an effective and stable tax structure, frequent
changes in the law should be avoided and an attempt made not to amend
the law for at least five years. Changes through the annual Finance Bill
should be restricted to procedural matters. Other amendments in tax
laws should be made through separate bills after a careful survey of their
effect. For this, the impact of various provisions should be evaluated
periodically with the help of reliable statistical data. In other words some
empirical study should be made before introducing or withdrawing any
provision. At present, in the absence of such scientific study, changes
in the laws are dependent upon the political climate and whims of finance
ministers rather than rational economic considerations. Therefore to
make an objective analysis which could form the basis of informed deci-
sions for the purposes of changing the law, continuous in-depth studies
should be made on various issues. These would then be less inflenced
by extraneous considerations. For making such research studies, ade-
quate or reliable statistical data should be made available. It is hoped
that the use of computer (as envisaged in the Seventh Five Year Plan and
as announced by the finance minister in the long term fiscal policy), will
certainly accelerate the flow of data from the field which will provide for
its appropriate storage and retrieval.
It is also desirable that the laws should be redrafted in a way which
will make them intelligible at least to a reasonably educated person willing
to make some effort. Use of archaisms and idiomatic expressions should
be avoided as far as possible.
A stable and fair structure will definitely lead to better tax compli-
ance and promote the confidence of the tax-payer in the administration.
Therefore, the whole scheme of capital gains taxation needs to be reviewed
in totality with all its concessions and exemptions re-examined, if this is
done, and as mentioned above no changes made for at least a five-year
period, most of the administrative problems will nearly disappear.
Ill Essential features and legal framework : latest reforms
Any profits or gains arising from the transfer of a capital asset are
taxed under the head 'capital gains'. 120
\2a. The substantive provisions relating to the computation of income chargeable
under this head of income are contained in sections 45 to 55A of part F, ch, IV, Income-
tax Act 1961,
144 JOURNAL OF THE INDIAN LAW INSTITUTE [Vol. 30 : 2

Taxation of capital gains is generally based upon realisation and in

this respect differs from taxation of income undei other heads of income,
i.e., business income, etc., where tax is payable on income that is either
realised or accrued. Therefore, generally capital gains are assessable as
income of the year in which the transfer takes place, even though they
may be realised later on.

(1) Period of holding

Capital gains are subject to tax differently, depending upon the
period of holding of asset. If held for a period of up to 36 months before
the date of transfer, the gains are treated like ordinary income, in case
this period is exceeded there is a concessional tax treatment. Initially
the holding period was only one year, raised to 60 months in 1977 and
reduced to the current level of 36 months. This period is somewhat arbi-
trarily fixed.
The 36 months period has become irrelevant particularly in respect
of business assets in view of the introduction of the concept of block of
assets for purposes of granting the depreciation allowance. This concept
was introduced by the Taxation Laws (Amendment and Miscellaneous
Provisions) Act 1986. Under this new scheme of depreciation allowance
of block of assets, the gains derived on transfer of a capital asset even if
held for more than 36 months by a tax-payer are treated as a short-term
capital gain and subject to tax as ordinary income.
It is interesting to note the dividing line between short-term and long-
term periods which varies in different countries. The period of holding
for concessional tax treatment in some countries is much less. It is six
months in West Germany, one year in Australia and two years in Sweden.
India has also taken a step in this direction and reduced the period to 12
months for the purposes of capital gains on transfer of shares. This special
concession has been allowed with the objective of attracting investment
in share of certain new companies. As the capital gains arise mainly on
account of inflation, the period of holding for other assets also needs to
be reduced from 36 months to at least 24 months, if not less.126

(2) Rates of capital gains tax and basic exemption limit

At present non-corporate tax-payers are allowed a basic exemption

of Rs. 10,000 in respect of long-term capital gains. Out of the balance
capital gains, further deduction is allowed at 50 per cent in respect of gains
derived from real estate, gold, bullion and jewellery and 60 per cent as
regards other assets. Accordingly, at the maximum marginal rate of 50
per cent, long-term capital gains from real estate are subject to tax at 25
per cent and from other assets at 20 per cent.

12b. For details of period of holding in some of the other countries, see appendix-
1988] TAXATION OF CAPITAL GAINS 145

For companies, presently the preferential treatment for capital gains

is built into the rate of tax relief. Capital gains on the sale of land and
buildings or any rights in either is taxed at 50 per cent. For assets other
than these it is 40 per cent.
To bring uniformity in cases of corporate and non-corporate tax-
payers, the Finance Act 1987 has permitted deduction to companies at 10
percent out of gains realised from real estate and 30 per cent from other
assets. The long-term capital losses are also treated as losses from business
after scaling down by 10 per cent/30 per cent depending upon the
nature of the asset. Under the new scheme for taxation of long-term capital
gains in the case of widely held companies, the tax rate will work out to
be 45 per cent on gains from real estate and 35 per cent on other assets.
In the case of closely held companies, the rate will still be higher.
The basic exemption limit of Rs. 10,000 from the taxable gains needs
to be changed. In fact, when capital gains tax was introduced in the year
1947forthe first time, Rs. 15,000 capital gains were exempt. Subsequently,
this figure was substituted by Rs. 5,000. Considering the fall in the price
of money since 1947, it is suggested that at least Rs. 50,000 should be the
threshold exemption instead of Rs. 10,000.

(3) Computation of capital gains—cost of acquisition

The general principle for computing capital gains is to deduct from
the sale price the cost of, acquisition to the tax-payer, and improvements
thereto as well as the expenditure incurred wholly and exclusively in
connection with the transfer. In case a capital asset becomes the property
of the tax-payer, (a) on account of total or partial partition of the
Hindu undivided family, (b) under a gift or will, (c) by succession, inheri-
tance or devolution, (d) on any distribution, inheritance or devolution of
assets on the dissolution of the firm, body of individuals or other asso-
ciation of persons, (e) on liquidation of a company, (/) under a transfer
to a revocable or an irrevocable trust, then the cost to the previous owner
plus the cost of improvements thereto is deemed to be the cost of acquisi-
tion to the tax-payer. However, where for some reason or the other it
is not possible to ascertain the cost for which the previous owner acquired
the capital asset, then as per section 55 (3) of the Income-tax Act 1961, the
fair market value of the asset on the date on which the previous owner had
acquired it is taken to be the cost of acquisition to the previous owner and
therefore to the tax-payer for computing his capital gains.
Tn the case of depreciated assets, the written down value, as adjusted
on account of balancing charge or balancing allowance, is deemed
to be the cost of acquisition of the asset. In respect of property which
is sold, balancing allowance represents the excess of the written down
value over the sale price while in the case of property which is discarded,
demolished or destroyed, it is the excess of the written down value over
the insurance, compensation moneys and amount of the scrap value.
146 JOURNAL OF THE INDIAN LAW INSTITUTE [Vol. 30 : 2

Balancing charge, on the other hand, represents the excess of sale price
of the capital asset over its written down value. The adjustment is done
with reference to the actual balancing charge. In case no such balancing
charge is actually levied, the written down value is taken to be the cost of
acquisition.
As regards any asset acquired before ] April 1974, the tax-payer has
the option of adopting the fair market value of the asset as on that date.
In such a case, the cost of acquisition is taken, at the option of the tax-
payer, to be the fair market value of the asset on the said date, as reduced
by the amount of depreciation, if any, allowed after the said date and as
adjusted. In certain countries like, Belgium, Brazil, Colombia, Mexico
and Taiwan, there are provisions for indexation of assets or the gains.
Similar provisions are worth studying for their introduction in India. Alter-
natively, the option for substituting the cost of acquisition of asset by the
fair market value may be considered to be allowed not on a fixed date but
on a moving date, i.e., the first day ofthe financial year ten years back from
year in which the asset is transferred. This will reduce the harmful effects
of inflation and bunching of realised gains in one year without the need
for too many amendments.

(4) Transfer and its exceptions

The word 'transfer' includes "the sale, exchange or relinquishment
of the asset or the extinguishment of any rights therein or the compul-
sory acquisition thereof under any law". Certain capital assets have, how-
ever, been excluded from the purview of this tax.
The transactions which are not regarded as transfers and hence not
liable to capital gains tax include :
(/) any distribution of capital asset on the total or partial partition
of a Hindu undivided family;
(ii) distribution of capital assets on the dissolution of a firm, body
of individuals or other association of persons;
(in) any transfer of a capital asset under a gift, will or an irrevocable
trust;
iiv) any transfer of capital asset by a company to a wholly owned
subsidiary Indian company or vice versa ;
(v) any transfer of capital asset on account of amalgamation and any
transfer of agricultural land in India before 1 March 1970.
With a view to procuring works of art, archaeological, scientific or
art collection, book, drawing, painting, etc., sale of such pieces of interest
to the government, a university, the national museum or national archives,
etc., does not attract capital gains tax. This is especially exempted so as
to encourage sale of such items to the government or government approved
institutions which can preserve and look after these objects or art which
might otherwise degenerate or perish.
1988] TAXATION OF CAPITAL GAINS 147

(5) Certain concessions

Capital gains arising out of the transfer of property used for residence
is exempt from tax in the case of an individual tax-payer provided he has
acquired another residential house for his residence within a stipulated
period and the value of his new house is equal to or more than the quantum
of capital gains. Thus if a dwelling house is sold for Rs. 1,00,000, mak-
ing a gain of Rs. 25,000 and a new house valued at Rs. 25,000 is acquired,
no capital gains tax is payable by the seller.
The entire capital gain is exempt if it arises on transfer of a residential
house, (being a Jong-term asset) the income of which is chargeable under
the head 'income from house property', if its full sale consideration does
not exceed Rs. 2,00,000. Where it exceeds this sum, only a propor-
tionate amount of capital gains is exempt. This exemption is available only
if the individual tax-payer has on the date of sale of the house no other
residential house. In Canada and the UK one residential house is totally
exempt from capital gains tax. Besides, capital gain arising on sale of any
long-term capital asset other than residential house is also exempt provi-
ded the net consideration is invested in acquiring a residential house.
This exemption was introduced recently to encourage construction of resi-
dential buildings, the shortage of which has been felt in all cities, big and
small. These concessions are fully justified to avoid any hardship that
would accrue as a result of increasing cost of house construction and in-
crease in prices of lands and buildings. The exemptions have also been
extended to Hindu undivided families with effect from 1 April 1987.
Similar provisions apply where a tax-payer transfers agricultural
land and within two years buys new land which is also used for agricul-
tural purposes. This exemption is applicable to agricultural land situated
within eight kilometers from the municipal limits. Other agricultural
lands are by definition excluded from capital assets.
Further no capital gains tax is levied in the case of compulsory acqui-
sition of lands and buildings of an industrial undertaking for the purpose
of shifting or re-establishing the said undertaking or setting up of another
industrial undertaking if the market value of the new land or building is
not less than the capital gains arising out of the transfer.
With a view to encouraging investment in particular channels, a
provision was introduced in 1977 providing for total relief from capital
gains tax if the net consideration (on net capital gains alone) was invested
in certain approved forms of financial assets for a stipulated period. Pre-
sently, these approved investments include, the securities of the Central
Government, special series of units of Unit Trust of India, National Rural
Development Bonds, debentures issued by Housing and Urban Development
Corporation Ltd. (HUDCO) and notified bonds issued by public sector
companies. Under this scheme of exemption, the tax-payer is debarred
from obtaining any loan or advance on the security of these deposits. He
148 JOURNAL OF THE INDIAN LAW INSTITUTE [Vol. 30 : 2

is required to reinvest the net consideration received on sale or transfer

of the asset within six months in new financial assets. In Norway, however,
the tax-payer is allowed the facility of making reinvestments of the capital
gains within four years from the date of transfer of the asset. Even this
period can be extended on application.
To encourage shifting of industries from urban areas which are thickly
populated and where the prices of lands and buildings have appreciated
very much and secure balanced regional development, a concession is
available under the provisions of section 280Z^4 of the Income-tax Act
1961. Under this provision, any company owning an industrial under-
taking situated in an urban area, is entitled for a tax credit certificate
with reference to the amount of tax payable on capital gains arising
from the transfer of its machinery plant, etc., to any other area. These
provisions, the government felt, did not prove to be very effective. There-
fore, the Finance Act 1987 omitted this section and inserted a new one.
It provides for exemption of capital gains arising on transfer of long-
tenn capital assets in the nature of machinery, plant, building or land
used for purposes of business of the industrial undertaking situated in an
urban area in connection with the shifting of such industrial undertaking
from an urban to a non-urban area. Accordingly, capital gains arising
in such cases will be exempt to the extert they are utilised within a period
of one year before or three years after the date of transfer, for the pur-
chase of new machinery, plant or acquiring land and building, etc., for
the purpose of the business in the area to which the undertaking is shifted
or incurs expenses on shifting the original asset and transferring the estab-
lishment of the undertaking to such areas and incurs expenses as may be
specified.

(6) Treatment of capital losses

A loss relating to a short-term capital asset can be set-off in the same
year only against gains in respect of any asset (whether short or long-term).
Thus although profit from transfer of a short-term capital asset is subjected
to tax like any other business income, loss incurred on such a transfer
can be set-off only against capital gains arising to the tax-payer.
Capital loss in such cases can be carried forward for eight years but in
subsequent years it can be set-off only against short-term capital gains.
Long-term capital loss can be set-off only against long-term capital
gains. It is so because such gains suffer tax at a lower rate and set-off of
losses under this head cannot be allowed against income which is liable to
be taxed at a higher rate. The long-term capital losses have to be carried
forward separately and can be set-off only against long-term capital
gains in the succeeding four years. However, no capital loss whether short
or long-term can be carried forward unless it exceeds Rs. 10,000.
With a view to simplifying the aforesaid provisions and also to ensure
uniform treatment of capital losses and capital gains, the Finance Act 1987
1988] TAXATION OF CAPITAL GAINS 149

has provided for scaling down of long-term capital loss (in the same manner
as deductions are allowed out of long-term capital gains) for the purposes
of set-off and carry forward. The losses scaled down in this manner will
be deemed as business losses. The new provisions are applicable in rela-
tion to the assessment year 1988-89 and subsequent years.
IV Certain legal issues and review of judical pronouncements
(i) Meaning of capital asset
Section 2(14) of the Income-tax Act 1961 defines "capital asset"
which includes property of every kind held by a tax-payer whether or not
connected with his business. However, certain items have been specifically
excluded from the definition. These include, (/) the stock in trade, con-
sumable stores, or raw materials held for the purpose of the tax-payer's
business or profession; 07) Gold Bonds issued by the Central Government
to augment the government's resources drained by the Indo-Chinese war
of 1962 as well as Indo-Pakistan war of 1965; (Hi) the Special Bearer Bonds
1991, issued to mop up black money in the economy; (iv) all personal effects
held for personal use of the tax-payer or any member of his family depen-
dent on him;13 and (v) the agricultural land situated in India outside the
urban areas.13"
The Income-tax Act does not define the expression "agricultural
land". However, the courts have laid down various factors to be consi-
dered for the purposes of determining whether a plot of land is to be treated
as "agricultural land" or not. These, inter alia, include, (/) whether assess-
ment of land is subject to land revenue; (ii) whether agricultural operations
are carried on the land; 077) whether the land is capable of agricul-
tural operations; and (iv) what is the character of the adjoining lands and
its description in the official records.
The Madras High Court in Beverly Estate Ltd. v. C.I.T.Ub held that
shade trees standing on tea estates do not constitute agricultural land and
thus come within the definition of capital asset. Hence it does not mean
that everything attached to the land is treated as agricultural land.
It, therefore, follows that capital asset includes all kinds of property,

13. However, capital gain arising on personal jewellery was subjected to tax with
effect from 1 April 1973.
13tf. Upto 1970 agricultural land in India did not constitute a capital asset and
any transfer thereof did not attract capital gains tax. However, it was noticed that many
land-holders in urban areas carried out some agricultural activity on their land befoie
selling it. Huge profits made on the sale of such land escaped capital gains tax. To
prevent this mode of avoidance, the Finance Act 1970 taxed capital gains arising on trans-
fer of agricultural land. If such land is situated, (a) within the jurisdiction of a munici-
pality or a cantonment board; or (b) in an area having a population of ten thousand
or more, or (c) within eight kilometers or the local limits of any municipality or canton-
ment.
13b. (1979) 117 I.T.R. 302.
150 JOURNAL OF THE INDIAN LA W INSTITUTE [Vol. 30 : 2

moveable or immoveable, tangible or intangible, fixed or circulating, except

otherwise excluded under the definition.
The question whether a particular item is a capital asset or not for the
purposes of section 2 (4) of the Income-tax Act has been the subject matter
of decision in a number of cases before various High Courts and the
Supreme Court. A few instances of items which have been held by the
courts to be capital asset include, {i) the share of a partner in a partnership
concern;14 07) leasehold rights in mines;15 (in) a licence obtained from the
government for the manufacture of a commodity;16 (iv) the right to manage-
ment of business as being part of the profit making .apparatus of the tax-
payer;17 and (v) route permits for buses granted by the road transport autho-
rity. The Calcutta High Court in Gasper v. C.I.T.]S held that the monthly
tenancy ofthe tax-payer is a capital asset and extinguishment ofthe tenancy
amounts to a transfer within section 2(47) of the Act and consideration
received by the tax-payer for it, is therefore liable to capital gains tax under
section 45(1) of the Act.
The question whether goodwill in a partnership firm constitutes a
"capital asset" or not came up before the Supreme Court in B.C. Srinivasa
Setty v. C.LT.1* where it was held that goodwill being a self-generated asset
for which no price is paid, the question of determining its cost of acquisition
for computing the amount of capital gains arising on its transfer cannot
arise at all and hence, such a capital asset is not contemplated under the
Act. Therefore, wherever there was a self-generated asset, its transfer
remained outside the purview of capital gains.
With a view to removing this legal difficulty, the Finance Act 1987
has amended section 45 ofthe Act to provide that where goodwill is genera-
ted, the cost of acquisition will be deemed to be nil and where it has been
purchased, the cost will be taken to be the actual price paid for it. The
cost of improvement also in relation to goodwill will be taken to be nil.
However, introduction of this new provision may create a new issue. For
instance, a running business which is transferred without making any men-
tion of transfer of goodwill. While the transfeior may claim that there
was no goodwill, the Revenue may take the view that the transaction inclu-
ded transfer of goodwill. The computation of goodwill may also create
problem in such a case.
(2) Definition of "transfer"
Section 2(47) ofthe Act defines "transfer" in relation to capital asset
to include the sale, exchange or relinquishment of the asset or extinguish-
ment of any rights therein or the compulsory acquisition thereof under
14. Rangaswami Naidu v. C.LT., (1957) 31 I.T.R. 711 (Mad.)
15. Rajmdm Mining Syndicate v. C.LT., (1961) 43 I.T.R. 460(A.P.).
16. Seshasayee Brothers Ltd. v. C.LT., (1961) 42 I.T.R. 568 (Mad.).
17. C.LT. v. New India Assurance Co. Ltd., (1980) 122 LT.R, 635 (Bom.).
18.(1979) 117 I.T.R. 581 (Cal.).
19. (1981) 128 I.T.R. 298 (S.C.)
1988] TAXATION OF CAPITAL GAINS 151

any law. The definition is so wide as to include any transaction whereby

the ownership of a tax-payer in a capital asset ceases for treating it as a
"transfer". The relinquishment of rights in favour of another person is
also treated as transfer. Similarly, if an asset is damaged or destroyed
and claims received from an insurance company exceed the cost of its acqui-
sition, the excess amount is treated as capital gains and subjected to tax.
Both voluntary and involuntary transfers are included under the definition
of "transfer".20
(3) When do capital gains arise ?
Gains from the transfer of a capital asset are taxable only during the
previous year in which transfer was effected and not when the sale proceeds
or other consideration was actually received. How a tax-payer keeps his
books of accounts does not affect the question when capital gains arise.
Capital gains can be taxed only at the time when the transfer is effected.
The Supreme Court in Alapati VenJtatramiah v. C/.T.21 held that transfer
means an effective transfer of title. According to the Transfer of Property
Act 1882 the title to the immoveable property passes to the transferee only
when the sale deed is executed and registered with the registrar.
Jn view of this, the delivery of possession of immoveable property
cannot by itself be treated as equivalent to its conveyance. Taking benefit
of this legal position, many transactions in immoveable property take place
by way of what is called "power of attorney". A person who wishes to
transfer such property to a purchaser merely executes a power of attorney
in his favour. The sale consideration passes into the hands of the trans-
feror as 'advance' and physical possession of immoveable property is handed
over to the transferee along with the power of attorney. Since the receipt
is in the nature of 'advance' for the purposes of record, this cannot be taxed
as capital gain. Consequently, the tax-payer escapes the tax on such a
transaction because no capital gains can be computed at this stage. If at
a much later stage, the sale is registered, it becomes difficult to evaluate
very correctly the sale consideration. Besides, the transferor would have
divested himself of the funds and is generally not in a position to pay.
Another difficulty arises when the immoveable property is sold under
an "agreement to sell5'. Under this agreement, initially, such agreement
is executed, and the sale deed, executed and registered after several years.
This normally happens in the case of big cities where properties are being
developed for construction of multi-storeyed buildings for the purchaser
of the property does not effect the transfer of title until the properties arc
constructed and a co-operative society ofthe flat owners is formed. In such
cases, due to delay in its formation, the actual transfer is not effected until
after the original seller of the immoveable property is not taxed on capital

20. Mangabre Electric Supply Co. Ltd. v. C.LT,, (1978) 113 LT.R. 655.
21. (1964) 57 I.T.R. m.
152 JOURNAL OF THE INDIAN LAW INSTITUTE [Vol. 30 : 2

gains until the year when the actual sale deed is executed. Meanwhile the
seller might have spent the money and may no longer be in a position to
pay the taxes.
With a view to preventing evasion of capital gains tax by resorting
to the above types of transactions, the Finance Act 1987 made an amend-
ment in the definition of "transfer" to include even those cases where physi-
cal possession of immoveable property is handed over to the purchaser
or when interest in a property is transferred and funds in lieu thereof are
received by its owner. In other words, the meaning of "transfer" giver
under section 53A of the Transfer of Property Act, will not be adopted foi
purposes ofthe Income-tax Act. This will make the gain taxable when the
property passes hands or when interest in a property is transferred and no1
when it is registered many years later.

V Problem of valuation of assets

Valuation of assets is one of the crucial problems in respect of taxa-
tion of capital gains. Very often to suppress such gains the sale deed is
registered at a value much lower than the actual market value for which the
transaction took place. This results not only in evasion of due tax on
capital gains but also other payments such as on account of stamp duty
levied by state governments on any transfer of immoveable property
exceeding a particular value.
Once a sale deed is registered, it becomes a legal document and the
consideration stated in the deed cannot be challenged by the Revenue autho-
rities unless they have compelling evidence in the form of some written
agreement for sale at a value higher than the registered one. But it has
been almost impossible for them to establish the fact of understatement
in such a way as to be sustained in a court of law.
To prevent evasion of capital gains tax by way of understatement?
the law empowers the assessing officer, in certain circumstances, to assume
that the sale took place at the market price. But before he can resort to
this assumption, he has to fulfil two conditions, viz., establish, (i) director
indirect connection between the purchaser and the seller; and (ii) that the
understatement was made with the object of avoiding or reducing the
liability of capital gains tax.
With regard to the first condition, the question before the Delhi High
Court in Shiv Shankar Lai v. CJ.T.22 was whether there was a direct or in-
direct connection between a person and a company in which the majority
of shares were held by the former or his relatives. The court held:
Although the assessee and the company in which he was
shareholder are two different legal entities, yet there is a close

22. (1974) 94 I.T.R. 433 (Delhi).

1988J TAXATION OF CAPITAL GAINS 153

connection between the assessee and the company in as much as

the only other shareholders of the company arc the assessee's
wife, son and daughter-in-law.22fl

The second and more difficult condition to invoke section 52(1) is that
the burden of proving that certain sales were effected with the object of
avoidance or reduction of tax on capital gains is on the Revenue. It is
not enough that the explanation offered by the tax-payer is not accepted
by the assessing officer, and that, there is a strong suspicion as to the real
motive which prompted him to sell the assets. There must be something
more positive (than mere suspicion) to suggest that sales were effected with
the object of avoidance or reduction of liability for capital gains.23 It was
held in another case24 that it is not enough if the reduction of tax liability is
the effect or result of the transfer, the important consideration is the basic
objective of the transfer and not the result.
Assuming that the conditions for invoking section 52(1) are satisfied,
the assessing officer is empowered to take the full value ofthe consideration
as the fair market value of the capital asset on the date of transfer, reject
the consideration declared by the tax-payer aitd compute the capital gains
accordingly.
As regards sub-section (2) of section 52, the condition required for
invoking this provision is that there must be a difference of 15 per cent or
more between the fair market value of the asset (on the date of transfer)
and the consideration declared by the tax-payer. It empowers the assessing
officer to compute the amount of capital gains arising on the transfer of
a capital asset with reference to its fair market value as on the date of its
transfer, if in his opinion such value exceeds 15 per cent of the full
consideration as declared by the tax-payer.
There was a controversy on the point whether for invoking the pro-
visions of section 52(2) of the Act, the tax-payer must be shown to have
actually received more than what is declared or disclosed by him as consi-
deration. There were two schools of thought, namely, (/') that the burden
of proof is on the Revenue to prove that this had been done; and (ii) that
once it established that the fair market value is more than the declared
consideration by more than 15 per cent, the provision of section 52(2) shall
become applicable and the assessing officer is not bound to prove that in
fact more money has been paid for the transfer than declared or disclosed
by him. The controversy was set at rest by the Supreme Court ruling
in K.F. Varghese v. I.T.O?h where the first view was upheld. The court
held:

21a. Id. at 450.

23. Sivakami Co. (P) Ltd. v. C.LT., (1973) 88 I.T.R. 31 (Mad.)
24. C.LT. v. A.M.M. Mohammed Ibrahim Saheb, (1962) 45 I.T.R. 166 (Mad.).
25. (1981) 131 I.T.R. 597 (S.C).
154 JOURNAL OF THE INDIAN LAW INSTITUTE [Vol. 30 : 2

[S]ub-s. (2) of s. 52 can be invoked only where the consideration

for the transfer of a capital asset has been understated by the
assessee or, in other words, the consideration actually received
by the assessee is more than what is declared or disclosed by
him and the burden of proving such an understatement or conceal-
ment is on the revenue.2*5"
Thus it will be evident from this decision that the invoking of section
52 is almost impossible, because the burden of proving understatement in
the sale consideration of a capital asset on its transfer is on the Revenue,
Similarly for invoking section 52(1), the assessing officer is required to
establish that the sale was effected with the object of avoiding or reducing
liability or capital gains tax and that the purchaser and seller are directly
or indirectly connected. Since such evidence cannot be procured from
examination of books of accounts and other documents produced by tax-
payers, this section has become almost inoperative and ineffective. It can-
not be invoked in cases ofbona fide transfers even if the consideration decla-
red is lower than the fair market value.
The Finance Act 1987 has omitted the provisions of section 52 of the
Income-tax Act. To deal with the problems of understatement, the
government, it appears, now intends to rely more on the other provisions
found in chapter XXC of the latter Act which deals with pre-emptive right
of the Central Government to purchase properties in certain cases. Under
this new chapter, the government can exercise such right to purchase pro-
perty without assigning any reason. Initially this provision has been applied
in respect of transfer of any immoveable property made for apparent consi-
deration exceeding Rs. 10 lakhs in any of the four metropolitan cities of
Bombay, Calcutta, Delhi and Madras.
The problem of proper valuation arises not only in regard to the sale
consideration, which is very often understated by tax-payers, but also in
regard to the fair market value as on 1-1-1954 (up to assessment year 1977-
78) or as on 1-1-1964 (up to assessment year 1986-87) or as on 1-4-1974
for the purpose of determining the cost of acquisition of the capital asset
which has been transferred. Determination of value of the property in
such cases is a very difficult task and there are hardly any instances of correct
valuation. Thus if sale consideration is understated and the fair market
value as on 1-4-1974 is overstated, the gain that is subjected to capital gains
tax is hardly a fraction of the real gain.
Section 55^4 of the Act authorises the revenue officers to refer to the
Valuation Cell, the valuation of any asset, to determine its fair market value.
This cell is formed by civil and mechanical engineers employed by the
government. They are to assist the revenue department in determining
a fair market value of lands and building as well as plant and machinery.
Since valuation is to some extent subjective, this practice has given rise to

25a. Id. at 618.

1988] TAXATION OF CAPITAL GAINS 155

malpractices. There are quite a few instances where the fair market value
determined by the cell is lower than the valuation declared by the tax-payer
or in the alternative, so much higher that they cannot be sustained when
challenged in courts.
The Economic Administrative Reforms Commission26 while dealing
with the problem of valuation has recommended in its report submitted in
December 1983 the establishment of valuation tribunals presided over by a
High Court judge and assisted by two experts, to which disputes relating
to valuation may be referred. If satisfied, the tribunal, after hearing the
parties concerned, and on perusal ofthe evidence, that in fact a larger consi-
deration has been received than what has been recorded, may order the
difference to be taxed as capital gains and authorise levy of suitable penalty
for concealment.
The commission further recommended that if9 on the contrary, the
tribunal finds no evidence but still comes to a finding that the price recorded
is below the fair market value, it may treat the difference as chargeable to
gift-tax. Where it finds that such value exceeds the recorded value by 25
per cent, the tax-payer should be deemed to have concealed the gift and
subjected to penalties accordingly. This recommendation, it seems, is
under serious consideration of the government.
Gne motive that influences understatement of consideration for trans-
fer of immoveable property is the heavy burden of stamp duty which is
generally borne by the purchasers. Stamp duty is administered by the
state government whereas the capital gains tax is levied by the Central
Government. Perhaps an agreement can be arrived at between them where-
by rates of stamp duty can be reduced. The state governments can be
suitably compensated for the tax lost. This would remove an inducement
for this fraudulent practice.
VI Principles of taxation and capital gains tax in India
While tax policy of any economy aims at achieving a number of objec-
tives such as raising of revenue, payment for goods and services provided
collectively through state, serving as an instrument of social policy, the
principles of taxation, i.e., equity, ability to pay, stability, certainty, etc.,
are very closely related to these considerations.
(1) Equity
A good system should be horizontally equitable, i.e., it should treat
like with like. A modern tax system must be so constructed as to be capable
of use for vertical redistribution between rich and poor.27 Kaldor recom-
mended levy of capital gains tax as a means of checking concentration of

26. The Economic Administrative Reforms Commission, Ministry of Finance,

Government of India (1983).
27. The Structure and Refoim of Ditect Taxation (Meade Committee Report 1978).
156 JOURNAL OF THE INDIAN LAW INSTITUTE [Vol. 30 : 1

wealth in a few hands.28 Capital gains accrue only to those who own pro-
perty and failure to tax the gains would discriminate in favour of property
owners and perpetuate severe inequalities in income and wealth.29 Income
in the form of capital gains is an important factor in aggravating economic
inequality. It is not fair that the exchequer should get a proportion of
those incomes when realised in the form of capital gains. The main argu-
ment for a capital gains tax is to meet the inequality which results when
some people can transpose taxable income into untaxed capital gains.

(2) Ability to pay

It is widely argued that taxes should be levied according to ability
to pay. Capital gains enhance a person's ability to pay taxes. It is evident
that a large majority of people find taxes less burdensome when they have
larger incomes or more funds. When the pre-tax income at his disposal
is so small, that the imposition of a tax leaves the tax-payer with barely
enough for his food, the tax is a genuine hardship, but when its payment
means giving up relatively unimportant luxuries or when it does not affect
the style of living at all, no real hardship results. The minority report of
the Royal Commission in the UK argued for inclusion of capital gains in
income taxation on the grounds that it increases a person's taxable capacity
by increasing his power to spend or save; and since distribution of capital
gains among different members of the tax-paying community are not in
fair proportion to their taxable income but concentrated in the hands of
property owners, their exclusion from taxation constitutes a serious discri-
mination in tax treatment in favour of a particular class of tax-payers.yo

(3) Efficiency
Another principle of taxation is 'efficiency'. Generally it is under-
stood that a tax system is inefficient in so far as it distorts the free choices
of the individual. A tax which reduces the supply of labour because it
distorts the choice between work and leisure is inefficient in this sense.
Similarly, a commodity tax which distorts the pattern of consumption is
also inefficient. This is the principle of least price distortion; that tax A is
more efficient than tax B if, for an equal revenue to the exchequer, it involves
less loss of satisfaction to the tax-payer. In other words, efficient tax system
is that which causes least excess burden or welfare loss.
According to Kaldor,31 the purpose of an efficient tax is to restrain
private expenditure. As capital gain accrues to wealth holders whose
marginal propensity to consume is less than that ofthe poorer people, econo-
mic efficiency of capital gains tax from the above viewpoint is lower than

29. Nicholas Kaldor, supra note 3.

30. Report of the Royal Commission on Taxation, vol. 3, p. 365 (1966).
31. Supra note 3 at 385.
1988] TAXATION OF CAPITAL GAINS 157

the efficiency of income-tax or consumption tax. Efficiency of capital

gains has been estimated at 0.10 por cent compared to, respectively, 0.67
per cent and 0.80 per cent.

(4) Flexibility

Flexibility is important in view of the use of taxation as a means of

regulating the economy. This is specially so in a developing economy
where revenues must rise with increase in incomes. Taxation as a measure
of stabilisation is extremely popular with Kenyesian economists when the
national economy is confronted with hyper-inflation, stagnation, or high
levels of unemployment. In view of its high potential for stabilisation,
it has come to be known as a built-in or automatic stabiliser.

(5) Certainty

Certainty is a principle in the tax system which v>e are apt to take
for granted; that the individual's tax liability should not be arbitrary and
should be calculable in advance; retrospective legislation may infringe this
principle. It contributes significantly to voluntary tax compliance and
reduces compliance costs.

(6) Simplicity

A tax system should be sufficiently simple both in content and termi-

nology for the tax-payer or average intelligence to comprehend at least its
main principles. Simplicity also embraces the need for a tax to be rela-
tively inexpensive to assess and collect.
In calculating cost of collection or tax operating cost, we must take
into account not only 'administrative' costs to the Revenue but also
'compliance costs' incurred by tax-payers in meeting the requirements of
the tax laws. Tax-payers may nctd to employ paid advisors and have other
miscellaneous costs.
None of these above principles of taxation is absolute. There is a
possibility of conflict of objectives m ^he tax structure. It is likely to arise
particularly between simplicity and equity and between equality arid effi-
ciency. Many of the complications of the tax systems spring from exemp-
tions and provisions for special treatment which seek to remove inequities,
yet their very existence not only reduce simplicity but also increases
inequities for those whom the circumstances have placed on the wrong side
of the special provisions. Frequent changes in taxation associated with
flexibility create inequities.
Capital gains tax in India has been criticised as inequitable since it
does not tax all capital gains. Another charge of inequity arises from the
fact that long-term capital gains are taxed at concessional rates. However,
it must be observed that some capital gains have been exempted from tax,
158 JOURNAL OF THE INDIAN LAW INSTITUTE [Vol. 30 : 2

so as to encourage investment in those areas (e.g., residential housing, in-

vestment in specified assets) which contribute to the economic growth of
the country and constitute the priorities in our Five Year Plans to banish
poverty and accelerate economic development.
Further preferential treatment of long-term capital gains is justified
since it represents accumulated gains of several years and is often illusory
because of fall in the value of money.
To conclude, on the whole, the system of capital gains tax in India
fulfills the principles of equity and ability to pay. It is fairly efficient,
flexible but not so simple in view of frequent changes. By granting conces-
sions and exemptions, it encourages investment in productive assets. Capi-
tal gains tax is a fiscal instrument available to the government for tapping
speculative activities which are not socially productive. However, because
ofthe large variance between the market value of land and its assessed value
for property tax purposes, capital gains tax is not an effective instrument
for thwarting land speculations, especially in the urban metropolian areas.
On the other hand, in Israel, strengthening of capital gains tax on land is
reported to have brought down land speculation. Yet the importance of
capital gains tax cannot be minimised in reducing the concentration of
wealth in a few hands. Although as a source of revenue for the government,
contribution of capital gains tax is very little, yet this is so mainly because
of administrative and valuation problems.
 TAXATION OF CAPITAL GAINS 159

APPENDIX
Taxation of capital gains
in some of the countries
Argentina
Taxed as ordinary income.
Australia
Generally no capital gains tax but gains derived from the sale of assets, e.g., real
estate or securities purchased with the intention to res 11 at a profit and sold within twelve
months of purchase are treated as assessable income.
Austria
Taxed as ordinary income. Profits from the sale of assets may be deducted from
the book value of newly purchased assets (to be owned for at least seven yeais in the
case of movables and fifteen years in the case of immoveables).
Belgium
Companies : Taxed at the rate of 22.5 per cent of the gain on the sale of property
held for more than five years. Otherwise gains included in income. Gains exempt pro-
vided the proceeds are reinvested in qualifying assets in Belgium within a peiiod of
three years. Capital loss can be set off against ordinary income regardless of the
period for which the asset was held.
In case of mergers, exempt if, (0 all transfers to the new company are exchanged
for capital stock; (//) if no tax free distributions of capital were made by old company;
and (Hi) the surviving company's principal place is in Belgium.
Individuals : The rate is 16.5 per cent if property held for five to eight years. If
sold before five yeais the rate is 33 pei cent. No tax on gains if property held for more
than eight years.
Capital gain is computed by incieasing the purchase price by 5 pet cent for each
year the land was held and subtracting the total from the selling price.
Special tax treatment in the case of securities.
Brazil
Resident companies : Taxed as ordinary income.
Resident individuals : 15 per cent gains on the sale of real estate and securities pro-
vided there are three or more ieal estate transactions in a year.
Non-resident individuals or legal entities : Gains on sale of securities at the time of
repatriation of the investment in foreign cuncncy with the Cential Bank, subject to 15
per cent withholding tax.
Canada
Companies : 50 pei cent of gains taxed as ordinary income. Provision for deduc-
tion of 50 per cent of capital losses from the taxable gains. Excess capital losses may be
carried back one year or forward indefinitely but to be deducted only against capital
gains.
Individuals : Gains from sale of a principal residence are exempt. Cumulative
tax exemption of capital gains up to a lifetime limit of C$ 500,000. To be phased in
over a peiiod of six years with a cumulative limit of C$ 25,000 in 1986 rising to
C$500,000 in 1991.
Chile
Taxed as ordinary income (unless otherwise exempted).
160 JOURNAL OF THE INDIAN LAW INSTITUTE [Vol. 30 : 2

Colombia
Companies : Gains on sale of tangible fixed assets, taxed as ordinary income.
Companies allowed to declare capital assets at their estimated market value at year end
and to adjust this figure by the official COL index. Gains on sale of fixed assets exempt
if 80 per cent of such gain reinvested for expansion or capitalisation, the acquisition of
fixed assets in industrial or agricultural projects or for stock subscriptions and new issues.
Remaining 20 per cent to be invested in 8 per cent IFI Bonds. Exemption also
allowed if 100 per cent of gains invested in IFI Bonds within the year the capital gains
are realised.
Individuals : Taxed as ordinary income.

Ecuador
Taxed as ordinary income with the following deductions :
(/) Gains from the sale of land may be reduced by 10 per cent for each year held.
(//) Gains on depreciable assets (sale price less book value) are reduced by 50 per
cent.
(7/7) Gains on certain security transactions are subject to a single tax of 8 per cent.

Egypt
Taxed as ordmaiy income.
Finland
Companies : Gains realised on sale of business assets and machinery- taxed as
ordinary income. However, exempt if gains transferred to repurchasing reserve and
used within two years to purchase machinery and equipment and within three years
to purchase land. Exempt if land has been held for ten years and securities for five years.
The tax is set at 20 per cent of the gross sale price.
Individuals : Taxed as ordinary income. A deduction of Fm 1 million allowed
with 20 per cent rate of tax on the gain.
France
Companies : Net short-term gains over short-term losses on assets held for less than
two years taxed at normal corporation tax rate. The payment can be spread over three
years. A net short-term loss can be deducted from regular income. But the gains on
sale of quoted shares are taxed at a rate of 15 per cent.
Long-term gains on assets held for more than two years taxed at the rate of 15 per
cent (25 per cent in the case of land). If the gains are distributed the rate of 35 per
cent (25 per cent in the case of land) unless distribution occurs when the company is
liquidated. Long-term losses may be deducted from long-term gains and may be carried
forward for ten years but may not be deducted from ordinarv income, except for liqui-
dation.
Individuals : Short-term gains on the moveable property (held for less than one
year), land and building (held for less than two years) taxed as ordinary income.
Long-term gains, i.e., gains from the property held for more than two years, are adjusted
for inflation and then reduced for an annual percentage for each year beyond the second,
e.g., 3.33 per cent for land and 5 per cent for buildings. One fifth of the gain is taxed
as income, and the tax thus computed is multiplied by five.
Germany (Federal Republic)
Companies : All realised gains and speculative gains on business assets
taxed at normal corporation tax rates. Gains exempt if, (/) the assets have a
useful life of at least 25 years; (77). they have been held by the selling company
 1988] TAXATION OF CAPITAL GAINS 161

for at least six years; and (//7) the proceeds arc reinvested in other specified assets within
Germany.
Gains from the sale of non-business assets are not taxable, provided assets are
held long enough so that the gain is not considered speculative (e.g., two years for real
estate and six months for securities). Losses are not deductible.
Individuals : Exempt if property held long enough not to be considered specula-
tive (e.g., six months for securities, two years for real estate).
Greece
Companies : Gains on transfer of both tangible and intangible assets are exempt
up to Dr. 1 million. 30 per cent rate applies above this amount. Exemption from tax
on gains if reinvested within two vcais.
Hong Kong
No tax on capital gains.
Indonesia
Companies : Gains realised on the ^aie of capital equipment 'axed as ordinary
income while capital losses are deductible Gains realised on the sale of shares arc exempt
to the companies selling shares to the public.
Gains realised while a company is enjoying a tax holiday arc subject to corporate
taxes at normal rates.
Israel
Gains realised on the sale of any fixed asset to the extent that the profits reflects the
increase in the cost of living between the dates of acquisition and sale, taxed at the rate
of 61 per cent for companies and the normal rate for individuals. The total tax not to
exceed 50 per cent of the taxable gain.
Gains on the sale of securities listed on Ta! Aviv Stock Exchange or bonds issued
or guaranteed by the government are exempt from tax.
Gains resulting from merger of industrial companies are also exempt.
Italy
Companies : Taxed as ordinary income. Exempt if credited to a special fund and
invested in depreciable assets within two accounting periods.
Individuals : Gains on sale of immoveable property arc subject to local tax.
Japan
Companies : Generally taxed as ordinary income. But gains from land sales
are taxed at additional 20 per cent surtax if the company holds the land less
than ten years.
Individuals : Taxable income from capital gains is calculated as follows:
(/) General rule : First divide capital gains between short-term and long-term
gain. The period of holding is five years for long-term gain. Then cost and expenses
are deducted from short-term gain and from long-term gains. Out of this Y 500,000
are allowed to be deducted as basic exemption from short term gain and remainder is
deductible from the long-term gain. Taxable income i\ net short-term gain and 50
per cent net long-term gain.
(//) Special rule : Capital gains from sale or transfer of land and building are
taxed separately from other income. In the case of the tax-payer owning land and
building for more than ten years, tax rate is generally ?0 per cent. In other cases tax rate
is 40 per cent.
Capital gains from sale of shares are generally exempt.
 162 JOURNAL OF THE INDIAN LAW INSTITUTE [Vol. 30 : 2

Korea
Companies : Gains realised from the sale of land, buildings and other assets taxed
at a rate of 40 per cent and gains from small houses at a rate of 30 per cent. Gains
from sale of houses and land within two years of acquisition are subject to a 50 per
cent tax. Additional 20 per cent surtax on gains realised from transfer of land. Gains
resulting from mergers exempt.
Individuals : Gains on sale of primary residence is exempt unless the same is sold
within six months of acquisition.

Kenya
Companies : Capital gains tax was suspended in the 1985 Budget to encourage
more floating of corporate securities.
Individuals : Taxed on 25 per cent on any capital gains made after 1 January 1982,
at their normal income-tax rates but only up to a maximum of 35 per cent. (For assets
acquired before 1975 and disposed of before 1985, the tax is reduced according to a
complex formula).

Luxembourg
Companies : Taxed as ordinary income. Gains from the sale of buildings or of
non-depreciable assets that have been held for at least five years may not be taxable if,
(i) written off against the value of other assets acquired in the same tax year; or (ii) are
used to purchase any asset within two years.
Individuals : Gains derived from sale of real estate held for more than two years
and other property held for more than six months are subject to lower rate of tax. Other-
wise taxed as ordinary income.

Mexico
Taxed as ordinary income. Tax rebate given on gains resulting from the sale of
real estate in case of shifting of the firm from Mexico City to certain zones specified for
development. A formula to adjust asset values to reflect inflation applies in case of sale
of land, buildings, shares of stock and other capital interests which varies according
to the number of years the asset is held.
Gains resulting from the sale of publicly traded stock by individuals are tax exempt.
Netherlands
Companies : Taxed as ordinary income. Gains realised as a result of corporate
mergers exempt.
Individuals : Gains on the sale of shares exempt in the hands of individual share-
holders holding less than one-third of a corporation's shares. Otherwise taxed at
the rate of 20-54 per cent with a provision of ad hoc relief in case of merger approved
by the Finance Ministry.

New Zealand
Generally exempt—taxed where the asset was purchased with the aim of reselling
it at a profit. Gains on the sale ofpatent rights taxed as ordinary income but may be
spread over six years.
Nigeria
Taxed at the rate of 20 per cent. Capital losses may not be set off against capital
gains unless the assets are sold together without specifying the sale value of individual
items.
1988] TAXATION OF CAPITAL GAINS 163

Norway
Companies: Gains on sale of land and immoveable assets taxed as ordinary income.
Exempt if reinvested within four years in other property. The four years period may be
extended on application.
Special rate of 10 per cent applies to sale of land to public authorities.
Gains on mergers taxable provided approved by tax authorities considered being
beneficial to the community.
Individuals : 30 per cent capital gains tax on profits arising from the sale of secu-
rities held for less than two years with a provision of setting-off the capital loss.

Pakistan
Companies : Gains realised on capital assets held less than a >ear taxed as ordinary
income. Gains realised on capital assets held for more than a vear taxed at 25 per cent.
Gains on sale of shares of public companies arc exempt until 30 June 1989.
Individuals : Gains realised on capital assets held less than a year taxed as ordinary
income.
Gains realised on capital assets held for moie than a >ear are subject to deduc-
tion of 60 per cent or Rs. 5,000, whichever is greater.
Panama
Companies : Special tax treatment of gains on sale of real property. Following
deductions are allowed from the gains : (i) the original acquisition cost; (ii) expenses
related to sale of the property; (Hi) an allowance of 10 percent of the original acquisi-
tion cost for each year the property was held by the seller; and (/v) the cost of any
improvements not included in the original purchase price or acquisition cost.
Individuals : Gains from sale of stocks, bonds and other securities—taxed as ordi-
nary income. Stock of companies registered with the National Securities Commission
and which has at least 25 per cent of its total assets invested in Panama, the gains are
exempt.

Peru
Taxed as oidinary income.

Philippines
Companies : Taxed as ordinary income.
Individuals : The net capital gains from the sale or disposition of real property are
subject to tax of 10-20 per cent.
Capital losses allowed to be deducted to the extent that they off-set capital gains
and a one year loss carry forward is allowed.
Portugal
Companies : Gains on sale of land taxed at 24 per cent. Other gains on sale of
fixed assets, securities rights, other property taxed at 12 per cent. In addition 15
per cent surtax is charged. Gains on mergers considered to be of national interest may be
reduced or waived. Gains on sale of shares not held with the purpose of exercising
control are exempt.

Puerto Rico
Companies : Gains realised from land held less than two years and other assets held
 164 JOURNAL OF THE INDIAN LAW INSTITUTE [Vol. 30 : 2

six months or less—taxed as ordinary income For assets held longer, corporations
report the entire amount, but if the tax on gains from these assets exceeds 25 per
cent, then an alternate method is used that limits the tax of 25 per cent.
Individuals : Gains realised from land held Jess than two years and other assets held
six months or less taxed as ordinary income. For assets held longer (other than land)
individuals report up to 40 per cent of the gains in their taxable income with a maximum
tax of 25 per cent.
For lands held for two years or longer, option to declare 40 to 75 per cent of gains
is taxable income or to pay 40 per cent tax on the gains if the land was held for seven
years or less but more than two years. Over seven years, a 25 per cent tax rate would
apply.

Singapore
No tax.

South Africa
Exempt but the tax-payer to prove that the asset was not acquired with the purpose
of reselling it.
Sweden
Companies and individuals : Gains on transfers of real property taxed as ordinary
income. Gains on sale of securities, 100 per cent taxable if held for less than two years;
40 per cent if sold after two years. Alternatively, the seller can deduct 25 per cent of the
sale value.
Gains on sale of other moveable property are taxed according to a sliding scale,
which ranges from 100 per cent (if the property has been in the seller's possession less
than two years) to no tax at all (after five years).
Gains on sale of a business or part of a business to the companies are exempt if
placed in special replacement reserves to be used within a given period for investment
in the remaining business or a new one in specified circumstances.
Taiwan
Gains on sale of machinery and other fixed assets taxed as ordinary income. Gains
on sale of land taxed under a formula related to the percentage gains over the original
cost under the Land Value Investment Tax Act.
Gains on sale of stocks or bonds exempt.

Thailand
Taxed as ordinary income for companies as well as individuals.

Turkey
Companies : Gains realised from land, building, equipment and shares—taxed as
ordinary income, Gains on sale of land and buildings exempt provided profits were
capitalised in 1984. The exempt percentage is 80 per cent for the year 1985, 1986;
70 per cent for 1987 and 60 per cent for 1988.
Individuals : Gains on the sale of land held more than four years exempt. Gains
on the sale of shares held more than a >ear exempt.

United Kingdom
Capital gain is calculated as the amount by which the proceeds from the sale of
1988] TAXATION OF CAPITAL GAINS 165

asset exceed its original cost with a provision of allowing deduction for inflation as mea-
sured by the retail price index (RPI).
Companies : Trading profits and capital gains aie computed separately. Gains
of all forms of property included in taxable income liable to corporation tax. Capital
losses cannot be set off against trading profits but trading losses may be s&t off against
capital gains arising in the same year. In certain circumstances set-off allowed, in earlier
years. In case of reinvestment of proceeds of sale of land, buildings and plant, within
12 months before or 36 months after the sale the gains are exempt. Gains are
exempt in case of mergers if the shareholders are compensated with stock or bonds
rather than cash, provided the new money continues in the same business.
Individuals : Gains exceeding pounds 6300 of all forms of property taxed at a fiat
rate of 30 per cent. Gains exempt on, (/) sale of owner occupied residences; (it) sale
of gift-edged stock and corporate bonds held over one year; (in) sale of National Savings
Certificate and government issued indexed bonds. Since the capital gains tax is asses-
sed separately from personal income-tax, capital losses cannot be set off against income-
tax liability, but can be carried forward indefinitely to offset future capital gains.

United States
Companies : Taxed as ordinary income. Capital loss cannot be deducted from
ordinary income but can be carried forward for fifteen years or back three years and
deducted from future or past capital gains.
Individuals : Taxed as ordinary income.

Uruguay
Taxed as ordinary income in the case of individual and commercial establishments.
Venezuela
Taxed as ordinary income.