The answer depends on the acquisition route
For tax year 2026–27, section 40 of the Income-tax Act, 2025 sets a special business-income cost rule for an asset received through specified routes and sold as stock-in-trade. It uses predecessor acquisition cost, cost of improvement and qualifying predecessor transfer expenditure. A valuation on receipt does not, by itself, replace this statutory working. First establish that section 40 applies and that the exclusion in subsection (2) does not. This guide addresses that cost trail, rather than the entire tax treatment of the receipt or sale. Income-tax Act, 2025, sections 1 and 40, as amended by Finance Act, 2026.
Which transactions belong in this working?
Section 40(1)(a) covers property of an amalgamated company under a scheme of amalgamation. Clause (b) covers an assessee receiving an asset under a gift, will or irrevocable trust, or on total or partial partition of a Hindu undivided family. In each case the relevant event for this provision is sale as stock-in-trade. Do not extend the list to every purchase, group transfer or succession merely because the consideration is low. Record the legal instrument, asset identity, relevant ownership history and the business classification on sale. Income-tax Act, 2025, sections 1 and 40, as amended by Finance Act, 2026.
Keep the statutory components separate
The first component is the acquisition cost in the hands of the amalgamating company, transferor or donor, as applicable. The second is cost of improvement made. The third is expenditure incurred by that predecessor wholly and exclusively in connection with the transfer. Maintain separate invoice references and avoid counting an improvement twice where it already forms part of the evidenced acquisition figure. A recipient's unrelated selling cost does not enter the third component simply because it was paid near the transfer date; assess any independent deduction under the applicable provision. Income-tax Act, 2025, sections 1 and 40, as amended by Finance Act, 2026.
Screen the express exclusion before using the formula
Section 40(2) excludes an asset referred to in section 67(6). Do not apply this carryover-cost working automatically to a capital-asset conversion case governed by that provision. Document the classification and timing analysis before selecting the cost rule. The illustrations below assume the section 40 route is established, the asset is sold as stock, and section 67(6) is not applicable; they do not decide a disputed conversion fact pattern. Income-tax Act, 2025, sections 1 and 40, as amended by Finance Act, 2026.
Reconcile the ledger without manufacturing a second deduction
Build an asset-wise tax-cost schedule alongside the accounting inventory schedule. A book valuation, scheme accounting entry or probate valuation may help identify the asset but is not a substitute for the statutory cost evidence. Where book cost charged on sale differs from section 40 cost, reconcile that difference once in the business computation. Do not deduct both the full book charge and the full statutory cost. Likewise, no sale-year cost should be claimed for an unsold item through this illustration's sale computation. Income-tax Act, 2025, sections 1 and 40, as amended by Finance Act, 2026.
Scope and period safeguards
The 2025 Act commenced on 1 April 2026. This article uses its section 40 for tax year 2026–27; it does not relabel an AY 2026–27 return for FY 2025–26 with new section numbers. Gift taxation, transfer exemptions, stock valuation, land-value substitution, amalgamation eligibility and other adjustments require their own analysis where relevant. The margins below isolate sale proceeds less the assumed verified section 40 cost, before other expenses and tax; they are not final taxable-income certificates. Income-tax Act, 2025, sections 1 and 40, as amended by Finance Act, 2026.
Applicable primary references
Income-tax Act, 2025, sections 1 and 40, as amended by Finance Act, 2026
Six worked illustrations
All facts and amounts below are fictional. Assumptions describe the model, not additional statutory rules.
Illustrative example 1: Gift with three evidenced components
A trader receives an eligible asset under a gift and sells it as stock for ₹40 lakh. The donor's acquisition cost is ₹20 lakh, separately evidenced improvement cost is ₹3 lakh, and qualifying donor transfer expenditure is ₹2 lakh. Section 40 cost is ₹25 lakh; the isolated sale margin is ₹15 lakh. No component has previously been included in another component.
Illustrative example 2: Will and a valuation on receipt
An eligible inherited asset has predecessor cost of ₹30 lakh, improvement cost of ₹5 lakh and qualifying predecessor transfer expenditure of ₹1 lakh. Its valuation on receipt is ₹80 lakh and sale proceeds are ₹90 lakh. The statutory cost working is ₹36 lakh, not ₹80 lakh; the isolated margin is ₹54 lakh. The ₹44 lakh difference between valuation and statutory cost is a reconciliation item, not an additional deduction.
Illustrative example 3: Amalgamation cost pack
Assume the scheme and asset satisfy section 40(1)(a), with no subsection (2) exclusion. Predecessor cost is ₹40 lakh, distinct improvement cost ₹6 lakh and qualifying predecessor transfer expense ₹4 lakh. Sale as stock for ₹70 lakh produces cost of ₹50 lakh and an isolated margin of ₹20 lakh. A fair-value entry of ₹65 lakh does not itself supply the tax cost.
Illustrative example 4: One invoice appears twice
The donor cost file shows acquisition of ₹24 lakh, which already includes a ₹4 lakh improvement invoice. A separate summary repeats that same ₹4 lakh as an improvement, alongside qualifying transfer expenditure of ₹1 lakh. The supported combined cost is ₹25 lakh, not ₹29 lakh. On ₹35 lakh sale proceeds, the isolated margin is ₹10 lakh rather than ₹6 lakh. The correction removes duplication, not the genuine improvement.
Illustrative example 5: Part of a separately identifiable portfolio sold
Two separate eligible assets have verified costs of ₹25 lakh and ₹35 lakh. Only the first is sold for ₹38 lakh in the model year. Its sale margin is ₹13 lakh; the ₹35 lakh cost of the unsold second asset is not also deducted against that sale. The total asset-level cost register still reconciles to ₹60 lakh before recording the sale movement.
Illustrative example 6: Book-to-tax sale-cost bridge
An eligible asset sold for ₹100 lakh carries a ₹90 lakh book cost charged on sale, while the independently verified section 40 cost is ₹60 lakh. The isolated book margin is ₹10 lakh and the corresponding tax margin is ₹40 lakh. The bridge adds ₹30 lakh to that book margin, assuming no other differences. It does not subtract ₹60 lakh again after leaving the ₹90 lakh book charge untouched.
Ten-step verification table
| Step | Action | Evidence |
|---|---|---|
| 1 | Identify the governing year | Sale date and a tax-year applicability note. |
| 2 | Confirm the acquisition route | Gift deed, will, trust instrument, partition records or qualifying amalgamation papers. |
| 3 | Identify each asset | Title, description and unique asset reference. |
| 4 | Establish sale as stock | Classification analysis, business records and sale documents. |
| 5 | Screen section 67(6) | Written conclusion on the express section 40(2) exclusion. |
| 6 | Trace predecessor acquisition cost | Original purchase evidence and predecessor ledger. |
| 7 | Verify improvements separately | Invoices and a duplicate-cost check. |
| 8 | Test predecessor transfer expenditure | Payer evidence and the wholly-and-exclusively connection. |
| 9 | Reconcile sold and unsold items | Asset-wise movement and book-to-tax cost bridge. |
| 10 | Review the wider computation | Separate receipt, valuation, exemption and other adjustment analysis. |
Sixteen practitioner FAQs
1. Does section 40 cover an ordinary cash purchase?
Not merely because the purchased item is later sold as stock. Establish one of the specified acquisition routes.
2. Can an amalgamated company use this provision?
Yes, where the statutory scheme-of-amalgamation route and the sale-as-stock condition are satisfied, subject to the express exclusion.
3. Are all intra-group transfers covered?
No. A group relationship alone is not a listed route in section 40(1).
4. Does a gift create a fresh fair-value tax cost under this section?
The provision uses its specified cost components; a receipt valuation alone does not substitute for them.
5. Why obtain the donor's old invoices?
The donor or transferor acquisition cost is a statutory component and needs an evidence trail.
6. Can the same improvement be counted twice?
No. Remove duplication where the acquisition figure already includes the improvement invoice.
7. Whose transfer expenditure is expressly included?
The expenditure of the amalgamating company, transferor or donor, as applicable, wholly and exclusively connected with that transfer.
8. Is the recipient's later selling expense part of that component?
Not simply because it concerns the same asset. Assess any separate deduction on its own legal basis.
9. Does this article decide whether a gift receipt is taxable?
No. Receipt taxation and any exemption require a separate analysis.
10. What is the subsection (2) checkpoint?
An asset referred to in section 67(6) is outside section 40; screen that provision before applying this working.
11. Should an unsold asset's full cost reduce another asset's sale margin?
No. Keep the asset identification and sold-item cost allocation intact.
12. Does a scheme valuation prove predecessor cost?
It may support identity or accounting, but it does not replace the predecessor statutory cost trail.
13. Is the illustrated margin final taxable income?
No. It excludes other business costs and any independently applicable statutory adjustments.
14. How should a book-cost difference be handled?
Reconcile the book charge to statutory sale cost once, with a traceable computation bridge.
15. Can missing records be replaced with an invented estimate?
No. Identify the evidence gap and resolve the appropriate supported treatment before making a claim.
16. Can the new section number be used mechanically in an FY 2025–26 return?
No. This article is for tax year 2026–27 under the 2025 Act; earlier-period applicability must be checked separately.
Conclusion
Build the section 40 cost trail for specified assets sold as stock-in-trade, separating predecessor cost, improvements and qualifying transfer expenditure.