Computation of capital gains in case of insurance receipts

Introduction

Receipt of insurance claim on destruction or damage of a capital asset gives rise to capital gain even though there is no transfer of capital asset. The capital gain in such a case is charged to tax in the tax year in which compensation is received.

1. Scope of provision [Section 67(2) & (3)]

If an asset is damaged or destructed in any of the following circumstances and the compensation is received from the insurance company, it shall be deemed that the capital asset is transferred during the year:

(a) Flood, typhoon, hurricane, cyclone, earthquake, or other convulsion of nature;

(b) Riot or civil disturbance;

(c) Accidental fire or explosion; and

(d) Action by an enemy or action taken in combating an enemy (whether with or without a declaration of war).

If a capital asset is destroyed in any circumstance other than as referred to above, the compensation received from the insurance co. shall not be chargeable to tax

Example, if in an accident vehicles, machinery and stock are destroyed, the receipt of insurance compensation in respect of vehicle and machinery shall not be charged to tax under this provision. However, the receipt of insurance compensation in respect of stock shall be charged to tax as business income.

This provision shall not apply in case of depreciable assets. Computation of capital gain/loss in respect of depreciable assets shall be governed by Section 74 which contains provisions regarding treatment of money received from insurance claims while determining the WDV of the block of assets, or while computing the capital gain or loss.

2. How to calculate capital gains?

The capital gains shall be computed in the following manner:

3. Factors for calculation of capital gains

Any profits or gains arising from receipt of any compensation from an insurer due to damage or destruction of any capital asset shall be chargeable to tax under the head capital gains in the tax year in which such compensation is received. For computation of capital gains in case of receipt of insurance compensation, 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 the indexation was traditionally allowed under the Income-tax Act when calculating long-term capital gain unless specifically restricted. 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 to simplify the computation of capital gains.

However, to ease the transition, the Government introduced a grandfathering provision which provides a specific relief to resident individuals and resident HUFs in respect of land or building (or both) acquired before 23-07-2024. In such cases, the taxpayer has the option to compute tax either:

(a) at 12.5% without indexation benefit; or

(b) at 20% after claiming indexation benefit.

This simplified framework has also been continued under ITA 2025. Thus, no indexation benefit shall be available in respect of capital assets damaged or destroyed except where the grandfathering provision applies.

3.1. Computation of period of holding

The period of holding of the capital asset shall be counted from the date of purchase or acquisition till the date of damage or destruction of such asset. It should be noted that while the capital gain from receipt of insurance claim on account of damage or destruction of capital asset is taxable in the year of receipt of insurance of claim, the holding period is still counted up to the date of damage or destruction of such asset. The definition of transfer under Section 2(109) is crucial for determining whether damage or destruction of a capital asset amounts to transfer.

3.2. Computation of full value of consideration

Insurance compensation may be received in money or in kind or in both. Where it is received in kind, market value of the property is taken as the full value of consideration for the purposes of computing capital gain. Where it is received partly in money and partly in kind, the aggregate of money value and the market value of the property is deemed to be the full of consideration for the purposes of computing capital gain.

3.3. Computation of cost of acquisition

The cost of acquisition of the capital asset damaged or destructed in the specified circumstances shall be computed as per general provisions.

3.4. Computation of cost of improvement

The cost of improvement of the capital asset damaged or destructed in the specified circumstances 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 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

On reinvestment of capital gains or sales consideration, certain exemptions can be claimed from the capital gains arising on receipt of insurance compensation subject to fulfilment of certain conditions.

3.8. Year in which taxable

Liability to pay tax on the capital gain shall arise in the tax year in which insurance claim is received on account of damage or destruction of a capital asset. Thus, where insurance claim was accepted in the year 2025–2026 but it is received in the tax year 2026–2027, the capital gain is taxable in the tax year 2026–2027

3.9. Tax Rates

Long-term capital gain arising on transfer of a capital asset shall be taxable at the rate of 12.5%. However, the resident individual and resident HUF have the option to pay tax at the rate of 12.5% without indexation benefit or 20% with indexation benefit on long-term capital gain from land or building acquired before 23-07-2024.

Short-term capital gain shall be taxable at normal rate applicable to an assessee.

References

Vania silk mills (P) Ltd. V. CIT [1991] 59 Taxman 3 (SC)

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.