[Opinion] How the Income Tax Act 2025 Silently Overturns the Landmark SC Ruling in V.S. Dempo

Punit Agarwal – [2026] 185 taxmann.com 577 (Article)

1. Introduction

The Income-tax Act, 2025 (“the new Act”), which comes into force with effect from 1st April, 2026, has been projected as a simplification and consolidation exercise. A closer reading, however, reveals that in the garb of re-drafting, the legislature has quietly neutralised several long-standing judicial precedents. One such casualty is the landmark ruling of the Hon’ble Supreme Court in CIT v. V.S. Dempo Company Ltd. [2016] 74 taxmann.com 15 (SC)/[2016] 242 Taxman 434 (SC)/[2016] 387 ITR 354 (SC), which had for nearly a decade enabled assessees to claim exemption under Section 54EC in respect of capital gains arising on the transfer of depreciable assets.

The instrument of this reversal is deceptively simple i.e. a two-word change in the opening clause of Section 85 of the new Act (corresponding to the erstwhile Section 54EC). The trigger of the exemption has been shifted from the transfer of a “long-term capital asset” to the arising of “long-term capital gains”. The consequence, though subtle on the face of the statute, is substantial in effect. This article examines how this linguistic shift effectively overturns the ratio of V.S. Dempo, and what it means for taxpayers dealing with depreciable assets on and after 1st April, 2026.

2. Issue Involved

Section 50 of the Income-tax Act, 1961 creates a legal fiction in the case of depreciable assets forming part of a block of assets. Notwithstanding the period of holding, any capital gain arising on the transfer of such an asset (or of the whole block) is deemed to be a short-term capital gain. The object of the fiction is straightforward i.e. to deny assessees a double benefit i.e., depreciation on one hand and indexed long-term capital gain treatment on the other.

The issue which occupied the courts for nearly two decades was whether this deeming fiction which converts a long-term gain into a short-term gain for the limited purpose of computation also disentitles the assessee from claiming exemption under other provisions of the Act, most notably Sections 54E, 54EC and 54F, each of which is available only in respect of a “long-term capital asset”.

Put differently, if an asset is a long-term capital asset (held for more than the prescribed period) but is depreciable, does the fiction in Section 50 travel beyond Sections 48 and 49 and destroy the assessee’s claim to rollover exemption?

3. Ratio laid down by Hon’ble Supreme Court of India in V.S. Dempo

In V.S. Dempo, the assessee had sold its loading platform M.V. Priyadarshni in the previous year relevant to assessment year 1989-90. The asset had been acquired in 1972 and was admittedly held for over 17 years. Depreciation had been claimed on the asset. The Assessing Officer denied exemption under Section 54E on the ground that, by virtue of Section 50, the gains were deemed short-term, and Section 54E was available only on long-term capital assets.

The Income Tax Appellate Tribunal and the Bombay High Court ruled in favour of the assessee. The High Court relied upon its own earlier decision in CIT v. ACE Builders (P.) Ltd. [2005] 144 Taxman 855 (Bombay)/[2006] 281 ITR 210 (Bombay). The Hon’ble Apex Court affirmed the view, holding categorically that:

“…there is nothing in Section 50 to suggest that the fiction created in Section 50 is not only restricted to Sections 48 and 49 but also applies to other provisions. On the contrary, Section 50 makes it explicitly clear that the deemed fiction created in sub-section (1) & (2) of Section 50 is restricted only to the mode of computation of capital gains contained in Sections 48 and 49… the fiction created under Section 50 is confined to the computation of capital gains only and cannot be extended beyond that… Section 54E does not make any distinction between depreciable asset and non-depreciable asset and, therefore, the exemption available to the depreciable asset under Section 54E cannot be denied by referring to the fiction created under Section 50.”

The rationale rested on three pillars, first, the plain language of Section 50 itself confined the fiction to Sections 48 and 49; secondly, the settled proposition that a legal fiction must be confined to the purpose for which it is created (the Hon’ble Supreme Court relied on State Bank of India v. D. Hanumantha Rao, 1998 (6) SCC 183); and thirdly, the structural fact that Section 54E, 54EC and 54F triggered off the character of the asset (a long-term capital asset), not the post-fiction character of the gain.