Calculation of the tax liability is complicated. Even tax officers grapple with it.
A friend sold his inherited house. I was asked to work out the capital gains. A week later, I was still calculating.
Section (47iii) of the Income Tax Act states that any transfer of a capital asset under a gift or a will does not attract capital gains tax. In other words, my friend will not have to pay capital gains tax on the inherited house.
| Transaction details | (Rs/lakh) | |
| 6/7/1983 | Purchase date and price | 1 |
| 6/7/1986 | Date and cost of adding room | 2 |
| 6/7/1990 | Date of Inheritance and value | 10 |
| 6/7/2010 | Date of sale and value | 50 |
| Computing capital gains | Rs | |
| A | Sale Value | 50,00,000 |
| B | Indexed cost of purchase [1 lakh x (711/182)] | 390,659 |
| C | Indexed cost of adding room [2 lakh x (711/182)] | 10,15,714 |
| Capital Gain [A - (B+C)] | 35,93,627 |
However, problems arose in the second leg of the transaction - when the flat was sold. Typically, if the inheritor were to eventually sell the property, the cost and the date of acquisition for capital gains purposes is to be taken as that of the ‘the previous owner’.
Section 48 sets the cat amongst the pigeons. Explanation (iii) defines ‘indexed cost of acquisition’ to mean an amount which bears to the cost of acquisition the same proportion as the cost inflation index for the year in which the asset is transferred bears to the cost inflation index for the first year in which the asset was held by the assessee or for the year beginning on the first day of April, 1981, whichever is later.
Simply put, for calculating long-term capital gains, you may use the higher of the indexed cost or the cost on April 1, 1981.
Explanation (iv) defines ‘indexed cost of any improvement’ to mean an amount which bears to the cost of improvement the same proportion as the cost inflation index for the year in which the asset is transferred bears to the cost inflation index for the year in which the improvement to the asset took place.
ILLUSTRATION
My friend’s father bought the house on July 6, 1983 for Rs 1 lakh. On July 6, 1986, he spent Rs 2 lakh for a room. He passed away on July 6, 1990. The market value of the house then was Rs 10 lakh. My friend sold the house on July 6, 2010 for Rs 50 lakh.
Let us first compute the indexed cost of the house. The market value of the house in 1990-91, the first year in which the asset first came into my friend’s possession, was Rs 10 lakh. This is of no consequence. His cost of acquisition, as per Section 47(iii), is Rs 1 lakh, (that his father paid in 1983-84). So, the date of acquisition would be July 6,1983.
The cost inflation index of 2010-11 is 711 and of 1983-84 is 116. Therefore, the indexed cost is Rs 612,931 (100,000 x 711/116). But, there is an oversight.
The date of acquisition of the house for my friend is July 6,1983 but that is not clear. The index for the year in which my friend first held the asset is required to be taken for computation. The house came into my friend’s possession in 1990-91 and the index for that year is 182. Therefore, the indexed cost is Rs 390,659 (100,000 x 711/182) and not Rs 612,931 as computed earlier.
Now, we need the indexed cost of improvement. If we extend the same principle here, we will be making a mistake. Re-examine the Explanation (iv) to get a clearer picture. It will tell you, unlike previously, the index to be considered is that of 1986-87, the year in which the improvement of Rs 200,000 was carried out. The index for 1986-87 is 140 and the indexed cost is Rs 10,15,714 (200,000 x 711/140).
Ergo, the total indexed cost is Rs 14,06,373 (390,659 + 10,15,714).
If you are confused, do not worry. Anyone would be, including the income tax officers. Meanwhile, it is the hapless taxpayers who suffer.
The writer is director, Wonderland Consultants
