Capital Gains computation: Should LTCG exemption u/s 54F apply before LTCL set-off?

Background of the case

In a recent ruling, Income-tax Appellate Tribunal, Mumbai Bench (hereinafter referred to as “the Tribunal” or “ITAT”), in the case of Nikesh Bhagwandas Mehta¹ (“the assessee”) decided on the interpretation of the interplay between Section 54F and Section 70(3) of the Income-tax Act, 1961 (“the Act”), in the context of capital gains computation. The central controversy of the case is whether the exemption under Section 54F of the Act in respect of long-term capital gains (LTCG) must be applied before the set-off provisions under Section 70(3) of the Act are given effect, or whether a long-term capital loss (LTCL) must first be adjusted against the LTCG, with the Section 54F exemption available only on the net capital gain.

Facts of the case

• The assessee, an individual, filed his return of income for AY 2022-23 declaring total income of approximately INR 49.54 lakh.
• During the year, the assessee earned LTCG of approximately INR 69.84 lakh from the sale of certain equity shares and claimed the entire amount as exempt under Section 54F. The assessee also incurred LTCL of approximately INR 37.72 lakh on the sale of a set of equity shares and carried forward this loss in the return of income.
• The position adopted by the assessee and the position as computed by the Assessing Officer differed in their treatment of the LTCL, as set out below:

• The CPC processed the return under Section 143(1) and disallowed the carry forward of the LTCL, effectively adopting the AO’s computation above.
• On first appeal, the CIT(A) held that the LTCL was required to be first adjusted against the LTCG under Section 70(3), and only the resulting net LTCG of approximately INR 32.11 lakh could be considered for the Section 54F exemption.
• Accordingly, the exemption was restricted to INR 32.11 lakh and the denial of carry forward of the LTCL was upheld.
• Aggrieved by the same, the assessee appealed to the Tribunal.

Key Issues

1. Whether the exemption under Section 54F must be given effect prior to the application of the set-off provisions under Section 70(3), having regard to the scheme of Sections 45 to 55A of the Income-tax Act, 1961.
2. Whether an assessee can simultaneously claim full exemption under Section 54F on the gross LTCG and also carry forward the LTCL independently, without any compulsory inter-source set-off under Section 70(3).

Key Takeaways

1. Statutory scheme and precedence of Section 54F over Section 70(3)

• Section 45(1) of the Act provides that profits and gains arising from transfer of a capital asset shall be chargeable to tax subject to the provisions of Sections 54 to 54H, which include Section 54F. The Tribunal held that the chargeability of LTCG is itself conditioned on, and qualified by, the benefit available under Section 54F. Accordingly, when the conditions of Section 54F are satisfied, the capital gain is effectively removed from the charging section at the stage of computation itself.
• Section 70(3) of the Act operates on the basis of a loss as arrived at under the computation made under Sections 48 to 55. Since Section 54F is integral to that computation, the Tribunal held that Section 70(3) can only be applied after the capital gain has been computed in accordance with Sections 45 to 55A, including the exemption under Section 54F. Accordingly, provisions of Section 54F will prevail over the provisions of Section 70(3).
• The Tribunal drew support from the Madras High Court ruling in CIT v. Vijay M. Mahtaney², wherein it was held that an assessee may first claim exemption under Section 54EC and thereafter set off the capital loss, and from the co-ordinate bench decision in Naresh Jain v. ACIT³, which affirmed that Section 70 comes into play only after capital gains are computed under Sections 45 to 55A.

2. Simultaneous claim of Section 54F exemption and carry forward of LTCL

• The Tribunal held that the assessee is entitled to claim full exemption under Section 54F on the gross LTCG of INR 69.84 lakh and, simultaneously, to carry forward the LTCL of INR 37.72 lakh to subsequent assessment years, without any compelled set-off between the two.
• It is not necessary to first apply Section 70(3) and adjust the LTCL against the LTCG before determining the quantum eligible for exemption under Section 54F. Scheme of Section 45 to 55A provides for computation of capital gains and the effect has to be given first to the provision of capital gains as provided under the said sections and then apply the provisions of Section 70.
• Thus, the Tribunal held that Section 70 would come into the computation of total income only when the capital gains has been computed in accordance with the provisions of Section 45 to 55A.

Conclusion

The Tribunal allowed the assessee’s appeal, holding that the exemption under Section 54F operates at the stage of capital gains computation under Sections 45 to 55A, prior to and independently of the set-off provisions under Section 70(3). Accordingly, a taxpayer satisfying the conditions of Section 54F is entitled to exemption on the full gross LTCG and may simultaneously carry forward an unabsorbed LTCL, without any compelled inter-source adjustment.

Kretha Comments

The ruling provides an important clarity on the practical ambiguity faced by individual taxpayers who, during the same financial year, earn LTCG on one set of capital assets qualifying for exemptions under Sections 54–54GB while simultaneously incurring LTCL on another set. The judgment squarely settles the sequencing question by clarifying that the Section 54F exemption operates at the stage of capital gains computation under Sections 45 to 55A, prior to and independently of the set-off provisions under Section 70(3).

From a compliance perspective, the decision also confirms that an assessee is entitled to carry forward the LTCL even where the gross LTCG for the relevant year stands fully exempt under Section 54F. The CPC’s approach of first setting off the LTCL against the LTCG and thereafter allowing the exemption under Section 54F was held to be inconsistent with the statutory framework.

1. ITA No. 8246/MUM/2025 ↩︎
2. [2013] 35 taxmann.com 228 (Mad) ↩︎
3. [2020] 118 taxmann.com 519 (Jpr) ↩︎