Important Keyword: Capital Gains Exemption, Compulsory Acquisition, Section 54D.

Section 54D: Capital Gain Exemption on Compulsory Acquisition

The Indian government undertakes numerous development projects nationwide to address infrastructure needs, foster economic growth, enhance living standards, and achieve sustainable development objectives. In some cases, these projects may require compulsory acquisition, also known as eminent domain or compulsory purchase, of land and buildings. Property owners affected by such acquisitions are entitled to fair compensation, which often results in capital gains.

To alleviate the tax burden on these gains, the Income Tax Act includes a provision under Section 54D that allows taxpayers to claim a capital gain exemption on income derived from the compulsory acquisition of land or buildings forming part of an industrial undertaking.

This exemption serves to support property owners who may face financial challenges due to the loss of their land or buildings for public development projects. By providing relief from capital gains tax, Section 54D aims to ensure that individuals and businesses affected by compulsory acquisition are not unduly burdened by tax liabilities, thereby facilitating smoother transitions and fair compensation for their assets.

Capital Gains investment under Section 54D.

When the government exercises its power of compulsory acquisition over land, the landowner becomes liable to pay tax on any resulting capital gains. However, Section 54D of the Income Tax Act provides relief by granting an exemption for such gains. This exemption applies to capital gains arising from the compulsory acquisition of land or buildings that form part of an industrial undertaking.

Under Section 54D, taxpayers can claim an exemption on the capital gains generated from compulsory acquisition if they reinvest the proceeds into acquiring land or building for the purpose of shifting or reestablishing the industrial undertaking. This provision aims to support affected landowners by easing the tax burden associated with the compulsory acquisition process, thereby facilitating the relocation or continuation of their industrial activities.

Eligibility to claim an exemption under Section 54D

Under Section 54D of the Income Tax Act, taxpayers can seek exemption from capital gains arising from the compulsory acquisition of land or buildings integral to industrial undertakings, provided they fulfill the following criteria:

1. Eligibility: Any taxpayer, whether an individual, Hindu Undivided Family (HUF), company, Limited Liability Partnership (LLP), firm, etc., is eligible to claim exemption under Section 54D.
2. Compensation Receipt: The taxpayer must have received compensation for the compulsory acquisition of land, building, or any rights associated with them, which are part of an industrial undertaking.
3. Industrial Use: The land or building in question must have been utilized for industrial purposes for a minimum of two years immediately preceding the compulsory acquisition.
4. Reinvestment: Within three years from the date of transfer, the taxpayer must invest in acquiring new land or building, rights in land or building, or construct a new building. This investment should be for the purpose of either relocating or re-establishing the existing industrial undertaking or setting up a new one.

Taxpayers can claim this capital gain exemption under Section 54D while filing their Income Tax Returns for the relevant financial year. They need to use Income Tax Returns-2 on the income tax portal and ensure submission before the due date of July 31st. This provision aims to provide relief to individuals and entities affected by compulsory acquisitions, facilitating their transition or continuation of industrial activities.

Quantum of exemption under Section 54D

In the case of Akash, who acquired land for an industrial undertaking in June 2004 for INR 3,50,000 and had it compulsorily acquired by the state government for INR 13,00,000 in January 2024, the amount of exemption under Section 54D will be determined as follows:

1. Cost of New Asset: Akash purchased another land for the industrial undertaking at INR 2,00,000 in March 2024.
2. Capital Gains: The capital gains arising from the compulsory acquisition of the old land, which is INR 13,00,000.

The amount of exemption under Section 54D will be the lower of these two values. In this case, since the capital gains from the compulsory acquisition exceed the cost of the new asset, the amount of exemption will be INR 2,00,000. This provision ensures that taxpayers receive relief proportional to the reinvestment made in their industrial activities, facilitating the continuity and growth of their enterprises.

The amount of exemption under Section 54D will be:

Under Section 54D, taxpayers who claim exemption for capital gains arising from the compulsory acquisition of land or buildings forming part of an industrial undertaking are subject to a lock-in period of 3 years.

The consequences of transferring the new industrial undertaking within this period are as follows:

1. Sale of New Industrial Undertaking Before 3 Years:
   • If the taxpayer sells the new industrial undertaking within 3 years from the date of purchase or construction, and the cost of the new property is less than the capital gains, the exemption under Section 54D is withdrawn.
   • The total sales value of the new property becomes taxable as capital gains, with the cost of acquisition being considered as NIL.
2. Sale of New Industrial Undertaking Before 3 Years (Cost of New Property > Capital Gains):
   • If the taxpayer sells the new industrial undertaking within 3 years from the date of purchase or construction, and the cost of the new property exceeds the capital gains, the exemption under Section 54D is withdrawn.
   • However, the taxpayer can claim the cost of acquisition (Total Purchase Price – Exemption under Section 54D) while calculating capital gains.
3. Sale of New Industrial Undertaking After 3 Years:
   • If the taxpayer sells the new industrial undertaking after 3 years from the date of purchase or construction, the exemption under Section 54D is retained.
   • The taxpayer can claim the index cost of acquisition while calculating capital gains on the sale of the new industrial undertaking. However, they must pay income tax on capital gains at the rate of 20%.

These provisions aim to ensure that taxpayers adhere to the intended purpose of the exemption and encourage long-term investment in industrial activities.

CGAS Scheme for claiming exemption under Section 54D

Under Section 54D, taxpayers can utilize the Capital Gains Account Scheme (CGAS) to claim exemptions. If a taxpayer cannot fully utilize the sales proceeds for the purchase or construction of a new industrial undertaking by the due date of submitting the Income Tax Return, they should deposit the funds into the Capital Gains Deposit Account Scheme (CGAS). The taxpayer can then claim an exemption for the amount already utilized for construction or purchase, along with the amount deposited in CGAS.

It is crucial to understand that if the taxpayer fails to utilize the amount deposited in the Capital Gains Account Scheme within the stipulated 3-year period, it will be taxable as income in the last year. This provision ensures timely and appropriate utilization of funds earmarked for industrial development, aligning with the intent of promoting long-term investment in industrial activities.

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Official Income Tax Return filing website: https://incometaxindia.gov.in/