Important Keyword: Capital Gain Exemption, Sale of Property, Section 54GB.
Table of Contents
Introduction
In recent years, India’s startup ecosystem has experienced rapid growth, with entrepreneurs increasingly seeking innovative ways to fund their ventures. One of the lesser-known yet powerful provisions in the Income Tax Act, 1961, Section 54GB, offers a unique incentive: capital gains tax exemption on the sale of residential property, provided the proceeds are invested in eligible startups. This section aims to encourage entrepreneurship and redirect personal wealth into productive business ventures.
In the realm of tax exemptions, the Income Tax Act offers avenues for relief on capital gains, with one such provision found in Section 54GB. This particular section extends a helping hand to individuals or Hindu Undivided Families (HUFs) grappling with capital gains resulting from the sale of a residential property.
What is Section 54GB?
Section 54GB of the Income Tax Act provides capital gains tax exemption on the sale of a long-term residential property (house or plot of land), if the net consideration is invested in the equity shares of an eligible startup. The rationale is to incentivize individuals and Hindu Undivided Families (HUFs) to invest in startups by channeling the capital gains from immovable property transactions. In other words, to alleviate the burden of Capital Gains Tax stemming from the sale of a residential property, taxpayers can seek solace in Section 54GB of the Income Tax Act. This provision extends an exemption opportunity applicable to the sale of a residential property, be it a house or a plot of land, categorized as a long-term capital asset. The caveat for availing this exemption is that the taxpayer must reinvest the proceeds from the sale into subscription for equity shares of an eligible company.
Key Conditions for Availing Exemption Under Section 54GB
To claim exemption under Section 54GB, the following conditions must be fulfilled:
1. Eligible Assessee
- The exemption is available to individuals and HUFs only.
2. Type of Asset Sold
- The asset sold must be a long-term capital asset, i.e., a residential property (house or plot of land) held for more than 24 months.
3. Investment in Eligible Company
- The capital gain or net consideration must be invested in the equity shares of an eligible startup or a small or medium enterprise (SME) as defined under the Micro, Small and Medium Enterprises Development Act, 2006.
- The investment must be made before the due date of filing the income tax return under Section 139(1).
4. Utilization of Funds by the Company
- The company must use the amount received from the assessee to purchase new plant and machinery within one year from the date of subscription in equity shares.
5. Shareholding and Employment Criteria
- The assessee must hold more than 25% of the share capital or voting rights in the company.
- The company should be an Indian company, and it should qualify as an eligible startup under DPIIT recognition norms at the time of investment.
Taxpayers can claim this exemption while filing their Income Tax Returns for the relevant financial year. They need to use ITR-2 on the income tax website and ensure submission before the due date of 31st July.
Meaning of Terms: Eligible Company and New Asset
An "eligible company" under Section 54GB of the Income Tax Act must fulfill specific criteria:
- Incorporation: The company must be incorporated in India.
- Timing of Incorporation: The company should be incorporated during the previous year in which the taxpayer earns capital gains up to the subsequent financial year's due date for furnishing of Income Tax Returns (ITR).
- Business Activity: The company must be engaged in the business of manufacturing an article or a thing.
- Shareholding/Voting Rights: The taxpayer must hold more than 50% of the share capital or voting rights in the company after investing in the subscription of its equity shares.
- Classification: The company should either be classified as a medium or small enterprise under the Micro, Small and Medium Enterprises Act, 2006, or it should be an eligible start-up.
As for the definition of "new asset," it refers to new plant and machinery but excludes certain items:
- Plant or machinery installed in any office premises or residential accommodation.
- Plant or machinery previously used by any other person within or outside India.
- Any vehicle or office appliances, including computers or computer software. However, in the case of an eligible startup, computers or computer software are included.
- Plant or machinery for which the actual cost is allowed as a deduction in computing the income under the Profit and Gain from Business or Profession (PGBP).
Amount of Exemption
The exemption is proportional and depends on the amount of net consideration invested in the equity shares. If the entire net consideration is invested, the entire capital gain is exempt. If only part of the consideration is invested, then proportionate exemption is allowed.
Formula:
Capital Gain Exempt = Capital Gain × (Amount Invested / Net Consideration)
Lock-In Period
Both the equity shares acquired and the new plant and machinery purchased by the company must be held for at least 5 years. If either is transferred before this period, the exempted capital gains shall become taxable in the year of such transfer.
Recent Updates and Time Limit
- Sunset Clause: Originally, the exemption under Section 54GB was applicable to property sold up to March 31, 2017, but it has been extended through several Finance Acts.
- As per the latest amendment (subject to changes), the exemption is available for residential property sold up to March 31, 2025, where investment is made in an eligible startup.
Exclusions and Restrictions
- Investment in second-hand plant and machinery, office appliances, and vehicles does not qualify.
- The company should not be engaged in businesses like real estate, finance, or other restricted sectors as defined.
Practical Example
Let’s say Mr. Sharma sells a residential property for ₹1.5 crore, realizing a capital gain of ₹40 lakhs. He invests ₹1 crore in equity shares of a DPIIT-recognized startup before the ITR due date. The startup uses the investment to purchase new machinery within one year.
Since the entire net consideration (₹1.5 crore) was not invested, the exemption will be proportionate:
Exempt Capital Gain = ₹40 lakh × ₹1 crore / ₹1.5 crore = ₹26.67 lakh
Thus, Mr. Sharma will need to pay capital gains tax on the balance ₹13.33 lakh.
Benefits of Section 54GB
- Encourages investment in India’s startup ecosystem.
- Enables tax-efficient capital reallocation.
- Promotes manufacturing and asset creation through investment in plant and machinery.
Consequences of Transfer of the equity shares
The consequences of transferring equity shares and new assets under Section 54GB of the Income Tax Act are contingent upon the duration of ownership:
Situation 1: Sale of shares and new assets before 5 years If either the taxpayer or the company sells the equity shares or the new assets within 5 years of acquisition, the exemption granted under Section 54GB will be revoked. The previously availed exemption amount will become taxable in the year of sale.
Situation 2: Sale of shares and new assets after 5 years In case the equity shares or the new assets are sold after 5 years from the date of acquisition, the exemption under Section 54GB remains intact. However, the taxpayer can claim the index cost of acquisition for calculating capital gains tax on the sale of equity shares. The capital gains will then be taxed at a rate of 20%.
What is the Capital Gains Account Scheme (CGAS)?
When a taxpayer sells a capital asset in a given financial year but is not immediately ready to reinvest the capital gains in a new residential property—as required under Sections 54, 54F, etc.—the Capital Gains Account Scheme (CGAS) provides a way to temporarily park the unutilized amount.
If the new property is not purchased or construction is not completed before the due date for filing the income tax return under Section 139(1), the assessee must deposit the unutilized capital gains into a CGAS account with any public sector bank before the ITR due date.
The amount already spent on purchase or construction, along with the sum deposited under CGAS, will be considered for exemption while computing capital gains.
Important Note:
If the amount in the CGAS is not utilized within the stipulated time frame (i.e., 2 years for purchase or 3 years for construction from the date of transfer), the unutilized amount will be treated as taxable capital gains in the year in which the 3-year period ends.
Frequently Asked Questions
1. Can I claim exemption under Section 54GB if I sell a residential plot and invest the amount in my own startup?
Answer: Yes, if you are an individual or HUF selling a long-term residential property and invest the net consideration in equity shares of a DPIIT-recognized startup (where you hold over 25% shares), you can claim exemption under Section 54GB.
2. I sold my house in May 2024. Can I still claim Section 54GB benefits in FY 2024–25?
Answer: Yes, the exemption is available for property sold up to March 31, 2025, provided the investment in an eligible company is made before the due date of filing ITR for FY 2024–25 under Section 139(1).
3. I invested in equity shares of a startup, but the startup failed to buy machinery within 1 year. Will I lose the exemption?
Answer: Yes, if the startup does not purchase new plant and machinery within 1 year of equity investment, the exemption under Section 54GB is revoked and the capital gains become taxable in that year.
4. I sold a house for ₹80 lakhs and invested ₹40 lakhs in a startup. Will I get full exemption under Section 54GB?
Answer: No, exemption is proportional. You will get exemption on only 50% of the capital gain, i.e., ₹40 lakh / ₹80 lakh × Capital Gain.
5. Can I claim Section 54GB if I invest in a startup already more than a year old?
Answer: Yes, as long as the startup is a DPIIT-recognized eligible company and you invest before the ITR due date, the age of the startup doesn’t disqualify your claim.
6. I deposited capital gains in a Capital Gains Account Scheme (CGAS). Can I still claim Section 54GB?
Answer: No, CGAS is applicable for Sections like 54 or 54F. For 54GB, you must invest directly in equity shares before the ITR due date to claim exemption.
7. What happens if I sell the equity shares of the startup within 5 years?
Answer: If you sell the equity shares before 5 years, the previously exempted capital gains become fully taxable in the year of sale.
8. Can I invest in a startup engaged in trading or financial services to claim 54GB exemption?
Answer: No, investment must be in an eligible startup engaged in manufacturing or eligible business activities. Trading, finance, and real estate sectors are excluded.
Read More: Section 111A: Tax on Short-Term Capital Gain
Web Stories: Section 111A: Tax on Short-Term Capital Gain
Official Income Tax Return filing website: https://incometaxindia.gov.in/
