Income Tax 2025

Appearance

Withdrawal of exemption in certain cases. ​

71(1) ​

The profits or gains arising from the transfer of capital asset not charged under section 67 by virtue of section 70(1)(c) and (d) shall, irrespective of anything contained in the said clauses, be deemed to be income chargeable under the head “Capital gains” of the tax year in which such transfer took place, if at any time before the expiry of eight years from the date of such transfer,—

  • (a) the transferee company converts the capital asset into, or treats it as, stock-in-trade of its business; or
  • (b) the parent company or its nominees or the holding company, ceases or cease to hold the whole of the share capital of the subsidiary company.

71(2) ​

If any of the conditions laid down in section 70(zd) or (zf) are not complied with, the profits or gains arising from the transfer of such capital asset or intangible asset not charged under section 67 by virtue of such conditions shall be deemed to be the profits and gains chargeable to tax under the head “Capital gains” of the successor company for the tax year in which such conditions are not complied with.

71(3) ​

If any of the conditions laid down in section 70(ze) are not complied with, the profits or gains arising from the transfer of such capital asset or intangible assets or share or shares not charged under section 67 by virtue of such conditions shall be deemed to be the profits and gains chargeable to tax under the head “Capital gains”of the successor limited liability partnership or the shareholder of the predecessor company, for the tax year in which such conditions are not complied with.

Explanation

Section Summary: ​

This section deals with the withdrawal of tax exemptions on capital gains in specific scenarios. It ensures that if certain conditions related to the transfer of capital assets (like shares or intangible assets) are not met, the previously exempted capital gains will become taxable. This applies to situations where the transferee company converts the asset into stock-in-trade, or when ownership structures (like parent-subsidiary relationships) change within eight years of the transfer.

Key Changes: ​

  1. New Conditions for Exemption Withdrawal: The section introduces specific conditions under which capital gains exemptions can be withdrawn. These include:

    • Conversion of a capital asset into stock-in-trade by the transferee company.
    • The parent or holding company ceasing to hold the entire share capital of the subsidiary company.
    • Non-compliance with conditions under sections 70(zd), (zf), or (ze).

  2. Extended Timeframe: The exemption can be withdrawn if the conditions are violated within eight years from the date of the transfer.

  3. Applicability to Intangible Assets and Shares: The section now explicitly includes intangible assets and shares, broadening the scope of assets covered.

Practical Implications: ​

  1. For Companies: Companies that transfer capital assets (e.g., shares, intangible assets) must ensure compliance with the conditions outlined in sections 70(zd), (zf), and (ze). Failure to comply could result in the withdrawal of capital gains exemptions, leading to additional tax liabilities.

  2. For Shareholders: Shareholders of predecessor companies or limited liability partnerships (LLPs) must monitor compliance with the conditions. Non-compliance could result in capital gains being taxed in their hands.

  3. For Tax Planning: Taxpayers must carefully structure transactions involving capital assets to avoid triggering the withdrawal of exemptions. This includes maintaining ownership structures (e.g., parent-subsidiary relationships) for at least eight years.

Critical Concepts: ​

  1. Capital Asset: Includes property of any kind (e.g., shares, intangible assets) held by a taxpayer, whether or not connected with their business or profession.
  2. Stock-in-Trade: Assets held for sale in the ordinary course of business, as opposed to being held as investments.
  3. Deemed Income: Income that is treated as taxable even if it was previously exempt, due to non-compliance with specific conditions.
  4. Interplay with Section 70: This section interacts with conditions laid out in sections 70(zd), (zf), and (ze), which provide exemptions for capital gains under certain circumstances.

Compliance Steps: ​

  1. Monitor Ownership Structures: Ensure that the parent or holding company continues to hold the entire share capital of the subsidiary company for at least eight years.
  2. Avoid Conversion to Stock-in-Trade: If a capital asset is transferred, the transferee company should avoid converting it into stock-in-trade within eight years.
  3. Document Compliance: Maintain records to demonstrate compliance with the conditions under sections 70(zd), (zf), and (ze).
  4. Report Non-Compliance: If conditions are violated, report the deemed capital gains in the relevant tax year.

Examples: ​

  1. Scenario 1: Company A transfers shares of its subsidiary, Company B, to Company C. Company C converts these shares into stock-in-trade within five years. Under this section, the capital gains exemption previously claimed by Company A will be withdrawn, and the gains will be taxed in the year of conversion.

  2. Scenario 2: A parent company transfers intangible assets to its subsidiary but sells a portion of its shareholding in the subsidiary within six years. Since the parent no longer holds the entire share capital, the capital gains exemption is withdrawn, and the gains are taxed in the year of the share sale.

  3. Scenario 3: A limited liability partnership (LLP) fails to comply with the conditions under section 70(ze) within eight years of transferring shares. The capital gains exemption is withdrawn, and the gains are taxed in the hands of the LLP or its shareholders in the year of non-compliance.