Section 54EC: Exemption on Capital Gains From Depreciable Assets

What is Section 54EC?

Section 54EC of the Income Tax Act, 1961 permits you to take an exemption of capital gain if you invest the amount in approved government bonds such as NHAI, REC, or IRFC within 6 months from the day of transfer.

You can take this exemption in the following situations:

• When you dispose of a long-term capital asset like land or building.
• When you transfer a depreciable asset (in this example, a building) you've held for longer than 24 months

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Applicability of Section 54EC

The taxpayers can avail the deductions and benefits under Section 54EC of the Income Tax Act only on fulfilling the below-mentioned conditions:

• The asset that has been transferred should be a long-term capital asset, and the transfer should yield long-term capital gains.
• The transfer should have occurred on or after April 1, 2000.
• The capital gains, either full or partial, should be invested in long-term specified assets.

Eligible long-term specified assets are the bonds issued by:

• National Bank for Agriculture and Rural Development (NABARD)
• Small Industries Development Bank of India (SIDBI)
• National Highways Authority of India (NHAI)
• National Housing Bank
• Rural Electrification Corporation Ltd (REC)

• All these bonds are redeemable after three years
• Investment in these bonds should be done within 6 months from the date of sale of the asset.
• According to Section 54EC(1), the aggregate amount of investment in these bonds during a financial year should not be more than ₹50 lakh.
• You cannot allow a deduction under Section 80C for any capital gains invested in these specified bonds.

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Tax Deductions Under Section 54EC Based on Amount Invested

The tax deduction under Section 54EC varies based on the amount of the capital gains invested by the assessee in the specified bonds:

• Full Investment: If the assessee fulfills all the conditions and invests the entire capital gain in the specified long-term bonds, he is eligible to claim a deduction for the entire capital gains amount invested.
• Partial Investment: If only a portion of the capital gains are invested, the assessee may claim a deduction only to the extent of the money actually invested.

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Other Exemptions Permitted Under Section 54EC

Here is the list of other exemptions available to assessee under section 54EC -

Joint Investment in Bonds

Section 54EC allows exemptions even when the assessee invests in specified bonds jointly with another person. The key condition is that the capital gains used for the investment must be traceable to the sale of the assessee’s original asset.

Depreciable Assets

If a depreciable asset (like a building) is held for more than 24 months and then sold, the assessee can still claim deductions under Section 54EC. Even though such gains are treated as short-term due to depreciation rules, Section 54EC considers them eligible for exemption if other conditions are met.

Non-Availability of Bonds

If the assessee is unable to invest within the 6-month window because the specified bonds were not available, they may still claim the exemption. The deduction remains valid if the investment is made once the bonds become available again, as long as the delay was genuine and beyond the assessee’s control.

Installments

In cases where capital gains are received in installments, the assessee can still claim an exemption. They must invest in the specified bonds within six months from the date of receiving each installment.

Closure of Subscription

If bond subscriptions close before the assessee can invest, the exemption under Section 54EC can still apply. The investment made after the six-month period will be accepted, provided the delay was due to the closure and the investment is made as soon as the bonds are available again.

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Tax Treatment of Depreciable Assets

Depreciable assets, under the Income Tax Act, 1961, are, in general, considered short-term capital assets despite being held for over 24 months. The reason is that their value erodes over a period of time, and their capital gains are computed on the basis of the Written Down Value (WDV) rather than the original acquisition cost. Due to this treatment, taxpayers in general are ineligible for exemptions on the capital gains.

But in CIT v. V.S. Dempo Company Ltd. (2016) 387 ITR 354 (SC), the Supreme Court made it clear that Section 50 is applicable only on the mode of calculation of capital gains and not the character of the asset. Thus, where a depreciable asset is held for over 24 months, the taxpayer may still be entitled to claim exemption under Section 54EC.

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Case Study

CIT v. V.S. Dempo Company Ltd. (2016) 387 ITR 354 (SC)

Facts of the Case:

In Assessment Year 1989–90, V.S. Dempo Company Ltd. sold a depreciable asset and claimed an exemption under Section 54E of the Income Tax Act, which allows exemption from capital gains tax if the proceeds are reinvested in specified assets within six months of transfer.

The Assessing Officer denied the claim, citing Section 50, which treats gains from depreciable assets as short-term. The Commissioner of Income Tax upheld this view.

The assessee appealed to the Income Tax Appellate Tribunal (ITAT), which ruled in its favor—a decision later upheld by the High Court. The Tax Department then escalated the matter to the Supreme Court.

Arguments:

• Tax Department: Claimed that Section 50 treats the asset as short-term for capital gains purposes, thereby disqualifying it from the exemption under Section 54E.
• Assessee: Argued that although Section 50 governs the computation of gains, it does not change the nature of the asset. Since the asset was held since 1972, it qualified as a long-term capital asset. The assessee also cited favorable judgments in ACE Builders Pvt. Ltd. and Polestar Industries.

Supreme Court Judgment:

The Court ruled in favor of V.S. Dempo Company Ltd., holding that:

• Section 50 only modifies how capital gains are computed for depreciable assets.
• It does not change the nature of the asset itself.
• Therefore, the asset retained its status as a long-term capital asset, making the assessee eligible for exemption under Section 54E.

The Supreme Court dismissed the tax department’s appeal and upheld the exemption claim.

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