Capital gains on compulsory acquisition of immovable property

Introduction

Where a capital asset is acquired by the Government under any law or where consideration for transfer of capital asset is determined or approved by the Government or RBI, the capital gains shall be chargeable to tax in the tax year in which initial compensation (or part thereof) is received.

1. Scope of provision [Section 67(12)]

If a capital asset is compulsorily acquired by the Government, or where the consideration for such transfer is to be determined or approved by the Government or the Reserve Bank of India, it shall be deemed that the capital asset is transferred during the tax year in which compulsory acquisition has taken place.

When the owner of the capital asset is not satisfied with the amount of compensation, he can approach the judicial authorities to enhance it. When compensation is enhanced, the capital gains computed originally shall not be re-computed. The capital gains shall be computed separately for the enhanced compensation part only and it shall be taxable on receipt basis.

2. How to calculate capital gains?

2.1. Capital gains in case of original compensation

The capital gains from original compensation shall be computed in the following manner:

2.2. Capital gains in case of enhanced compensation

3. Factors for calculation of capital gains

Any profits or gains arising on compulsory acquisition of capital assets shall be chargeable to tax under the head capital gains in the tax year in which such transfer takes place. For computation of capital gains in such case, the following factors are considered:

(a) Period of holding;

(b) Full value of consideration;

(c) Cost of acquisition;

(d) Cost of improvement;

(e) Expenditure incurred in connection with transfer;

(f) Adjustment for the capital gains taxed under Section 67(10);

(g) Exemptions allowed under Section 82 to 88.

It should be noted that indexation was also a key factor for computing long-term capital gain from the transfer of immovable property. However, the Finance (No. 2) Act, 2024 removed the indexation benefit and introduced a uniform tax rate of 12.5% on long-term capital gains under Income-tax Act, 1961. This change was made to simplify capital gains computation for both taxpayers and the tax authorities.

However, to ease the transition to these new rules, the Government introduced a grandfathering provision. This provision allows resident individuals and resident HUFs to still apply indexation on land or building acquired before 23-07-2024 and pay tax at the old rate of 20% if the tax under the new law (i.e., tax calculated at 12.5% without indexation benefit) results in a higher amount.

This simplified framework has also been continued under Income-tax Act, 2025.

3.1. Computation of period of holding

The period of holding of asset transferred shall be counted from the date of purchase or acquisition till the date of compulsory acquisition of capital asset. In subsequent computation of capital gain in respect of enhanced compensation, the nature of capital gain is determined with reference to first computation. Thus, if the capital gain under first computation was long-term, it will remain so in subsequent computation also.

3.2. Computation of full value of consideration

The compensation received or receivable by the assesse in respect of the compulsorily acquisition of capital asset will be treated as full value of consideration for the purpose of computing the capital gains in respect of original compensation.

Similarly, the enhanced compensation received by the assesse in respect of the compulsorily acquisition of capital asset will be treated as sales consideration for the purpose of computing the capital gains in respect of enhanced compensation.

3.3. Computation of cost of acquisition

The cost of acquisition of the capital asset transferred by way of compulsory acquisition shall be computed as per general provisions.

Where compensation is received in installments, the cost of acquisition is allowed to be deducted in full in the year in which first installment is received. It is not to be apportioned over different instalment. If the assessee incurs realization expenses or legal expenses in respect of subsequent instalments, the deduction is allowed for such expenses in computing capital gain.

For computing capital gain from enhancement compensation, cost of acquisition and cost of improvement is taken at nil. Thus, only realization expenses may be claimed as deduction in computing capital gain from enhancement of compensation.

3.4. Computation of cost of improvement

The cost of improvement of the capital asset transferred by way of compulsory acquisition shall be computed as per general provisions.

3.5. Indexed cost of acquisition or improvement

The indexation benefit is no longer available for computing long-term capital gains on capital assets. However, the Government has introduced a grandfathering provision. This provision allows resident individuals and resident HUFs to still apply indexation on land or building acquired before 23-07-2024, but only if the tax calculated without indexation results in a higher amount.

Thus, where the grandfathering provision applies, the "Indexed Cost of Acquisition" and the "Indexed Cost of Improvement" are used to compute the capital gain instead of the original cost of acquisition and improvement.

3.6. Adjustment for the capital gain taxable under Section 67(10)

Where the amount is chargeable to tax as income of partnership firm under Section 67(4), the firm shall attribute such amount to the capital asset remaining with it, including capital assets forming part of block of asset. Such attribution is allowed, at the time of computation of capital gains from the transfer of such capital asset remaining with the partnership firm, by way of deduction under Section 72(5). The deduction under Section 72(5) is allowed if the following conditions are satisfied:

(a) There should be a reconstitution of the partnership firm;

(b) Capital asset or money or both should be given to the partner on such reconstitution;

(c) Capital gain is computed and taxed in the hands of the firm under Section 67(10); and

(d) The book value (or historical value or WDV) of at least one of the capital assets remaining with the firm after such reconstitution should be less than its fair market value. It may also include the self-generated asset.

The amount chargeable to tax under Section 67(10) shall relate to revaluation of any capital asset or valuation of self-generated asset or self-generated goodwill of firm if the revaluation is based on a valuation report obtained from a registered valuer defined under Rule 56.

3.7. Computation of exemptions

Certain exemptions can be claimed under Sections 82 to 88 from the capital gains arising from transfer of capital asset by way of compulsory acquisition subject to fulfilment of certain conditions.

3.8. Year in which taxable

Capital gain is chargeable to tax in the tax year in which such compensation or part thereof is first received. Thus, capital gain is chargeable to tax on receipt basis. If any amount of compensation is to be received in pursuance of an interim order of a Court or Tribunal, it is chargeable to tax in the tax year in which the final order of such Court or Tribunal is made.

Where compensation is enhanced or further enhanced by any court, or Tribunal or other authority, the capital gain resulting from enhancement of compensation is also taxable on receipt basis.

4. Others

4.1. Capital gains if enhanced compensation is received by another person

Where due to the death of original transferor or for any other reason, enhanced compensation is received by any other person, the recipient of such compensation is taxable on such capital gain.

4.2. Capital gains if compensation is reduced

Where compensation is reduced subsequently by any Court or Tribunal or other authority, the assessed capital gain of that year is re-computed with reference to the reduced compensation, taking it as the full value of consideration.

4.3. Capital gains in case of dispute on amount of compensation

Compensation or enhanced compensation shall be taxable in the tax year in which it is received, even if such compensation is subject-matter of dispute. Where amount of compensation is subsequently reduced by any Court, Tribunal or other authority, the capital gain of that year, in which compensation received was taxed, shall be recomputed.

In such a case, the Assessing Officer shall re-compute the capital gain under Section 288 within 4 years from the end of the tax year in which order reducing the compensation was passed by the court, Tribunal or other authority.

References

Resident individuals and HUFs may opt for the benefit of indexation while computing long-term capital gains arising from the transfer of land or building acquired before 23-07-2024, where the tax without indexation exceeds the tax computed with indexation.

Resident individuals and HUFs may opt for the benefit of indexation while computing long-term capital gains arising from the transfer of land or building acquired before 23-07-2024, where the tax without indexation exceeds the tax computed with indexation.

This article is general information and not tax advice. Provisions change. Confirm your position with a qualified professional before acting.