Adjustment of exemption limit

Everyone gets a basic exemption limit — a slice of income on which no tax is charged at all. Ordinary income, like salary or business profit, automatically uses up that slice first. But some capital gains are taxed at flat, special rates — and normally the basic exemption limit does not apply to them.

The workbook's adjustment fixes this for one specific group of taxpayers: a resident individual or a resident HUF. If their other income does not use up the full basic exemption limit, the shortfall can be filled using long-term capital gains taxed under Sections 112 or 112A, or short-term capital gains taxed at 20% under Section 111A — before those gains are taxed at their special rate.

The rule. If a resident individual's or HUF's total income — excluding long-term capital gains under Section 112/112A and short-term capital gains under Section 111A — is below the maximum exemption limit, the shortfall is used to reduce the taxable amount of those capital gains. Only the gain remaining after absorbing the shortfall is taxed at the special rate.

Shortfall = Maximum exemption limit − (Total income excluding 111A/112/112A gains)
Taxable capital gain (at special rate) = Capital gain − Shortfall

This benefit belongs only to resident individuals and HUFs — it is not available to companies, firms, non-residents, or to gains under Section 112A specifically where the taxpayer is claiming the Section 87A rebate against them (the workbook notes separately that the Section 87A rebate itself is not available against Section 112A long-term capital gains, though it is allowed against the rest of the total income).

Take the workbook's own figures. A resident individual has total income, excluding long-term capital gains, of Rs 1,85,000. He also has a long-term capital gain of Rs 2,50,000 from the sale of unlisted shares, taxable under Section 112.

His basic exemption limit, under the old tax regime, is Rs 2,50,000.

Shortfall = 2,50,000 - 1,85,000 = 65,000
Capital gain reduced by the shortfall = 2,50,000 - 65,000 = 1,85,000

Only Rs 1,85,000 of the long-term capital gain is taxed at Section 112's special rate. The remaining Rs 65,000 of the gain has, in effect, been absorbed into his unused basic exemption limit, and escapes tax at the capital gains rate entirely — instead of the full Rs 2,50,000 being taxed at the special rate on top of his Rs 1,85,000 of other income.

Chapter 11 (Taxation of Equity Products), section 11.10 — Adjustment of Exemption Limit from Capital Gains — states the rule and works the exact Rs 1,85,000 / Rs 2,50,000 example. Expect a computation question: given other income below the exemption limit and a capital gain figure, compute how much of the gain escapes the special rate.

• Only resident individuals and HUFs get this adjustment — not companies, firms, or non-residents.
• It applies to Section 111A short-term gains and Section 112/112A long-term gains — the shortfall can be set against any of these, but the workbook's own worked example uses Section 112.
• This is separate from the Section 87A rebate, which the workbook says is not available against Section 112A long-term capital gains, even though this exemption-limit adjustment is.
• The basic exemption limit itself depends on the tax regime chosen — old or new — so the size of the available shortfall changes with that choice.