Cost of improvement [Section 55] :
(1) Goodwill of a business, etc.: In relation to a capital asset being goodwill of a business or a right to manufacture, produce or process any article or thing, or right to carry on any business, the cost of improvement shall be taken to be Nil.
(2) Any other capital asset:
(i) Where the capital asset became the property of the previous owner or the assessee before 1-4-1981, cost of improvement means all expenditure of a capital nature incurred in making any addition or alteration to the capital asset on or after the said date by the previous owner or the assessee.
(ii) In any other case, cost of improvement means all expenditure of a capital nature incurred in making any additions or alterations to the capital assets by the assessee after it became his property. However, there are cases where the capital asset might become the property of the assessee by any of the modes specified in section 49(1). In that case, cost of improvement means capital expenditure in making any addition or alterations to the capital assets incurred by the previous owner.
However, cost of improvement does not include any expenditure which is deductible in computing the income chargeable under the head “Income from house property”, “Profits and gains of business or profession” or “Income from other sources”.
Il lustration
Mr. X & sons, HUF, purchased a land for Rs 40,000 in 1991-92. In 1995-96, a partition takes place when Mr. A, a coparcener, is allotted this plot valued at Rs 80,000. In 1996-97, he had incurred expenses of Rs 1,85,000 towards fencing of the plot. Mr. A sells this plot of land for Rs 15,00,000 in 2015-16 after incurring expenses to the extent of Rs 20,000. You are required to compute the capital gain for the A.Y.2016-17.
| Financial year | Cost Inflation Index |
| 1991-92 | 199 |
| 1995-96 | 281 |
| 1996-97 | 305 |
| 2015-16 | 1081 |
Solution
Computation of taxable capital gains for the A.Y.2016-17
| Particulars | Rs | Rs |
| Sale consideration | 15,00,000 | |
| Less: Expenses incurred for transfer | 20,000 | |
| 14,80,000 | ||
| Less: (i) Indexed cost of acquisition (Rs 40,000 * 1081/281) | 1,53,879 | |
| (ii) Indexed cost of improvement(Rs 1,85,000 * 1081/305) | 6,55,689 | 8,09,568 |
| Long term capital gains | 6,70,432 |
Note – As per the view expressed by Bombay High Court in CIT v. Manjula J. Shah 16 Taxman 42, in case the cost of acquisition of the capital asset in the hands of the assessee is taken to be cost of such asset in the hands of the previous owner, the indexation benefit would be available from the year in which the capital asset is acquired by the previous owner. If this view is considered, the indexed cost of acquisition would have to be calculated by considering the Cost Inflation Index of F.Y.1991-92.
Illustration
Mr. B purchased convertible debentures for Rs 5,00,000 during August 1998. The debentures were converted into shares in September 2002. These shares were sold for Rs 15,00,000 in August, 2015. The brokerage expenses is Rs 50,000. You are required to compute the capital gains in case of Mr. B for the assessment year 2016-17.
| Financial Year | Cost Inflation Index |
| 1998-99 | 351 |
| 2002-03 | 447 |
| 2015-16 | 1081 |
Solution
Computation of Capital Gains of Mr. B for the A.Y.2016-17
| Particulars | Rs |
| Sale consideration | 15,00,000 |
| Less: Expenses on transfer i.e. Brokerage paid | 50,000 |
| Net consideration | 14,50,000 |
| Less: Indexed cost of acquisition (Rs 5,00,000 * 1081/447) | 12,09,172 |
| Long term capital gain | 2,40,828 |
Note : For the purpose of computing capital gains, the holding period is considered from the date of allotment of these shares i.e. September 2002 – August 2015.
Illustration
Mr. C purchases a house property for Rs 1,06,000 on May 15, 1963. The following expenses are incurred by him for making addition/alternation to the house property:
| Particulars | Rs | |
| a. | Cost of construction of first floor in 1972-73 | 1,35,000 |
| b. | Cost of construction of the second floor in 1983-84 | 3,10,000 |
| c. | Reconstruction of the property in 1992-93 | 2,50,000 |
Fair market value of the property on April 1, 1981 is Rs 4,50,000. The house property is sold by Mr. C on August 10, 2015 for Rs 98,00,000 (expenses incurred on transfer: Rs 50,000). Compute the capital gain for the assessment year 2016-17.
| Financial year | Cost Inflation Index |
| 1981-82 | 100 |
| 1983-84 | 116 |
| 1992-93 | 223 |
| 2015-16 | 1081 |
Solution
Computation of capital gain of Mr. C for the A.Y.2016-17
| Particulars | Rs | Rs |
| Gross sale consideration | 98,00,000 | |
| Less: Expenses on trans | 50,000 | |
| Net sale consideration | 97,50,000 | |
| Less: Indexed cost of acquisition (Note 1) | 48,64,500 | |
| Less: Indexed cost of improvement (Note 2) | 41,00,762 | 89,65,262 |
| Long-term capital gain | 7,84,738 |
N otes:
Indexed cost of acquisition: Rs 4,50,000 × 1081/100 = Rs 48,64,500
Fair market value on April 1, 1981 (actual cost of acquisition is ignored as it is lower than market value on April 1, 1981.)
| Indexed cost of improvement is determined as under: | Rs |
| Construction of first floor in 1972-73
(expenses incurred prior to April 1, 1981 are not considered) |
Nil |
| Construction of second floor in 1983-84 (i.e., Rs 3,10,000 * 1081 / 116) | 28,88,879 |
| Alternation/reconstruction in 1992-93 (i.e., Rs 2,50,000 * 1081 / 223) | 12,11,883 |
| Indexed cost of improvement | 41,00,762 |