Withdrawal of Capital Gain Exemption: Section 71 of the Income Tax Act 2025 Explained

Section 71 of the Income-tax Act, 2025 withdraws a capital gains exemption that was given earlier when the conditions attached to it are later broken. It covers transfers between a parent and its wholly owned subsidiary, a firm or sole proprietorship that turns into a company, and a company that turns into an LLP. If the condition fails, the gain that was not taxed under section 67 is deemed to be capital gains income. The year in which it is taxed depends on which exemption is being withdrawn.

This guide explains each of the three sub-sections, the eight-year and five-year windows, and which tax year carries the gain. Every point is taken from section 71 and section 70 of the Act (as amended by the Finance Act, 2026). Last reviewed against that text on 10 November 2026.

What does section 71 of the Income Tax Act 2025 do?

Section 70(1) lists transfers that the capital gains charge in section 67 does not apply to. Examples are a transfer to a wholly owned subsidiary, a firm being succeeded by a company, or a company converting into an LLP. Section 71 is the claw-back. The exemption is given in the year of transfer. If the conditions behind it are broken later, section 71 deems the profits or gains to be income chargeable under the head "Capital gains".

The section has three parts, and each one points to different clauses of section 70(1).

Sub-section	Exemption being withdrawn (section 70(1))	What breaks it	Whose income and which tax year
71(1)	Clause (c): company to its wholly owned subsidiary Clause (d): wholly owned subsidiary to its holding company	Within eight years from the date of transfer: (a) the transferee company converts the asset into, or treats it as, stock-in-trade; or (b) the parent company or its nominees, or the holding company, ceases to hold the whole of the share capital of the subsidiary	Capital gains of the tax year in which the transfer took place
71(2)	Clause (zd): firm succeeded by a company Clause (zf): sole proprietorship succeeded by a company	Any condition laid down in clause (zd) or (zf) is not complied with	Capital gains of the successor company for the tax year in which the condition is not complied with
71(3)	Clause (ze): private or unlisted public company converting into an LLP	Any condition laid down in clause (ze) is not complied with	Capital gains of the successor LLP or the shareholder of the predecessor company, for the tax year in which the condition is not complied with

When is the exemption withdrawn on a transfer to or from a subsidiary?

Section 70(1)(c) exempts the transfer of a capital asset, other than stock-in-trade, by a company to its subsidiary, if the parent or its nominees hold the whole of the share capital of the subsidiary and the subsidiary is an Indian company. Clause (d) is the reverse: the subsidiary transfers to its holding company, the holding company holds the whole share capital, and the holding company is an Indian company.

Section 71(1) then watches the arrangement for eight years from the date of transfer. The gain becomes taxable if, before those eight years end, either of two things happens:

• the transferee company converts the capital asset into stock-in-trade of its business, or simply treats it as stock-in-trade; or
• the parent company or its nominees, or the holding company, stops holding the whole of the share capital of the subsidiary.

Note the year. Under section 71(1), the gain is deemed income of the tax year in which the transfer took place, not the year in which the trigger happened. The text of the sub-section does not say how an earlier year is reopened, so a practitioner dealing with a live case should check the procedure for that year separately.

What happens if a firm or proprietorship that became a company breaks the conditions?

Section 70(1)(zd) exempts a transfer by a firm to a company on succession, and clause (zf) does the same for a sole proprietorship. The conditions are:

Condition	Firm to company, clause (zd)	Sole proprietorship to company, clause (zf)
Assets and liabilities	All assets and liabilities of the business immediately before succession become those of the company	All assets and liabilities of the business immediately before succession become those of the company
Who gets shares	All partners become shareholders in the same proportion as their capital accounts on the date of succession	The sole proprietor holds at least 50% of the total voting power
Other consideration	Partners receive nothing other than allotment of shares in the company	The proprietor receives nothing other than allotment of shares in the company
Voting power	Partners together hold at least 50% of the voting power, and keep at least 50% for five years from the date of succession	The proprietor keeps at least 50% for five years from the date of succession

If any of these is not complied with, section 71(2) treats the gain that was not charged under section 67 as income of the successor company under the head "Capital gains", for the tax year in which the condition is not complied with. This is different from section 71(1): the gain lands in the year of the breach, not the year of the original transfer.

What happens if a company that became an LLP breaks the conditions?

Section 70(1)(ze) covers a private company or an unlisted public company converting into an LLP under section 56 or 57 of the Limited Liability Partnership Act, 2008. It has seven conditions, and failing any one of them triggers section 71(3):

• all assets and liabilities of the company become those of the LLP;
• all shareholders become partners, with capital contribution and profit share in the same proportion as their shareholding on the date of conversion;
• shareholders receive no consideration or benefit other than a share in profit and capital contribution in the LLP;
• their aggregate profit sharing ratio stays at 50% or more at all times during five years from the date of conversion;
• the company's total sales, turnover or gross receipts in any of the three preceding tax years did not exceed Rs 60 lakh;
• the total value of assets in the company's books in any of the three preceding tax years did not exceed Rs 5 crore; and
• no amount is paid to any partner out of the accumulated profit standing in the company's accounts on the date of conversion, for three years from the date of conversion.

Section 71(3) then deems the gain to be chargeable to the successor LLP or the shareholder of the predecessor company, for the tax year in which the condition is not complied with. The section uses that wording and does not say which of the two bears the tax in a given situation, so read it with the facts in front of you.

How much tax can section 71 bring back? Two worked examples

Both examples use deliberately simple numbers. They assume the gain is full value of consideration less cost of acquisition, with no indexation, expenses on transfer or other adjustments, and they stop at the gain. The rate of tax depends on the holding period and the asset, which this article does not cover.

	Example 1: parent and wholly owned subsidiary (section 71(1))	Example 2: firm succeeded by a company (section 71(2))
Facts	Alpha Ltd transfers land to Beta Ltd, its wholly owned Indian subsidiary, on 15 August 2026 (tax year 2026-27). Alpha's cost was Rs 40,00,000 and the land's value at transfer was Rs 1,50,00,000. On 20 February 2033, Alpha sells 10% of Beta's shares to an outsider.	Gamma & Co, a firm, is succeeded by Gamma Pvt Ltd on 1 October 2026. Land transferred had a cost of Rs 30,00,000 and a value of Rs 1,00,00,000. In June 2029 (tax year 2029-30) the partners' combined holding falls to 45% of the voting power.
Exemption at the time	Section 70(1)(c): no capital gains under section 67 in 2026-27	Section 70(1)(zd): no capital gains under section 67
What breaks it	Alpha no longer holds the whole of Beta's share capital. The date is within eight years of 15 August 2026, so section 71(1)(b) applies	The partners' holding is below 50% inside the five-year period, so a clause (zd)(iv) condition is not complied with
Gain deemed	Rs 1,50,00,000 minus Rs 40,00,000 = Rs 1,10,00,000	Rs 1,00,00,000 minus Rs 30,00,000 = Rs 70,00,000
Tax year and taxpayer	Tax year 2026-27 (the year of transfer), in Alpha's capital gains	Tax year 2029-30 (the year of non-compliance), in Gamma Pvt Ltd's capital gains

The arithmetic is plain subtraction, but the year is the point of the exercise. In Example 1 the gain goes back to 2026-27 even though the trigger happened in 2033. In Example 2 it is reported in 2029-30, the year the holding dropped.

Real-life examples

Ravi's proprietorship. Ravi runs a trading business as a sole proprietor and moves it into Ravi Traders Pvt Ltd. He holds 100% of the voting power, receives only shares, and all assets and liabilities move across. Two years later he sells 60% of his shares to an investor and keeps 40%. His holding is now below 50% inside the five years from succession. Section 70(1)(zf)(ii) is not met, so section 71(2) makes the gain from the original transfer chargeable in the company's hands for the year in which he sold.

Meena's company becomes an LLP. Meena and her brother own a small private company with turnover below Rs 60 lakh and assets below Rs 5 crore. They convert it into an LLP, with the same profit shares as their shareholding. In the second year, the LLP pays Meena an amount out of the accumulated profit that stood in the company's accounts on the date of conversion. That breaks section 70(1)(ze)(vii), which bars such payments for three years. Section 71(3) brings the earlier exempted gain into capital gains for the year of the payment.

A parent company changes its plan. A holding company transfers a building to its wholly owned subsidiary for use as an office. A few years later the subsidiary decides to sell flats in it and treats the building as stock-in-trade of its business. That is section 71(1)(a). The window is eight years from the date of transfer, so the sale plan matters even if it is a change of mind.

Quick reference: windows and conditions

Item	Rule	Where
Watch period for subsidiary transfers	Eight years from date of transfer	Section 71(1)
Firm or proprietor to company	Shareholding of at least 50% voting power must continue for five years from succession	Section 70(1)(zd)(iv), (zf)(ii)
Company to LLP: profit share	At least 50% in aggregate for five years from conversion	Section 70(1)(ze)(iv)
Company to LLP: no payout from accumulated profit	Three years from conversion	Section 70(1)(ze)(vii)
Company to LLP: size limits	Turnover up to Rs 60 lakh and assets up to Rs 5 crore in each of the three preceding tax years	Section 70(1)(ze)(v), (vi)
Year of tax, subsidiary case	Year of the original transfer	Section 71(1)
Year of tax, succession and conversion cases	Year in which the condition is not complied with	Section 71(2), (3)

What are the common mistakes with section 71?

• Treating the exemption as final. The relief in section 70 is conditional. The conditions keep running for five or eight years, and for three years in one case.
• Using one tax year for all three cases. Subsection (1) goes back to the year of transfer. Subsections (2) and (3) use the year of the breach.
• Letting the parent's holding slip. Even a small sale of subsidiary shares means the parent no longer holds the whole share capital.
• Forgetting the stock-in-trade trigger. Treating the transferred asset as stock-in-trade, not only a formal conversion, is enough under section 71(1)(a).
• Overlooking the payout bar in the LLP case. Paying a partner out of the accumulated profit in the company's accounts on the conversion date can fail clause (ze)(vii).
• Not tracking the clocks. A conversion done in 2026 can be undone by a share sale in 2031 or 2033, long after the file was closed.

How can CA firms keep track of these windows?

The difficulty with section 71 is time. A restructuring is closed in one year, and the conditions keep running for three, five or eight more. A CA firm needs a reminder for each client's window and a note of which condition applies. Finexo's practice management software lets you keep client-wise tasks and dates in one place so these long-dated checks do not depend on memory. It does not compute capital gains or file returns.

Where this is in the Act

• Section 71(1): withdrawal for transfers under section 70(1)(c) and (d), eight-year window.
• Section 71(2): withdrawal for conditions in section 70(1)(zd) and (zf).
• Section 71(3): withdrawal for conditions in section 70(1)(ze).
• Section 70(1): the list of transfers not regarded as transfer for section 67.
• Section 67: the capital gains charge.

Related reading: capital gains under the 2025 Act, short-term vs long-term.

This article explains the Income-tax Act, 2025 (as amended by the Finance Act, 2026). It is general information, not tax advice. Confirm the position for a specific case with a qualified chartered accountant.