Capital Gains Exemption on Shifting an Industrial Undertaking: Sections 87, 88 and 89 (Income Tax Act 2025)

Under the Income-tax Act, 2025, if an industrial undertaking in an urban area sells its machinery, plant, building or land because it is shifting, the capital gain is exempt to the extent it is spent on the new set-up. Section 87 covers a shift to a non-urban area, section 88 covers a shift to a Special Economic Zone (SEZ), and section 89 gives extra time when the old asset was taken by compulsory acquisition and the compensation came late. The window is one year before to three years after the transfer.

This guide explains who can use these sections, what has to be bought or spent, what happens to gain that is not used, and how the deposit works. Every point is taken from sections 87, 88, 89 and 263 of the Act as amended by the Finance Act, 2026 (tax year 2026-27 onwards). Last reviewed on 10 November 2026. This is information, not tax advice.

What do sections 87 and 88 of the Income Tax Act 2025 cover?

Both sections deal with the same event: an industrial undertaking situated in an urban area transfers a capital asset used in its business and moves the undertaking elsewhere. The assets covered are machinery, plant, building, land, or any rights in building or land, all used for the business of the undertaking. The only difference is where the undertaking goes.

	Section 87	Section 88
Original location	Industrial undertaking in an urban area	Industrial undertaking in an urban area
New location	Any area other than an urban area	Any Special Economic Zone, in an urban or any other area
Relationship	General rule	Applies "irrespective of anything contained in section 87"
Machinery or plant bought	Must be "new" machinery or plant (s. 87(1)(b)(i))	"Machinery or plant" with no "new" in the text (s. 88(1)(b)(i))
Link to the transfer	Transfer "in the case of shifting"	Transfer "in the course of or in consequence of" shifting
Window to buy or spend	1 year before to 3 years after the transfer	1 year before to 3 years after the transfer
Gain not used	Deposit before the return is filed	Deposit before the return is filed

The rest of the mechanics in the two sections are worded the same way, so the explanation below applies to both unless it says otherwise.

What is an "urban area" for this exemption?

Section 87(5) says an urban area is any area within the limits of a municipal corporation or municipality that the Central Government has declared to be an urban area for the purposes of this section, having regard to population, concentration of industries and the need for proper planning. Section 88(5) uses the same meaning. So being inside a municipality is not enough. Check that the area is covered by the Central Government's declaration.

What must the business do to claim the exemption?

Within one year before or three years after the date of the transfer, the assessee must have done the following in the new area (or SEZ, for section 88), as listed in section 87(1)(b) and 88(1)(b):

• purchased new machinery or plant for the business of the undertaking;
• acquired building or land, or constructed a building, for the business;
• shifted the original asset and transferred the establishment of the undertaking to the new area; and
• incurred expenses for any other purpose specified in a scheme notified by the Central Government.

Cost and expenses on all or any of these purposes together are called the "new asset" in the section. Notice that the text lists the four items with "and" between them, and then speaks of "all or any" of them when measuring the spend. If your case is borderline, read the clause with your adviser before relying on a single purchase.

The dashed marker is illustrative. The return due date depends on the assessee and the tax year of the transfer. The point of the diagram is that spending can happen before the transfer, but unused gain has to be dealt with at the return stage, not at the end of three years.

How is the capital gain taxed after the shift?

Instead of the whole capital gain being charged in the tax year of the transfer, sections 87(1) and 88(1) treat it as follows:

• Spend on the new asset is less than the gain: the difference is charged under section 67 as income of the tax year of the transfer.
• Spend is equal to or more than the gain: no capital gain is charged under section 67.

Worked example 1: part of the gain is taxed

Assumptions: tax year 2026-27. A manufacturing unit in a notified urban area sells its factory building and land on 10 August 2026. The capital gain is Rs 40,00,000. The unit moves to a non-urban area (section 87) and within the window spends Rs 25,00,000 on new plant and Rs 10,00,000 on a new building.

Step	Amount (Rs)
Capital gain on the original asset	40,00,000
New plant	25,00,000
New building	10,00,000
Total spend on the new asset (25,00,000 + 10,00,000)	35,00,000
Spend is less than gain, so the difference is charged under section 67 (40,00,000 - 35,00,000)	5,00,000

Rs 5,00,000 is charged as capital gain for tax year 2026-27. The rate that applies to it depends on the type of asset and holding period, which is covered in the other capital gains posts on this site.

Worked example 2: the whole gain is exempt

Assumptions: tax year 2026-27. A unit sells old machinery on 5 September 2026 with a capital gain of Rs 18,00,000 and shifts to an SEZ (section 88). It had bought new plant for the SEZ unit in March 2026 for Rs 12,00,000 (within one year before the transfer) and buys more plant for Rs 9,00,000 in June 2027.

Step	Amount (Rs)
Spend within the window (12,00,000 + 9,00,000)	21,00,000
Capital gain	18,00,000
Spend is more than the gain, so gain charged under section 67	Nil

What if the gain is not spent before the return is filed?

Sections 87(2) and 88(2) apply when the gain has not been used for the new asset within one year before the transfer, or before the return of income is filed under section 263. In that case:

1. the unused amount must be deposited in a specified bank or institution and used as per the scheme notified by the Central Government;
2. the deposit must be made before the return is filed, and not later than the due date for filing the return under section 263(1) that applies to the assessee; and
3. proof of the deposit must be submitted along with the return.

Under section 87(3) and 88(3), the amount already used plus the deposited amount is deemed to be the cost of the new asset. This is what lets the deposit count towards the exemption.

Worked example 3: deposit that is only partly used

Assumptions: tax year 2026-27. Capital gain of Rs 50,00,000 on a transfer on 10 August 2026. By the return due date, Rs 30,00,000 has gone into the new unit. Rs 20,00,000 is deposited under the scheme. By 10 August 2029 only Rs 12,00,000 of the deposit has been used on the new asset.

Step	Amount (Rs)
Used before the return (cost of new asset so far)	30,00,000
Deposited under section 87(2)	20,00,000
Deemed cost of new asset for 2026-27 (30,00,000 + 20,00,000)	50,00,000, so no gain charged for 2026-27
Deposit used by the end of three years	12,00,000
Unutilised (20,00,000 - 12,00,000)	8,00,000
Charged under section 67 as income of the tax year in which three years from the transfer expire (tax year 2029-30)	8,00,000

Under section 87(4)(b), the assessee can withdraw the unutilised amount in accordance with the scheme. The tax and the withdrawal are separate steps in the section.

What happens if the new asset is sold within three years?

Sections 87(1)(B) and 88(1)(B) deal with a sale of the new asset within three years of its being purchased, acquired, constructed or transferred. For computing that capital gain, the cost is nil where the full gain was exempt (the "equal to or more than" case), or is reduced by the amount of the capital gain where the exemption was partial. This is the same idea as an early-sale clawback. If you may sell the new asset soon, get the computation checked before you rely on the exemption.

What does section 89 do when compensation is received late?

Section 89 applies irrespective of sections 82, 83, 84, 85 and 86. It has two conditions: the transfer of the original asset was by compulsory acquisition under any law, and the compensation awarded was not received on the date of transfer. When both are true, the period available under those sections to acquire the new asset, or to invest or deposit the capital gain in a specified bank or institution, is counted from the date the compensation is received.

Section 89 is limited to the sections it names, 82 to 86. It does not refer to sections 87 or 88, so do not assume the later start date carries over to an undertaking shift.

Real-life example: Ravi and the delayed compensation

Ravi's land is acquired by a government authority under a law on 15 January 2027. The compensation is awarded, but Ravi receives it only on 20 June 2027. For an exemption under one of sections 82 to 86 that depends on investing the gain or acquiring a new asset within a stated period, that period starts on 20 June 2027, not 15 January 2027. Without section 89, the clock would have started on the date of transfer and a good part of it would have been used up waiting for money.

Real-life example: Meena's workshop

Meena runs a small fabrication unit inside a notified urban area. In 2026 she sells the workshop building and land and moves the operation to a plot in an SEZ. She buys new machinery for the SEZ unit four months before the sale and builds a shed after it. Because the spend on the new asset is more than her capital gain, nothing is charged under section 67. Had it fallen short, she would have paid tax on the shortfall only. And if she had not finished spending by her return due date, she would have needed to deposit the balance under the scheme and attach proof with the return.

Quick reference

Point	Rule	Where
Assets covered	Machinery, plant, building, land, rights in building or land	s. 87(1)(a), 88(1)(a)
Window to buy or spend	1 year before to 3 years after the transfer	s. 87(1)(b), 88(1)(b)
Spend less than gain	Difference charged under s. 67	s. 87(1)(A)(I), 88(1)(A)(I)
Spend equal or more	No capital gain charged	s. 87(1)(A)(II), 88(1)(A)(II)
Unused gain at return	Deposit before filing, not later than due date, proof with return	s. 87(2), 88(2)
Deposit not used in time	Charged in the tax year in which 3 years from transfer expire	s. 87(4), 88(4)
Sale of new asset within 3 years	Cost nil, or reduced by the gain	s. 87(1)(B), 88(1)(B)
Compulsory acquisition, late compensation	Period runs from receipt of compensation	s. 89

Common mistakes

• Assuming any municipal area is "urban". The section requires an area declared by the Central Government as an urban area for this section.
• Waiting for the end of three years to deposit. The deposit has to be made before the return is filed and by the return due date, with proof attached to the return.
• Forgetting the one-year lookback. Spend made up to one year before the transfer can count towards the new asset.
• Ignoring the three-year hold on the new asset. A sale within three years brings in the nil or reduced cost rule.
• Applying section 89 to a shifting case. It extends time only for sections 82 to 86, and only for compulsory acquisition where compensation is not received on the date of transfer.

Where this is in the Act

• Section 87: exemption on shifting from an urban area; section 87(5) defines urban area.
• Section 88: exemption on shifting to a Special Economic Zone.
• Section 89: extension of time after compulsory acquisition.
• Section 67: the section under which the taxable difference is charged.
• Section 263(1): return of income and due date, which fixes the deposit deadline.

For reinvestment exemptions on other assets, see our posts on sale of a residential house and capital gain bonds. For a TDS example under the same Act, see TDS on rent.

For a CA firm, the hard part of these claims is the calendar: the transfer date, the one-year and three-year windows, and the return due date for the deposit. Finexo's practice management software can track those dates against each client and remind you before they pass. It does not compute the exemption or make the deposit for you.