Cost of acquisition
What an assessee is treated as having paid for a capital asset — usually the price actually paid, but overridden by special rules for bonus shares, ESOPs, gifts and inherited assets.
In plain language
A capital gains computation needs one number above all others: cost of acquisition. Take the sale value. Subtract the cost of transfer. Subtract the cost of acquisition. Subtract the cost of improvement. What is left is the gain.
As a general rule, cost of acquisition is simply the price the asset was bought for, plus expenses spent on buying it. But the Income Tax Act does not stop there. It lists many situations where the cost is deemed to be something else. These special rules come up all the time in practice.
How it works
A sample of the workbook's Table 8.4, "Calculation of cost of acquisition":
| Situation | Cost of acquisition |
|---|---|
| Shares bought on or after 01-04-2001 | Price actually paid (subject to the Section 112A cut-off) |
| Shares bought on or before 31-03-2001 | Higher of price paid or fair market value as on 01-04-2001 |
| Equity shares/units taxed under Section 112A, acquired on or before 31-01-2018, sold after 01-04-2018 | Higher of actual cost, or the lower of FMV as on 31-01-2018 and full consideration |
| Right shares | Price actually paid |
| Renouncement of the right to subscribe for shares | Nil |
| Securities held in Demat form | The security that entered the Demat account first is deemed sold first (FIFO) |
| Asset acquired by inheritance, gift, will or HUF partition | Cost to the previous owner; if that cannot be determined, its FMV on the date the previous owner acquired it |
| Stock-in-trade converted into a capital asset | Fair market value on the date of conversion |
Where indexation applies, the Indexed Cost of Acquisition takes this cost of acquisition one step further, multiplying it by the ratio of the Cost Inflation Index (CII) of the year of transfer to the CII of the year of acquisition (or 2001-02, whichever is later) — though for transfers on or after 23 July 2024, indexation is withdrawn for most asset classes, with land and buildings acquired before that date as the main exception.
A worked example
Illustrative figures, using the workbook's general rule.
Mrs Fernandes bought 500 shares of a listed company on 10 May 2010 for Rs 1,20,000, paying a brokerage of Rs 1,200. Her cost of acquisition is Rs 1,21,200 — the price paid plus the expense of acquiring the shares.
Now compare that to a gift. Her brother received the same 500 shares as a gift from her in 2015. His cost of acquisition is not the value on the date of the gift — under the special rule for assets acquired by gift, his cost of acquisition is deemed to be Mrs Fernandes's own original cost, Rs 1,21,200 — the previous owner's cost, carried straight through, along with her original holding period for computing whether the eventual sale is long-term or short-term.
Why NISM asks about it
Chapter 8 (Capital Gains), section 8.3, Table 8.4, gives the special-situation cost-of-acquisition rules in full, immediately followed by the indexed cost of acquisition formula. Expect a question giving one of the special situations — bonus shares, gift, ESOP, right shares — and asking for the resulting cost of acquisition.
Common exam traps
- "Cost of acquisition" is rarely just "what was paid" once a special situation applies — check the table before assuming the general rule.
- Gifted or inherited assets carry the previous owner's cost and holding period, not a fresh valuation on the date received.
- Renounced rights have a cost of acquisition of nil.
- Demat securities use FIFO to identify which specific shares were sold and at what cost.
- Distinguish from indexed cost of acquisition, which is a further step applying the Cost Inflation Index — not every computation calls for it, especially after the 23 July 2024 change.
Check yourself
1.What is the cost of acquisition of bonus shares issued on or after 1 April 2001?
- a)The market price on the date of allotment
- b)A proportionate part of the cost of the original shares
- c)NIL
- d)The face value of the shares
Show the answer
Answer: (c) NIL
Table 8.4 provides that where bonus shares are issued on or after 01-04-2001, the cost of acquisition is NIL. If they were issued on or before 31-03-2001 the cost is the fair market value of the share as on 01-04-2001. With a nil cost, the entire sale consideration of a bonus share is capital gain — which is why investors who treat bonus shares as costless windfalls are often surprised by the tax.
2.In the indexed cost of acquisition formula, what is used as the denominator?
- a)The CII of the year in which the asset is transferred
- b)The CII of the year in which the asset is first held by the assessee, or the CII of 2001-02, whichever is later
- c)The CII of 2001-02 in every case
- d)The CII of the year in which the assessee filed his first return
Show the answer
Answer: (b) The CII of the year in which the asset is first held by the assessee, or the CII of 2001-02, whichever is later
The formula is Cost of Acquisition × CII of the year in which the asset is transferred ÷ CII of the year in which the asset is first held by the assessee OR CII of 2001-02, WHICHEVER IS LATER. The "whichever is later" matters because 2001-02 is the base year — for an asset first held in 1985 you cannot go behind 2001-02. For the indexed cost of improvement, the denominator is the CII of the year the improvement was made.
3.An investor holds shares of one company bought on different dates in a single demat account and sells part of the holding. Which shares are deemed sold?
- a)Whichever shares the investor specifies to the depository
- b)The shares that first entered the demat account, under the FIFO method
- c)The most recently purchased shares, under the LIFO method
- d)A weighted average of all holdings
Show the answer
Answer: (b) The shares that first entered the demat account, under the FIFO method
For securities held in demat form the period of holding is determined as per the FIRST-IN-FIRST-OUT (FIFO) method — the securities that first entered into the demat account are deemed to be the first sold out, and Table 8.4 applies the same rule to the cost of acquisition. The investor has no choice in the matter within one account; an adviser wanting flexibility must place different purchases in separate demat accounts.
Where this is taught
Free preparation for NISM Series X-BRelated terms
- Bonus sharesAdditional shares issued free to existing shareholders in proportion to their holding — no tax at allotment, a nil cost of acquisition, and a fresh holding period from the allotment date.
- Cost Inflation IndexAn index notified by the CBDT each year, with 2001-02 as the base of 100, used to restate the cost of a long-term capital asset in current rupees so that inflation is not taxed as capital gain.
- Cost of improvementCapital expenditure incurred on or after 1 April 2001 on additions or alterations to a capital asset, by the owner or a previous owner, deducted along with cost of acquisition in computing capital gains.
- FIFO methodThe rule that securities sold from a demat account are deemed to be those that entered the account first — which fixes both their period of holding and their cost of acquisition for capital gains.
- Indexed cost of acquisitionCost of acquisition scaled up by the Cost Inflation Index, so that only the real gain is taxed; withdrawn for transfers on or after 23 July 2024 except for land or building acquired before that date.
- Stock-in-tradeSecurities or goods held for the purpose of business — excluded from the definition of capital asset, so profit on their sale is business income, not capital gains.
- Telegraphic Transfer buying rateThe State Bank of India's telegraphic transfer buying rate for a foreign currency — the rate the Income Tax rules use to convert foreign-currency capital gains and income from securities into rupees.
- Capital asset (Section 2(14))Section 2(14)'s wide definition of what can generate a capital gain — property of any kind held by an assessee — narrowed by exclusions for stock-in-trade, personal effects and rural agricultural land.
- Capital Gains Account SchemeA deposit scheme letting a taxpayer claim a capital gains exemption (Sections 54, 54B, 54D, 54F, 54G) even if reinvestment is not done before the tax return is due, by parking the unused gain in a designated account.
- Consolidation of sharesA company merging several of its shares into fewer, higher face-value shares without changing total share capital — not treated as a transfer, so the old cost of acquisition is simply apportioned.
- Cost apportionment on split or consolidationThe rule for spreading an original cost of acquisition across new shares after a stock split or consolidation — proportionately, so the total cost paid never changes, only how it is divided.
- Depreciable assetA business asset on which depreciation has been claimed under the Income Tax Act — any gain on selling one is always short-term capital gain, however many years it was actually held.
- Exchange as transferConverting preference shares into equity shares of the same company meets the definition of an exchange, yet Section 47(xb) specifically excludes it from capital gains — cost and holding period simply carry over.
- Expenditure in connection with transferCosts incurred wholly and exclusively to complete a transfer — brokerage, stamp duty, registration and legal fees — deductible from capital gains, but STT and CTT are specifically barred.
- Nil cost ruleThe tax principle that certain rights or shares received without payment are given a cost of acquisition of nil, so the whole sale proceeds, not just a profit margin, become the taxable gain.
- Offer for sale in an IPOThe tax rule that gains on unlisted shares sold to the public through an IPO's offer-for-sale route are taxed under Section 112A, as if the shares had always been listed and STT-paid.
- Full value of considerationThe amount received or receivable for transferring a capital asset — usually the actual sale price, but replaced by fair market value in specific situations the Act names, such as unquoted shares sold below value.
- Long-term capital assetA capital asset held for more than the prescribed period before transfer — generally more than 24 months, and more than 12 months for listed securities and equity oriented fund units.