The beauty of capital gains taxation is that it can be exceedingly simple or impossibly complicated, depending on the situation. The rates differ according to the asset sold.

In some cases indexation is applicable and in others it is not. As a consultant it is my job to know these things.

However, ever so often, just when you think you have mastered a subject, there comes a twist that takes you by surprise. This is precisely what happened the other day when I was doing what I thought was a routine computation.

My client, a friend, had lost his father and consequently inherited the house the family lived in. Recently he sold the house and moved into a larger place. He wondered if I could work out the capital gains for him. I told him to come over any time, it wouldn't even take ten minutes. A week passed and I was still trying to work out the calculations!

The problem arose when dealing with Sec (47iii) of the Income-Tax Act, which states that any transfer of a capital asset under a gift or a will does not attract capital gains tax.

Obviously, my friend cannot be asked to pay capital gains tax just because he suddenly came to possess an asset hitherto not owned by him. The same principle applies in the case of a gift. Just the act of a donee receiving a gift has no tax consequences whatsoever.

However, the problem arose during the second leg of the transaction -- when he sold the flat. In a typical case of flattering only to deceive, if the inheritor (or donee) were to eventually sell the property, the cost and the date of acquisition for capital gains purposes is to be taken as that of the father a.k.a. "the previous owner". Now, I wonder in such a case, if the assessee (or his tax consultant or even the Income-Tax officer) can figure out how much tax has to be paid!

It is the next section, Sec. 48, which sets the cat amongst the pigeons. Explanation (iii) defines 'Indexed cost of acquisition' to mean an amount, which bears to the cost of acquisition the same proportion as the Cost Inflation Index for the year in which the asset is transferred bears to the Cost Inflation Index for the first year in which the asset was held by the assessee or for the year beginning on April 1, 1981, whichever is later.

In simple terms, this means that for calculating long-term capital gains, you may use indexed cost or the cost on 1.4.81, whichever is higher.

There is yet another component of cost, which is the cost of improvement of the asset. Explanation (iv) defines 'Indexed cost of any improvement' to mean an amount which bears to the cost of improvement the same proportion as the Cost Inflation Index for the year in which the asset is transferred bears to the Cost Inflation Index for the year in which the improvement to the asset took place.

All this can be extremely confusing, so let's get back to the example of my friend. His father had bought a house on 6.7.83 for Rs 100,000. On 6.7.86 he spent Rs 200,000 to add another room to the house. He died on 6.7.90, leaving the house to his son.

The market value of the property at the time was Rs 10 lakh (Rs 1 million). The son sold this house on 6.7.99 for a net consideration of Rs 50 lakh (Rs 5 million). Capital gains had to be worked out. It should have been simple. But let's see...

Let us first compute the indexed cost of the house. The market value in FY 90-91, the first year in which the asset was held by the son, was Rs 10 lakh. This value is of no consequence. His cost of acquisition, thanks to Sec. 47(iii), is evidently Rs 100,000, the same that his father paid in FY 83-84.

Consequently, the date of acquisition would also be 6.7.83. The cost inflation index of FY 99-00 is 389 and that of FY 83-84 is 116. Therefore, the indexed cost is Rs 335,345 (100,000 x 389/116).

This calculation seems all right at face value. However, there is an oversight! Examine the above mentioned Explanation (iii) again. Yes, the date of acquisition for the son is certainly 6.7.83 but it does not come into the picture at all for any purpose whatsoever, including computation of indexed cost!

The index for the year in which the son first held the asset is required to be taken for computation! The son came into possession of the house in FY 90-91 and the index for that year is 182. Therefore, the indexed cost is Rs 213,736 (100,000 x 389/182) and not Rs 335,345 as computed earlier.

Now, let us work out the indexed cost of improvement. Ironically, if we extend the same principle here, we would be making a mistake. For, re-examine Explanation (iv). A minute reading will tell you that here, unlike in the previous case, the index to be considered is that of FY 86-87, the year in which the improvement of Rs 200,000 was carried out. The index for 86-87 is 140 and the indexed cost is Rs. 555,714 (200,000 x 389/140).

Ergo, the total indexed cost is Rs 769,450 (213,736 + 555,714).

But should the legislation, particularly related to Income-Tax be so complicated? This is as far as acquiring the property under a will is concerned. Imagine the absurd situation that will arise where a husband gifts property to his wife and the wife subsequently sells it.

First of all, since gift to spouse attracts clubbing provisions u/s 64, all income, including the capital gains if any, generated from the house property would be clubbed in the poor husband's hands. He would have to pay a much higher capital gains tax than what he would have had to pay had he himself sold the house.

The reason is simple: the husband's indexed cost of acquisition would be lower to the extent of the time elapsed between him buying the house and his wife actually selling it.

If you are confused, don't worry; anyone would be, including the ITOs perhaps. I wonder how the CBDT expects assessees to even understand these provisions let alone apply them to their given situation.

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