Section 48 of the Income Tax Act: Tax Computation on Capital Gains

Introduction

Section 48 of the Income Tax Act, 1961, outlines the method for computing capital gains from the sale of capital assets. For Non-Resident Indians (NRIs), the First Proviso to this section provides specific provisions to account for foreign exchange fluctuations during such transactions.

This article covers:

An overview of Section 48 and its deductions
Details of the First Proviso and its applicability
Computation of capital gains for NRIs
Exchange rate considerations under Rule 115A
Benefits of the First Proviso for NRIs

What is Section 48 of the Income Tax Act

Section 48 provides the framework for calculating capital gains arising from the transfer of capital assets. The computation involves deducting specific expenses from the full value of the consideration received.

Formula:

Capital Gains = Sale Consideration – (Cost of Acquisition + Cost of Improvement + Transfer Expenses)

For long-term capital assets, the cost of acquisition and improvement can be adjusted using the Cost Inflation Index (CII) to account for inflation.

Key Deductions Allowed Under Section 48

Expenditure on Transfer: Expenses directly related to the transfer, such as brokerage, legal fees, and stamp duty
Cost of Acquisition: The original purchase price of the asset
Cost of Improvement: Expenses incurred for enhancing the value of the asset

These deductions ensure that only the actual gain is taxed, providing a fair assessment of tax liability.

Understanding the First Proviso to Section 48

The First Proviso to Section 48 offers a special method for NRIs to compute capital gains on certain assets acquired in foreign currency. It allows for the conversion of the sale proceeds, cost of acquisition, and expenditure on transfer into the same foreign currency used to purchase the asset. This reconversion helps neutralise the impact of currency fluctuations.

Who Does It Apply To

The First Proviso applies to:

NRIs who bought assets in foreign currency
Foreign investors holding shares or securities abroad
Non-resident entities transferring assets purchased overseas

It is applicable when the capital gains arise from the transfer of shares or debentures of an Indian company purchased in foreign currency.

Why Was The Proviso Introduced

The proviso was introduced to:

Provide relief to NRIs from currency fluctuation risks
Ensure fair taxation by computing gains in the same currency used for investment
Encourage foreign investment in Indian securities

By allowing reconversion into foreign currency, NRIs are taxed on the actual economic gain, not on gains inflated or deflated by exchange rate movements.

Foreign Exchange Rate Considerations Under Rule 115A

Rule 115A specifies the exchange rates for converting capital gains for NRIs. The rates are determined as follows:

Important Exchange Rate Rules

Average Rate: The average of the Telegraphic Transfer Selling Rate (TTSR) and the Telegraphic Transfer Buying Rate (TTBR) on the relevant date
Relevant Date for Acquisition: The date of purchase of the asset
Relevant Date for Transfer: The date of sale or transfer of the asset

These rates ensure consistency and fairness in the computation of capital gains for NRIs.

How is Capital Gains Computed for NRIs

For NRIs, the computation under the First Proviso involves:

Converting sale proceeds (INR) to the original foreign currency using the average of TTBR and TTSR on the transfer date.
Converting acquisition cost using the average rate on the purchase date.
Deducting expenses (brokerage, legal fees) in the foreign currency.
Reconverting net gains to INR using the TTBR on the transfer date.

Example: Capital Gains Computation for an NRI

Mr. Sharma, an NRI, purchased shares of an Indian company in 2015 for $10,000. In 2025, he sold these shares for ₹9,00,000. Let’s assume the exchange rates of both years as:

2015: 1 USD = INR 60
2025: 1 USD = INR 80

Computation:

Cost of acquisition in INR: USD 10,000 × INR 60 = INR 6,00,000
Sale consideration in USD: INR 9,00,000 ÷ INR 80 = USD 11,250
Capital gain in USD: USD 11,250 − USD 10,000 = USD 1,250
Capital gain in INR: USD 1,250 × INR 80 = INR 1,00,000

Thus, the taxable capital gain is ₹1,00,000.

Key Benefits of the First Proviso to Section 48

Neutralises Currency Fluctuations: By reconverting amounts into the original foreign currency, NRIs are protected from exchange rate volatility
Fair taxation: Ensures that only the actual economic gain is taxed, not gains inflated by currency movements
Encourages Investment: Provides confidence to NRIs to invest in Indian securities without the fear of adverse tax implications due to currency changes

These benefits make the First Proviso a significant provision for NRIs investing in India.

What is Section 48?

Individuals can calculate the actual capital gains received from the sale of capital assets, under Section 48 of the Income Tax Act, 1961.

Can non-resident Indians take advantage of the indexation benefits?

Yes, indexation benefits are available to resident and non-resident Indians, provided that it is long-term capital gains.

What is the indexation of capital gains?

Indexation is a method by which investors can account for inflation in their long-term capital gains. This helps them calculate the true profit.

What do you mean by cost of acquisition?

An acquisition cost is the total cost an organisation recognises on its books of account for equipment and property. This cost is computed after adjusting incentives, discounts, closing costs and similar expenses before including sales tax.