In public interest, both the Central and state government acquires private land also known as a compulsory acquisition.
For acquiring private land, governments are required to pay compensation and also rehabilitate and resettle the affected persons in India.
A person needs to pay capital gain tax on the profit portion of the compensation received under compulsory acquisition.
In this article, we will cover the taxation of compensation received from the compulsory acquisition and its exemption under section 54D.
Capital Gain Tax on Compensation [Section 45(5)]
We will learn Capital gain tax on compulsory acquisition when:
- It is acquired under any law, or
- The compensation is approved or determined by the Central Government or the Reserve Bank of India, or [State govt. is not covered]
- Any compensation enhanced or further enhanced by any court, Tribunal or other authority.
Calculation of Capital Gain Tax
|Cost of acquisition or indexed cost of
acquisition (in case of long term capital asset)
|Cost of improvement or indexed cost of
improvement (in case of long term capital asset)
|Long term or short term capital gain||xx|
There are 4 type of compensation under compulsory acquisition
- Initial Compensation
- Enhanced Compensation
- Compensation under Interim Order
- Reduced Compensation
Initial compensation refers to the compensation awarded initially by the central govt. or RBI.
Capital gain tax is payable on this compensation in the year in which such compensation (or part thereof) is first received.
Further, for computing capital gain, initial compensation is taken as full value of consideration.
From the full value of consideration, cost of acquisition and cost of improvement should be deducted to arrive at the value of capital gain.
Example: Indian Railway acquires an agricultural Land of Mr. Yogeswar Lal for Rs.100 Lakh in the financial year 2017-18 (AY 2018-19) and compensation of Rs.80 lakh is received in the financial year 2018-19 (AY 2019-20).
The capital gain shall be taxable in the financial year 2018-19 (AY 2019-20) for the full sales consideration i.e Rs.100 lakh in this case.
Enhanced compensation refers to a compensation awarded in addition to the initial compensation.
This compensation is awarded by the court, Tribunal or other authority.
Similar to initial compensation, enhanced compensation is also taxable in the year of receipt.
While computing capital gain, any litigation expenses for getting the compensation enhanced are deductible from the compensation received.
In this case, the cost of acquisition and the cost of the improvement shall be taken as zero (0).
If the enhanced compensation is received by any other person due to death of the transferor or any other reason, it would be taxable as income of the recipient under the head “Capital Gain”.
Enhanced compensation can be short term or long term capital gain depending upon the nature of original capital gains.
Compensation under Interim Order
The amount of compensation received in pursuance of an interim order of the court, tribunal or other authority shall be chargeable to tax in the year in which the final order of such court, Tribunal or other authority is made.
Subsequent to the sanction of compensation, both initial and enhanced compensation can be reduced by any court, Tribunal or other authority.
In this case, the capital gain should be recomputed for the assessment year to which such compensation originally relates.
Interest on Compensation from Compulsory Acquisition
Interest on late receipt of compensation is taxable under the head “Income from other sources”. [u/s 56(2)(viii)]
However, 50% of this interest shall be exempted. [u/s 57(iv)]
Such interest would be taxable in the year of receipt. [u/s 145B]
The Central Government acquires a house property owned by X on October 17, 1995. This property was purchased on April 10, 1976 for Rs.76000 ( cost of improvement incurred during 1986-87: Rs.40000 and Fair market value of the property on April 1, 1981 was Rs. 1,42,000).
The Government awards Rs.5,77,000 as compensation which is received partly(Rs.77,000) on May 13, 2014 and partly (Rs.5,00,000) on April 1,2015.
Being Aggrieved against the award, X files an appeal. The court, as per order dated August 12, 2016, enhanced the compensation from Rs.5,77,000 to Rs.9,50,000(legal expenses incurred by X: Rs.20,000). X received the additional compensation of Rs.3,73,000 on April 15,2017.
Compute the Income of X under the head “Capital Gains”. Does it make any difference if the additional compensation is received by his sons A and B (in 1:1) on April 2017 after the death of X?
For Assessment year 2015-16 [Financial year 2014-15]
|indexed cost of acquisition(note 1)||399020|
|indexed cost of improvement(note 2)||80286|
|Long term capital gain||97694|
Note 1: Indexed cost of acquisition= 142000*[281(CII 1995-96) / 100(CII 1981-82)] = 3,99,020/-
Note 2: Indexed cost of Improvement= 40000*[281(CII 1995-96)/140(CII 1986-87)]= 80,286/-
For Assessment year 2018-19 [Financial year 2017-18]
|cost of acquisition||0|
|cost of improvement||0|
|Expenses on transfer (legal expenses)||20000|
|Long term capital gain||353000|
If the additional compensation is received by A and B, after the death of X, then 50% of Rs.3,53,000/- will be taxable in the hand of A and likewise, 50% will be taxable as income of B for the assessment year 2018-19.
Exemption of Capital Gain on Compulsory Acquisition [Section 54D]
Capital Gain tax is exempted if a land or building belongs to an industrial undertaking and the taxpayer within a period of 3 years after the date of compulsory acquisition purchase any other land or building or any right in any other land or building or construct any other building for the purposes of shifting or re-establishing his old industrial undertaking or setting up another industrial undertaking.
The asset acquired under compulsory acquisition must have been used by the taxpayer for his industrial undertaking for 2 years immediately preceding the date on which the acquisition took place.
The amount of exemption will depend on the cost of new land and building. (new asset)
When Cost of New Land or Building (new asset) is less than Capital Gain
Where the cost of new land or building is less than the capital gain, the difference between the amount of the capital gain and the cost of the new asset shall be charged under the head “Capital Gains” of the year in which new land or building is acquired.
If the new asset is sold within 3 years of its purchase or construction then for calculating capital gain, the cost of acquisition of new asset shall be taken as zero (0).
When Cost of New Land or Building (new asset) is equal to or more than Capital Gain
Where the cost of new land or building is equal to or more than the capital gain, the whole amount of the capital gain will be exempted.
If the new asset is sold within 3 years of its purchase or construction then for calculating capital gain, the cost of acquisition of new asset shall be reduced by the amount of capital gain.
Long-term capital gain: Rs.10,00,000/-
Cost of New Assets: Rs.12,00,000/-
If the new asset is sold within 3 years of its purchase then the revised cost of new asset will be Rs.2,00,000/- [12 lakh less 10 lakh]
This reduction of cost will increase capital gain tax on sale of new asset.
The amount of the capital gain which is not utilised by the taxpayer for the purchase or construction of the new asset before the due date of furnishing the income tax return (ITR), shall be deposited by him before furnishing such return and within the due dates in bank or institution as may be specified in, and utilised in accordance with, any scheme which the Central Government may, by notification in the Official Gazette, frame in this behalf and such return shall be accompanied by proof of such deposit.
The amount utilised for the purchase or construction of the new asset together with the amount so deposited shall be deemed to be the cost of the new asset.
The deposited amount should be used within 3 years from the date of compulsory acquisition.
If the amount is not used within the said period then the un-utilized amount will be charged under the head “Capital Gain” in the year in which the period of 3 years expires.