Circular No. 721-Income Tax Dated 13-9-1995

SECTIONS 112, 115A, 115AC, 115AD,
115B AND 115BBA

Determination of Tax in
certain Special Cases

SECTION 112 – TAX ON LONG-TERM CAPITAL GAINS

731. Clarification regarding computation of tax in respect of long-term capital gains under section 112

1. Section 112 was inserted in the Income-tax Act by the Finance Act, 1992 with effect from 1-4-1993. It provides that where the total income of an assessee includes any income, arising from the transfer of a long-term capital asset, which is chargeable under the head “Capital gains”, the tax payable by the assessee on the total income shall be the aggregate of,—

     (i)   the amount of income-tax payable on the total income as reduced by the amount of such long-term capital gains; and

   (ii)   the amount of income-tax calculated on such long-term capital gains at appropriate rates.

2. Doubts have been expressed in some quarters about interpreta­tion of the provisions of section 112. Some people are interpret­ing the provisions of section 112 in such a manner that the tax payable on long-term capital gains is to be computed on the entire amount of long-term capital gains without applying the provisions of set-off of loss contained in section 71(2) where there is loss under any other head. As a result, it has been interpreted that the provisions of section 112 will override those of section 71, effectively denying the benefit of set-off of loss from a source other than “capital gains” with income from long-term capital gains. It is also interpreted that even if the facility of set-off of loss under any other head is allowed with the long-term capital gains, the flat rate of tax will be ap­plicable to the whole of the long-term capital gains. That means while the whole of long-term capital gains will be subject to tax, the amount of loss which has been set-off in terms of sec­tion 71(2) will not be allowed to be carried forward.

3. The confusion in interpreting the provisions of section 112 is arising mainly from the interpretation of the initial part of section 112 :

‘Where the total income of an assessee includes any income aris­ing from the transfer of a long-term capital asset, which is chargeable under the head “Capital gains”…’

The above phraseology contains two significant expressions, “total income” and “includes any income”. The total income is to be computed in the manner prescribed in the Income-tax Act. Set-off of loss as per the provisions of sections 70 to 80 is a stage which is part of this procedure. When this procedure is adopted for computing gross total income or total income, only the amount of income after set-off remains under a head as part of gross total income or total income. Only that amount of long-term capital gains which is included in the total income would be subject to tax at a prescribed flat rate. Thus, if there was a loss of Rs. 10,000 from business and there is long-term capital gains of Rs. 30,000, then after setting off of loss of Rs. 10,000 with long-term capital gains, only Rs. 20,000 would remain under the head “Capital gains” to be included in the gross total income or total income. The flat rate of tax will be applicable in respect of Rs. 20,000 and not Rs. 30,000, since the amount of long-term capital gains included in that total income is Rs. 20,000. (Here it is assumed that the total income ignoring, long-term capital gains, is above the exemption limit).

4. The following illustrations will clearly show the correct interpretation of the provisions of section 112 :

Computation of tax on long-term capital gains :

There would be no income under the head “Capital gains” after business loss has been set-off with long-term capital gains. Hence, there would be no tax in this case.

Circular : No. 721, dated 13-9-1995.