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What Are Capital Assets As Per Income Tax Act In India

Updated on January 24, 2018
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Currently pursuing a professional course in Assurance. I have practical knowledge and experience in audit, systems control and accounting.

Why is it important to know about capital assets?

The Income Tax Act 1961 provides a clear definition of Capital Assets under section 2(14) which is very comprehensive. It is a very peculiar definition which requires a little interpretation to actually understand what capital assets really are. You may ask yourself why should you bother with the definition of capital assets, but the fact is this definition is all that stands between you and the tax authorities when you sell or transfer a capital asset. If you fail to pay capital gains tax in the year in which you transfer a capital asset, you will be liable to penalty. Also once you know what capital assets are, you can actually plan any transfer of assets accordingly so that you get the maximum tax benefit.

International Taxation: The Indian perspective (SpringerBriefs in Law)
International Taxation: The Indian perspective (SpringerBriefs in Law)

This book is highly recommended for its in depth coverage of capital gains and tax issues regarding cross border taxation and their implications. Several case laws have been quoted and explained too. For those who have multiple business establishments in India and abroad, this is a must have reference source. I have used this for both exam and professional practice purposes and it is quite comprehensive. It also deals with Foreign Institutional Investment, Non resident taxation, exemptions and benefits, Foreign currency exchange bonds, Rupee denominated bonds and other securities issued outside India by Indian companies.

 

The Definition

The Income Tax Act 1961 defines capital assets as:

a.) "Any property or assets held by the Assessee, whether connected with business or not,

b.) Securities held by Foreign Institutional Investors (FIIs).

But excludes:

  1. Inventory
  2. Personal movable items of the Assessee and any person dependent on him, but excludes - Jewellery, drawings, sculptures, paintings, archeological artifacts and any other works of art
  3. Rural agricultural land
  4. Gold bonds 1999 or Gold deposit certificates of gold monetization scheme 2015."

Jewellery - a capital asset
Jewellery - a capital asset
Land is an immovable capital asset
Land is an immovable capital asset

Any property or assets held....

The first part of the definition clearly indicates that all the properties and assets of any person shall be covered. Oh by the way assessee means any individual, company or any other artificial juridical person as per the law. It also mentions that the properties or assets held may or may not be connected with business. This is interesting to note because when people say capital assets, we generally start thinking along the lines of machines or other gadgets used by companies to produce goods or render services. But deeper interpretation is needed to truly understand this point.

For a baker, who bakes bread, his oven would be a capital asset. This is because, only by using his oven, he is able to produce goods (which is bread) for sale. However, an oven is a common machine found in most of our houses. Does this make oven a capital asset for us? Nope. But the definition says whether or not connected with business. Confused? No need to be. To understand this, we must look at point 2 of the exclusions. It excludes all movable personal items except for some (Jewellery, sculptures, drawings, paintings, archeological collections and other works of art).

Perhaps a more apt example would be land. You see, land is a capital asset for a business as well as for an individual. So if you hold land which may or may not be connected with your business, it is a capital asset. But land is immovable. What about movable assets which are capital assets? Easy, they have already given you movable items that are capital assets - Jewellery, sculptures, drawings, paintings, archeological collections and other works of art. Do you own a famous painting, perhaps one by Leonardo Da Vinci? It doesn't matter whether you hang it in your house or in your office. It remains a capital asset.

Securities held by FIIs

Several Foreign Institutional Investors invest in Indian shares and securities. The Income Tax Department has clearly indicated that all such investments specifically in shares and securities shall be considered as capital assets. This point was added in the definition because investors often claimed that they held securities as inventory and not as capital asset (The oven example). A change in the nature of the assets from capital to inventory meant that the department could not tax the sale of such assets as it fell outside the purview of a capital asset. To compensate for this, point b was added in the definition. This means that irrespective of whether the FII held shares or securities as a capital asset or not, it would remain a capital asset in the eyes of the tax department. If you are wondering how shares can be held as inventory, think of securities trading companies. The ones whose sole business is to buy and sell securities. For such companies, purchase and sale of securities is in the normal course of business and therefore forms part of inventory.

The exclusions

  1. Inventory - As you guys clearly saw above, inventory has been specifically excluded from the definition of a capital asset. Inventory simply means any goods that are meant for sale in the ordinary course of business, or are in the process of such production, or consumed during production. So for a car manufacturer, cars would be inventory. For a jeweler, gold and jewels would form part of inventory (however for a normal person gold, precious stones and precious metals remain a capital asset). So it is the intended use of an asset that is important for deciding if it is inventory or not.
  2. Personal movable items - This point has already been covered in our explanation above. Personal movable items means clearly the asset should be movable and have a very personal attachment with the assessee. A car is an example. But gold is not an example as it is clearly excluded.
  3. Rural agricultural land - Even though immovable property has been clearly understood as a capital asset, it excludes land located in rural areas. This has been done specifically to help farmers buy or sell land without the burden of payment of taxes. Also almost all agriculture related income is also exempted from tax.
  4. Gold bonds - These are basically bonds issued by the Government as alternatives to invest in gold. They have the benefit of easy trading and regular fixed returns. The bonds are pegged to the gold rate in the market and therefore achieve capital appreciation too.

In conclusion

Any asset not covered by the above definition of capital asset are not chargeable to tax under capital gains. However, they may still be liable to tax under other heads of income such Profits or Gains from Business or Profession or Income From other Sources. Well folks, see you next time with more tax knowledge!

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