Has the Income-tax Act, 2025 Changed the Law on Capital Gains Exemption for Depreciable Assets?
One of the most settled principles under the Income-tax Act, 1961 was that a deeming fiction created for computation purposes could not be extended to deny a tax exemption unless the statute expressly so provided. This principle was authoritatively affirmed by the Supreme Court in the landmark decision of CIT v. V.S. Dempo Co Ltd.
However, with the enactment of the Income-tax Act, 2025, a subtle change in statutory language may have altered this settled legal position. Although the amendment appears minor at first glance, it has the potential to trigger significant litigation in the years ahead.
The Position under the Income-tax Act, 1961
Under the 1961 Act, exemption under Section 54EC (and similar provisions like Section 54E considered in V.S. Dempo) was available where capital gains arose from the transfer of a long-term capital asset.
The emphasis was clearly on the nature of the asset transferred.
In the V.S. Dempo case, the assessee sold a depreciable asset that had been held for more than seventeen years. By virtue of Section 50, the gain was deemed to be short-term capital gain for the limited purpose of computation.
The Revenue argued that since the gain was treated as short-term, exemption meant exclusively for long-term capital assets should not be available.
The Supreme Court rejected this contention.
It held that Section 50 merely provides a special method of computation and creates a legal fiction only for Sections 48 and 49. The fiction cannot be extended beyond its limited purpose. Consequently, although the gain was computed as short-term, the asset itself continued to remain a long-term capital asset, thereby entitling the assessee to the exemption.
Thus, the Court drew a clear distinction between:
the character of the asset, and
the method of computing the capital gain.
This judgment became a guiding principle for taxation of depreciable assets held over the long term.
What Has Changed in the Income-tax Act, 2025?
The corresponding exemption provision now appears in Section 85 of the Income-tax Act, 2025.
The opening words are no longer identical.
Instead of referring to the transfer of a long-term capital asset, Section 85 grants exemption where the assessee has long-term capital gains arising from the transfer of land or building, or both.
At first sight, this appears to be merely a drafting change.
However, legally, the focus has shifted.
The old law examined the nature of the asset.
The new law appears to examine the nature of the gain.
Why Is This Distinction Important?
Under the earlier law, the eligibility test was relatively simple:
“Was the transferred asset a long-term capital asset?”
If the answer was yes, the exemption became available, irrespective of the computational fiction contained in Section 50.
Under Section 85 of the 2025 Act, however, the first condition itself requires the assessee to have long-term capital gains.
This raises an important interpretative question.
If the gain is computed and characterised as short-term capital gain under the special provisions applicable to depreciable assets, can it still be said that the assessee satisfies the very first requirement of Section 85?
This issue did not arise under the earlier statutory language.
Does the Judgment in V.S. Dempo Still Govern the Field?
The ratio of V.S. Dempo was founded upon the language of the 1961 Act.
The Supreme Court repeatedly emphasized that the exemption depended upon the transfer of a long-term capital asset and not upon the computational label attached to the gain.
Section 85 appears to adopt a different legislative formulation.
Instead of asking:
“Was the transferred asset long-term?”
it appears to ask:
“Has the assessee earned long-term capital gains?”
This seemingly small drafting change could materially affect the applicability of the earlier judicial precedent.
Has Parliament Intentionally Changed the Law?
Whether this amendment is merely a drafting refinement or a conscious legislative response to judicial decisions such as CIT v. ACE Builders Pvt. Ltd. and V.S. Dempo remains uncertain.
However, courts generally presume that Parliament does not alter statutory language without intending some legal consequence.
The omission of the expression “transfer of a long-term capital asset” and its replacement with “long-term capital gains” may therefore indicate a deliberate legislative intent to make the character of the gain, rather than the character of the asset, the decisive factor.
If this interpretation ultimately prevails, the Revenue may contend that where gains are computed as short-term under the special provisions for depreciable assets, the basic condition prescribed by Section 85 itself remains unfulfilled.
The Road Ahead
This change is likely to generate substantial litigation. Among the issues that courts may have to examine are:
Whether the special computation provisions merely determine the quantum of gain or also determine its character for exemption purposes.
Whether the principle that a legal fiction must remain confined to its statutory purpose continues to apply despite the altered wording.
Whether Parliament intended to legislatively dilute or override the principles emerging from ACE Builders and V.S. Dempo.
Whether exemption provisions under the Income-tax Act, 2025 should now be interpreted with greater emphasis on the statutory character of the gain rather than the nature of the underlying asset.
Conclusion
The Supreme Court’s decision in V.S. Dempo continues to hold the field in respect of the Income-tax Act, 1961. However, the drafting of Section 85 in the Income-tax Act, 2025 introduces an important textual shift that cannot be ignored.
While it would be premature to conclude that exemptions will automatically be denied in every case involving depreciable assets, the revised language undoubtedly strengthens the Revenue’s argument that the assessee must actually have long-term capital gains, and not merely a long-term capital asset.
Whether Parliament has consciously legislated a departure from the long-settled principle laid down in V.S. Dempo is a question that only future judicial interpretation can answer. Until then, Section 85 is likely to remain one of the most closely watched interpretative issues under the Income-tax Act, 2025.
