Capital Gains — Some Current Issues
Capital Gains — Some Current Issues
CA. Pradip N. Kapasi
“I do not pretend that the opinion I hold rests on any firm logical foundation. Logic is out of place in these
questions and the embarrassment that I feel is increased with the knowledge that my views are not shared by
the members of the house, but this fact is not surprising. It is not easy to penetrate the tangled confusion of
these Acts of Parliament, and though we have entered the labyrinth together, we have unfortunately
found exit by different paths.”
— Lord Buckmaster
The prudence, in presenting a paper before a gathering of the elite participants, lies in restricting the
scope to the limited issues. This approach, usually adopted, demanded a departure on account of the
oceanic depth of the subject of the capital gains. A feeble attempt has been made in this direction by
narrowing the scope mainly to the deeming fictions contained in the general law of the capital gains. The
group leaders may deal with as many issues as are possible, for the benefit of the participants, and select
fifteen issues for discussion at the general assembly. Hope this approach will enable us to concentrate on
the issues that have been tested by the touch stone of the common need.
1. Full value of the consideration and s. 50C
1.1 S. 50C contains a deeming fiction for substituting the full value of the consideration, for the
purposes of s. 48, with the value adopted or assessed or assessable by the Stamp Valuation
Authority for payment of the stamp duty. The provisions apply only on satisfaction of the twin
conditions. One, the capital asset being transferred is a land or a building or both and two,
the full value of the consideration received or accruing as a result of the transfer is less than
the stamp duty value.
1.2 This fantastic provision introduced by the Finance Act, 2002, w.e.f. 1-4-2003, has been recently
amended by the Finance (No. 2) Act, 2009 w.e.f. 1-10-2009. The provisions are found to be
constitutional by the Madras high court in the case of K.R. Palani Samy, 306 ITR 61 and
recently by the Bombay high court in the case of Bhatia Nagar Premises CHS Ltd., under an
order dated 19-8-2010.
1.3 The provisions are made applicable only on transfer of a ‘capital asset’ and accordingly does
not apply to a case of transfer of stock in trade. K.R. Palani Samy, 306 ITR 61, Tiruvengadum
Investment, 320 ITR 346 (Mad.), Inderlok Hotels, 122 TTJ 145 (Mum.) and Excellent Land
Development, 1 ITR (Trib.) 563 (Del). The provisions will not apply on transfer of an agricultural
land, it being not a ‘capital asset’.
1.4 The application of s. 50C is restricted to land and building or both. These terms (i.e.), the ‘land’
and ‘building’ are not defined in the Income-tax Act. Chapter XX-C of the Income-tax Act, the
provisions of the Transfer of Property Act and the General Clauses Act, as also the Bombay
Stamp Act deal with the concept of an ‘immovable property’ , the scope whereof is wider than
the ‘land and building’ and includes any right, title and interest in the land and building.
1.4.1S. 27 of the Act provides that a member of a society to whom a building or part thereof
is allotted shall be deemed to be the owner of that building. It also provides that a person
in possession of the building in part performance of a contract shall be deemed to be the
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owner of that building. A provision is also contained in s. 27 for deeming a person to be
the owner of the building in a case where he acquires any rights in a building by virtue
of a transaction referred to in s. 269(UA)(f).
1.4.2 The issue that requires the participants consideration is whether the provisions of s. 50C
are applicable in the cases of transfer of the following assets—
(a) Tenancy rights.
(b) Premises in a building owned by a society.
(c) Development rights.
(d) Rights under an agreement for sale.
(e) Leasehold rights.
1.4.3The incidental issue that may be considered is whether the provisions will apply where a
part of the land or building is transferred on transfer of an undivided interest therein.
1.5 The Stamp Valuation Authority means any authority of a State Government. Under the
circumstances an issue which may be examined is about the applicability of s. 50C to a land
and building situated within the Union Territory.
1.5.1 The Stamp Duty is normally levied on execution of an instrument, under any of the
two methods. The duty is either levied on an ad valorem basis or in the alternative by
payment of a fixed amount. For example, the Stamp Duty on a conveyance of a land
is levied under Article 25 of the Bombay Stamp Act at 5% on the True Market Value of
the land while the Stamp Duty is levied under Article 5 of the said Act at the rate of
` 20 per square feet of the area of the residential premises, where the tenancy thereof is
transferred. It is therefore seen that no valuation of the property is made in cases where
the Stamp Duty is not levied on an ad valorem basis i.e. on the value of the property.
However it is seen that recently in many cases the documents of transfer of tenancy
are stamped with reference to the ready reckoner rates for the land and building on ad
valorem basis @ 5% of such value.
1.6 The fiction of s. 50C, introduced for the purpose of substituting the full value of the
consideration for the purpose of s. 48, is somewhat similar to the one contained in s. 50 and
50B(2) of the Act. The fiction contained in s. 50 has been found to have a limited application
by the court and the benefit of reinvestment u/ss. 54EC, 54ED, etc. has been found to be not
deniable in respect of a deemed short term capital gains. In the circumstances, the participants
may examine the possibility of the benefit of reinvestment oriented exemptions u/ss. 54 to 54ED
of the Act in a case where the apparent consideration is invested in the prescribed assets. In
the alternative is it possible to give effect to the said provisions of Ss. 54 to 54ED, first, in the
order of preference and thereby exhausting the capital gains before applying the provisions of
s. 50C.
1.6.1S. 50B provides for the manner of computation of capital gains in a case of a slump
sale. A slump sale ordinarily means the sale of one or more undertakings for a lump sum
consideration without values being assigned to individual asset and liabilities, transferred
under such a sale. The asset and liabilities in such a sale may include land or building or
both. In execution of the deed for slump sale, it is possible that the value of the said land
and building might have been specified for determination of stamp duty payable thereon.
In the circumstances the issue that arises for consideration, is about the application of
the provision of s. 50C in computing the capital gains u/s 50B.
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1.6.2Likewise, when a building on which the depreciation has been allowed is transferred,
the income thereof will be computed under the special provisions of s.50. Again the
question arises about the application of section 50C where one is required to determine
whether the stamp duty value or the agreement value would be relevant for the purposes
adjustment in block of assets.
1.6.3Ss. 45(1A), 45(2),45(3), 45(4) and 46 are deeming provisions which contain certain fictions
for substituting the full value of the consideration for the purposes of s. 48. These fictions
are similar to that of section 50C. The question that arises for consideration, under the
circumstances, more particularly in the context of s. 45(3), is about the precedence of
application of these provisions in preference to s. 50C for ascertaining the full value of
the consideration. The participants are requested to ascertain the applicability of section
50C in such cases and particularly in a case where a partner has introduced a plot of
land into a firm by way of a capital contribution in which he is a partner.
1.7 S. 50C, on its introduction, provided for the substitution of the value adopted or assessed by
a Stamp Valuation Authority. The use of the restricted term “adopted or assessed” has led
some of the benches of the Tribunal to hold that the provisions of s. 50C were not attracted in
cases where the instrument of transfer was not registered (stamped). Navneet Kumar Thakkar,
112 TTJ 76 (Jd.), Carlton Hotels, 122 TTJ 515 (Luck.) and Vijaylaxmi Dhadda 20 DTR 365
(Jp.). Fearing the severe consequences of a possible glitch, the Parliament has introduced an
amendment, with the objective of bringing in an unstamped instrument of transfer within the
ambit of s. 50C. With this objective in mind, the substitution of even an ‘assessable’ value is
made possible w.e.f. 1-10-2009. The amendment possibly confirms that the decisions of the
tribunal are final for the transfers effected up to 30-9-2009, unless a view is taken that the
amendment is clarificatory.
1.7.1 The term “assessable” is defined vide Explanation 2 to mean that the price which the
Stamp Valuation Authority would have adopted or assessed if “it” were referred to such
authority for the purposes of the payment of the stamp duty. The Explanation is very
ambiguous and seems to be raising more issues than solving the one on hand. The
participants are requested to guide the Assessing officer in ascertaining the value to be
substituted in computing the capital gains arising out of an unstamped instrument of
transfer after the amendment. Can an amount of assessable value be ascertained without
the help of the Stamp Valuation Authority.
1.8 S. 50C(2) provides for a possible remedy to address the grievance of an assessee, arising on
account of the stamp duty valuation. It authorizes the Assessing Officer to refer the valuation of
the capital asset to a Valuation Officer (‘V.O.’) appointed u/s 12A of the Wealth Tax Act by the
Central Government. An Assessing Officer may refer the valuation to the V.O. on satisfaction
of the two conditions. One, that the assessee claims before the A.O. that the Stamp Valuation
Authority (‘S.V.A.’) value exceeds the FMV of the “property” and two, that such SVA value has
not been disputed in any appeal or revision or reference before any other authority or a court.
1.8.1Several procedural aspects need to be attended to in order to make the most of this
remedy available to the assessee. While no specific method or form is prescribed, for
records, it will be essential to apply to the Assessing Officer requesting him to refer
the valuation to the V.O. by placing the objection to the SVA valuation on record. The
time for such an application may be determined by the participants in the regime of
electronic returns. They may also consider whether the A.O. is bound to notify his
intention of substituting the returned consideration with the SVA value before completing
the assessment.
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1.8.2On receipt of the application by the A.O., he is bound to refer the valuation to the V.O.
It appears that he has no discretion in the matter. Maghraj Baid 114 TTJ 841 (JD.) and
Manjurani Jain 24 SOT 24 (Del.).
1.8.3A claim by the assessee for objecting to the SVA valuation is essential for invoking the
reference to V.O., failing which the A.O. would not be bound to make any reference for
valuation. Ambattur Clothing Co. 221 CTR 196 (Mad.). The participants may examine the
possibility of making such a claim in the appellate proceedings.
1.8.4S. 50C(3) mandates that the SVA value shall be substituted for the full value of the
consideration in cases where the value determined u/s 50C(2) by the V.O. exceeds
the SVA value. Needless to say that the V.O.’s value should be substituted where such
value is less than the SVA value. Ravikant 110 TTJ 297 (Del.) and R.V. Singh 26 DTR
129 (Luck.) The A.O. has no power to refer the valuation to the V.O. in cases where the
assessee has accepted the stamp duty value or the higher agreement value. It is not
permissible for the A.O. to adopt a value higher than the said values where he is of the
opinion that such values are lower than the market value. Punjab Poly Jute, 120 TTJ 233
(Asr.).
1.8.5An all important aspect of the provision that requires collective consideration is about the
finality of the valuation by the SVA or V.O. Is it possible for an Assessing Officer to desist
from making an addition in cases where the difference between the agreement value and
the final valuation is found to be range bound, say 20% of agreement value by relying on
the Supreme Court decision in C. B. Gautam’s case, 199 ITR 530. The Supreme Court in
the case of U. P. Jal Nigam, AIR 1996 SC 1170 held that the valuations under the stamp
laws, while being the guiding post, cannot be the conclusive evidence for substituting the
valuation in other laws.
1.8.6One usually comes across cases wherein an assessment is completed pending the
receipt of the report from the V.O. In such cases, the course of action to be followed
subsequent to the finalization of assessment needs to be examined. S. 155(15) provides
for a case for rectification of the value substituted for computation of capital gains by such
value determined in appeal, revision or reference proceedings within a period of 4 years
from the end in which the order revising the value was passed. This provision appears
to have a limited application which is restricted to the proceedings under the stamp
laws; it does not facilitate rectification of the order on subsequent receipt of V.O.’s report,
requiring the tax payer to file an appeal for keeping the issue alive, failing which there
may be an unpleasant difficulty. In this connection, one may refer to the decision of the
Madras High Court in the case of Rajni Venugopal wherein a view is taken that an order
of assessment could not be stayed for an indefinite period, 16 DTR 319. The Madras High
Court in a latter decision in case of N. Minakshi, 30 DTR 1 has held that an Assessment
Order passed pending the receipt of V.O.’s report requires to be rectified for giving effect
to the V.O.’s report on its receipt. The participants may examine the possibility of treating
the act of substitution as infructuous in such circumstances.
1.8.7The issue that also requires consideration is about the right of an assessee to seek a
reference to the V.O. in cases where the stamp duty valuation has been disputed by the
purchaser and also in cases where such valuation is disputed by the assessee himself.
1.8.8An interesting issue arises in a case where the value received by the assessee as per the
order of the court or under the public auction is found to be less than the value adopted
by the Stamp Authority.
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1.9 There are cases where a conveyance is executed in pursuance of the agreement executed on
or before 1-4-2003. In such cases whether the value adopted for payment of stamp duty on
conveyance can be substituted or not is a question which was examined by the Tribunal in the
cases of Neville D. Nooranha, 115 TTJ 390 (Kol.) and Mr. Sivaparvathy, 129 TTJ 463 (Visakha).
1.10 In many of the cases, the additions are made in the hands of the purchasers of the property
on the basis of the stamp duty value by applying the provisions of s. 50C r.w.s. 69B or without
such application. The Punjab & Haryana high court recently, in the context of what is being
discussed here, has held that no addition could be sustained in the hands of a purchaser by
resorting to s. 50C Chandni Bhuchar, 223 ITR 510 (P&H).
1.11 The remaining question is about the need for the assessee to substitute the stamp duty value
in computing the capital gains while filing the return of income. Will not doing so attract the
penalty for concealment of income. Apparently it appears that no penalty should be levied
however, failure to compute the correct capital gains in the absence of any dispute with the
stamp valuation may invite penalty proceedings.
1.12 It is not uncommon to come across the cases where the A.O. fails to invoke the provisions of s.
50C in assessing the capital gains. The lapse whether can invite the revision or reassessment
of the completed assessment is an issue which participants may please consider.
2. Development agreement
2.1 A model development agreement, executed between a landlord and a developer, provides for
the development of the land and by construction of a building thereon by the developer. The
consideration is payable in cash or kind or both over a period of time, usually spread over a
number of years. It provides for a licence to enter the plot of land and complete the work of
development. The landlord grants a power of attorney, at times irrevocable, and authorizes the
developer to sell the flats and receive the consideration for himself.
2.2 It was for long believed that such an arrangement takes care of the provisions of clauses (v)
and (vi) of s. 2(47) of the Act. It was believed that a license to enter the plot of land was not
akin to the possession of the kind treated as in part performance of an agreement for sale
u/s 53A of the Transfer of Property Act. Several decisions, in the past supported this view by
holding that the transfer did not take place on execution of a development agreement.
2.3 This position is disturbed by the decision of the Bombay High Court, delivered in the case
of Chaturbhuj Dwarkadas Kapadia, 260 ITR 491. The Court in that case stated that the
agreement was an agreement for sale in disguise. It noted that clause (v) of s. 2(47) was
specifically introduced to plug the mischief of deferring the taxation through the means of
such agreements. It held that neither the date of substantial compliance nor the date of actual
possession was relevant for taxation of such agreement. The court held that the date of
agreement was relevant for determining the year of taxation. The court laid down the guidelines
for the Income Tax Department to be followed in all cases.
2.3.1 In that case, the assessee an owner of an undivided right in 10 buildings located at
Gamdevi, Mumbai granted development rights under an agreement dated 18-8-1994 for
development to take place only after settlement of the claim of the tenants and procuring
of the permissions and approvals. The rent was continued to be received by the assessee
who also paid municipal taxes thereon. The permissions from the authorities under
the Coastal Regulatory Zone regulations was obtained in April, 1995 and the ULCA
in February, 1996. Substantial payments were made by March, 1996 and a power of
attorney was given in March, 1997. Irrevocable licence to enter the premises was given
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in the financial year 1998-99. The assessee had offered the income for tax in the A.Y.
1999-2000. The Income tax Department had taxed the income for the A.Y. 1996-97
2.3.2The main observations of the court, in the decision, are :
•
an arrangement conferring privileges of ownership even without transferring title fell
under clause(v).
•
if the contract as a whole indicates passing or transferring of complete control to
developer the date of contract to be the year of chargeability of capital gains.
•
substantial performance of contract based on the payment and permission is not
relevant.
•
a grant of a limited power of attorney to the developer to deal with property is
sufficient.
•
development agreement does not constitute a transfer under general law.
•
development agreement, read as a whole, if a disguised agreement for sale,
s. 2(47)(v) to apply.
•
an agreement to give a limited Power of Attorney whether given or not and an
irrevocable license contemplate transfer under clause (v).
•
date of actual possession by grant of an irrevocable license is not relevant for
2(47)(v).
•
the year of chargeability is the year in which the contract is executed.
2.4 The said decision requires us to have a complete re-look at the established notions of transfer
under a development agreement or on an agreement for sale and mandates us to address the
following issues comprehensively;
•
Does the grant of a licence to enter a plot of land is the same as the possession u/s 53A
of the TOPA,
•
Does a clause providing for possession at a future date, attract the provisions of s. 2(47)
on execution of agreement.
•
Is possession at all necessary for attracting the provisions of s. 2(47).
•
Whether parting with the possession, pending the clearances, attract the provisions of
s. 2(47) on execution of agreement on parting with the possession or when the
clearances are received.
•
Is an agreement for sale, any different from a development agreement, in any manner.
•
Whether the provisions of clauses (v) and (vi) are all encompassing.
•
Whether the decision requires a reconsideration.
2.5 The issues require a deeper consideration for seeking a better and cleaner alternative, as
payment of taxes in full, by the landlord on execution of agreement, without receiving a part
consideration that can meet the tax demand, is nay impossible.
2.6 Some of the decisions that have sought to chart a different course by distinguishing the said
decision of the Bombay High Court are;
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•
Smt. Geetadevi Pasari, 14 SOT 63 (Mum.), wherein the Chaturbhuj Dwarkadas’s decision
was not followed on the ground that the possession was not parted with. The appeal of
the Revenue against the said decision of the tribunal was rejected by the Bombay High
Court on the ground that no substantial question of law arose out of the decision of the
tribunal. The Court observed that possession was not parted with by the landlord. August,
2009. IT Review, 32.
•
Gandhi & Co. the Mumbai tribunal in the case reported in 13 SOT 82, held that the
Chaturbhuj Dwarkadas’s decision did not apply to the facts of the case where the
agreement was subject to obtaining approval of the Charity Commissioner.
•
General Glass (P) Ltd., 14 SOT 32 (Mum). In this case the tribunal again distinguished
the said Chartbhuj Dwarkadas’s case on the grounds that in the facts of the case, the
developer was not willing to perform his part of obligation.
•
G. Saroja, 301 ITR 124 (Mad.) where it was held that clause (v) of s. 2 (47) did not apply
as no written agreement was executed.
2.7 These decisions appear to have confounded the complexities and cannot be held to be the
guiding lights and in any case can be held to have been delivered on the peculiar facts.
The participants may list the alternatives that convincingly meet the challenges posed by the
Chaturbhuj Dwarkadas’s decision.
3.
Conversion of capital asset into stock-in-trade – s. 45(2)
3.1 The Supreme Court in the case of Shirinbai Kooka, 46 ITR 86 held that no transfer took place
on conversion of a capital asset into a stock-in-trade. The effect of this decision was nullified
by the introduction of s. 45(2) of the Act w.e.f. 1-4-1985. With this introduction, the law now
contains an express provision for bringing to tax the gains arising on conversion of a capital
asset in to a stock-in-trade.
3.2 S. 45(3) begins with a non-obstante clause for its application independent of the provisions
of s. 45(1). It provides that the profit or loss arising from the transfer by way of conversion of
a capital asset into or its treatment as stock-in-trade, of a business carried on by him, shall
be chargeable to tax as income of the previous year in which such stock-in-trade is sold or
otherwise transferred. It further provides that the fair market value of the asset on the date of
such conversion shall be deemed to be the full value of the consideration for the purposes
of s. 48. Simultaneously, clause (iv) has been introduced in s. 2(47) for treating the act of
conversion or treatment as a ‘transfer’.
3.3 The gains that arise on conversion or treatment is chargeable to tax in the year of sale
or transfer of the converted capital asset. The section provides for two distinct events; of
conversion of capital asset in to a stock in trade and the sale of such stock. Both these
events may not fall in the same year and may take place into two different years. Under the
circumstances one needs to ascertain the year in which the capital gains is required to be
computed. The charge for taxation is surely in the year of sale of stock-in-trade while the
deemed transfer takes place in the year of conversion. Answer to this question is crucial for
the determination of; the period of holding, the end year of indexation, the year of set-off of
losses and the last date for reinvestment.
3.3.1One way is to hold that the period of holding of the capital asset shall end with the actual
sale and accordingly all the provisions of the Act prevailing in the year of actual sale
shall apply. The other way is to give full effect to the deemed transfer by applying the
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provisions of law in the year of deemed transfer by computing the capital gains though
the gains so ascertained is eventually taxed in the year of actual sale. For example, Mr. X
in computing the total income of A.Y. 2009-10 had set off the brought forward loss of ` 50
lakh, relating to A.Y. 2005-06, against the deemed capital gains of ` 50 lakh, computed on
account of conversion of capital asset on 31-3-2009. The Assessing Officer wants to tax
the said deemed capital gains of ` 50 lakh in the year of actual sale i.e. the A.Y. 2010-11
ignoring the fact of set off of losses in A.Y 2009-10.
3.3.2 In an another example, the Assessing Officer has sought to apply the provisions of s.
50C for bringing to tax the deemed capital gains, on sale of the converted stock-in-trade,
in assessment of income for the A.Y. 2008-09. He ignored the fact that the conversion of
the capital asset took place in the A.Y. 2002-03. In assessing the income for A.Y. 2008-09,
the A.O. has indexed the cost of acquisition by adopting the C.I.I. for the F.Y. 2001-02 and
has also denied the exemption u/s 54EC for A.Y. 2008-09 holding that the reinvestment
should have been done within a period of 6 months from the date of conversion.
3.4 The charge for taxation, as noted earlier is in the year of sale or transfer of the converted asset.
The questions that arise for consideration, in the context, are;
•
In case of piecemeal sales of an asset in different years, whether the taxation u/s 45(2)
would be in the first year or the last year of sale or in the different years .
•
Whether the term ‘transfer’ while applying s. 45(2) shall be understood within the meaning
of s. 2(47) or as is understood under the general law.
3.4.1 For example, Mr. X the owner of a plot of land has converted the said plot of land into
stock-in-trade of his business of development of land and building in the year relevant to
A.Y. 2002-03. He constructed 100 flats in the said plot of land during the F.Y. 2002-03 and
2003-04 and sold the same in four years relevant to A.Y. 2005-06 to A.Y, 2008-09. The
building was conveyed to the society on 31-3-2008. He has reinvested the sale proceeds
in purchasing prescribed bonds on 30-9-2008. In Naynaben R. Desai, 124 ITD 387(Ahd.),
it was held that the grant of development rights to a firm where the landlord assessee
was a partner amounted to conversion attracting provisions of s. 45(2) as against that
in R. Gopinath (HUF) 133 TTJ 595, it was held by the Chennai tribunal that the grant
of rights on execution of a development agreement subsequent to conversion did not
amount to transfer for the purposes of s. 45(2).
3.5 The participants may explore the usefulness of these provisions in cases where the capital
gains is treated as a business income by the Assessing Officer which is presently done in
cases of capital gains on sale of specified shares for deduction u/s 10(38) or the benefit of
concessional rate of taxation u/s. 111A.
3.6 A question that arises for consideration is about the automatic applicability of the provisions,
once a capital asset is found to be treated as a stock-in-trade. The law does not require any
special documentation to mark the conversion. The fact that the asset has been treated as
a business asset shall be sufficient to acknowledge the act of conversion; the proof of the
pudding is in eating it. Accepting the proposition that s. 45(2) has an automatic application
can cut both the ways, in some cases, it may be helpful to the assessees and in some to the
revenue.
3.6.1 The related issue that arises, is about the need for an assessee to have commenced the
business before converting the capital asset in to a stock-in-trade of such business. There
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is no stipulation in the provision, express or implied, that require that the assesee before
the conversion should have been engaged in the business. A business can begin with
the conversion.
3.7 The Special Bench of Kolkata tribunal in the case of Octavius Steel Co. Ltd. 78 TTJ 170, held
that, the sale of an asset attracted the liability for payment of tax u/s. 45(2) even where the
conversion took place prior to 1-4-1985.
4.
Conversion of stock-in-trade
4.1 The Supreme Court in the case of Shirinbai Kooka, 46 ITR 86, held that no transfer took place
on conversion of a capital asset into a stock-in-trade. The effect of this decision is nullified on
introduction of s. 45(2) of the Act w.e.f. 1-4-1985. With this introduction, the law now contains
an express provision for bringing to tax the gains arising on conversion of a capital asset. The
law however continues to be without any express provision, for treatment to be given in a case
where a stock-in-trade is converted in to a capital asset.
4.2 The revenue regularly tries to tax the difference, between the cost of such stock and the market
value thereof, on the date of conversion. In some cases even the assessee tries to claim, the
negative difference arising on conversion as, a business loss. The urge for such conversion of
stock-in-trade into a capital asset, is greater in cases of the shares of the listed companies as
the capital gains on subsequent transfer of shares held as a capital asset is exempted from
the liability to capital gains tax.
4.3 The issue was first examined by the Supreme Court in the case of Sir Kikabhai Premchand,
24 ITR 605. In that case the assessee, a dealer in bullion and stocks had withdrawn certain
silver bars and shares from the stock-in-trade of the business carried on by him by debiting
his capital account. The Income Tax Department brought to tax the difference between the cost
of the assets and the market value prevailing on the date of conversion. The Supreme Court
in the above facts of the case held, that no business income arose on withdrawal of stock-intrade by the proprietor.
4.4 The Calcutta High Court in the case of Dhanuka & Sons, 124 ITR 24 rejected the claim, of the
assessee, for allowance of a business loss arising on account of withdrawal of shares from
stock-in-trade represented by the difference between the cost of such shares and the lower
market value on the date of withdrawal. The Tribunal in the case of Bright Star Investment (P)
Ltd., 24 SOT 288, recently, held that the provisions of s. 45(2) cannot be applied to a case of
conversion of stock-in-trade to bring to tax the notional income as the business income. The
law in India, on this aspect, appears to be different than the English law in as much as such
conversion of a business asset into a capital asset was held to be attracting tax on business
income in the U.K. Sharky v. Werneher, 29 ITR 962 (HL).
4.5 The direct offshoot of such conversion is the determination of the cost of acquisition and the
period of holding of the converted capital asset and also the determination of the base year
of indexation. The Calcutta tribunal in the case of B.K.A.V. Birla 35 ITD 136, had held that the
period of holding commenced from the date of conversion of stock in trade into a capital asset.
4.6 The Mumbai Tribunal in the case of Bright Star Investment (P) Ltd., 24 SOT 288 held that the
cost of purchase or the market value on the date of conversion, whichever was beneficial to
the assessee could be taken as the cost of acquisition of the converted capital asset. The
Bombay high court in the case of Jhanvi Investment (P) Ltd., 304 ITR 276 held that the cost of
purchase on the date of acquisition and not on the date of conversion shall be the cost for the
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purposes of s. 48. The high court also held that the assessee should be allowed to substitute
the fair market value as on 1-4-1981 if the asset was acquired before 1-4-1981.
4.7 The tribunal in the said Bright Stars’ case held that in the absence of a specific provision, one
of the following two formulae, favourable to the assessee, be accepted:
•
the difference between the book value of the shares and the market value of the shares
on the date of conversion be taken as a business income and the difference between the
conversion value and the selling price be treated as the capital gains as was done by the
Assessing Officer, or
•
the difference between the sale price of the shares and the cost of acquisition of shares
be taken as capital gains and the indexation be given from the date of conversion.
4.8 The Pune Bench of the tribunal had an occasion to comprehensively examine these aspects in
the case of Kalyani Exports and Investment (P) Ltd., 78 ITD 95 wherein the Tribunal held that:
•
the cost of acquisition for computing the capital gains would be the cost of purchase,
•
such cost would be eligible for substitution of FMV as on 1-4-1981,
•
such cost would be indexed by taking the year of purchase as the basis or 1-4-1981, and
•
the period of holding commenced with the date of purchase.
4.9 In the circumstances, the participants are requested to determine the correct position in law
on this above discussed aspects.
5. Introduction of Capital Asset – s. 45(3)
5.1 The Supreme court, in the case of Sunil Siddharthbhai, 156 ITR 509 held that it was not
possible to compute the capital gains that arose on introduction of a capital asset by a partner
into a firm. S. 45(3) has been introduced, by the Finance Act, 1987 w.e.f. 1-4-1988, to modify
the effect of the said decision. It provides that the profits and gains arising from transfer of
a capital asset, by a person to a firm in which he is a partner, by way of capital contribution
or otherwise shall be chargeable in the year in which such transfer takes place. The section
further provides that the amount recorded in the books of account of the firm, as the value of
the capital asset, shall be deemed to be the full value of the consideration for the purposes
of s. 48. No amendment, simultaneously, has been made in s. 2(47) of the Act for specifically
covering the deeming fiction.
5.2 The provision apparently applies to the case of a capital contribution of a capital asset. A
“capital asset” within the meaning of s. 2(14) excludes the stock-in-trade and therefore, it is
believed that s. 45(3) does not cover, within its scope, the introduction of the stock-in-trade
into the firm by a partner. However, the special bench of the ITAT has recently held that the
provision of s. 45 shall apply even to the case of an introduction of stock-in-trade by a partner
on the ground that such stock-in-trade at the particular moment of introduction was a capital
asset. DLF Universal Ltd., 123 ITD 1 (Del.)(S.B.). The participants are requested to examine
the validity of this decision.
5.3 The section, as noted, provides that the amount recorded in the books of account of the firm
be deemed to be the full value of the consideration for the purposes of computation of capital
gains. This value, recorded in the books of account of the firm, may not always be the same
as the amount with which the account of the introducing partner is credited. Dharamshi B.
Shah, 32 DTR 106 (Ahd.) (TM).
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5.4 The scope of the provision travels beyond the capital contribution by a partner. The use of the
term “or otherwise” confirms this. Accordingly any payment in kind, by a partner, not in the
nature of a capital contribution may attract the provisions of s. 45(2).
5.5 The provision presupposes a transfer u/s 2 (47), before it is applied for taxing any capital gains.
In the absence of a transfer u/s 2(47), the provision of s. 45(3) might not apply even though
the account of a partner is credited with some value.
5.6 An asset, though introduced as a capital asset, may be treated as a stock-in-trade by the
firm thereby attracting the provisions of s. 45(2) in the firm’s hands with the simultaneous
application of s. 45(3) in the hands of the partner.
5.7 The provision at times helps the assessee for shifting or eliminating the burden of capital gains
tax from the hands of the partner to that of the firm with the unabsorbed losses.
5.8 The issue about the applicability of the provisions of s. 50C, while applying the provisions
of s. 45(3), is discussed elsewhere in the paper. Recently s. 56(2)(viia) has been introduced
w.e.f. 1-6-2010, to provide that the fair market value of any shares of the specified company,
by a firm without consideration, shall be taxed as income from other sources in the year of
receipt. The provision also applies to the cases of such receipt for inadequate consideration,
by taxing the difference between the fair market value and the consideration. The participants
are requested to examine the implication of such a provision to the case of capital contribution
of the specified shares into the firm by a partner at the book value.
5.9 There are no specific provisions for determination of the cost of acquisition of such asset in the
hands of the firm, though logically the cost should be the same as the value that is recorded
in the books of account of the firm. S. 49(4) contains a specific provision for cases covered
by the said section 56(2)(viia).
5.10 The Authority for Advance Ruling has held that the provisions of ss. 92 to 92F were applicable
on contribution of a capital asset into the firm by an Associate Enterprise. Canora Resources
Ltd., 313 ITR 5 (AAR).
6. Distribution of capital asset on dissolution – Section 45(4)
6.1 S. 45(4) has been introduced w.e.f. 1-4-1988 by the Finance Act, 1987 to nullify the effect of
the several Supreme Court decisions including in the cases of Dewas Cine Corporation 68 ITR
240 and Bankelal Vaidya 79 ITR 594. The section provides that the profits and gains, arising
from the transfer of a capital asset by way of distribution of a capital asset, on dissolution of
the firm or otherwise, shall be chargeable to tax as the income of the firm of the previous year
in which the said transfer takes place. It further provides that the fair market value of the asset
on the date of such transfer shall be deemed to be the full value of the consideration for the
purposes of section 48.
6.2 This provision is one of the most discussed about provisions of the Act and has been the
cause of substantial litigation since its introduction. The law that has emerged so far is broadly
as under:
•
S. 45(4) is applicable in a case of dissolution of a firm on account of the death of a
partner, Singla Rice Mills, 82 ITD 531 (Del.), Southern Tubes, 306 ITR 216 (Ker).
•
S. 45(4) applies to the case of retirement, Burlington Exports, 45 ITD 494 (Mum), A.N.
Naik & Associates, 265 ITR 346 (Bom).
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•
S. 45(4) is attracted in cases where the original partners of the firm are retired through
a series of events and are replaced by the new partners. Gurnath Talkies, 226 CTR 474
(Karn).
•
The liability to the capital gains tax arises in the year of distribution of capital asset and
not in the year of dissolution. Vijayalaxmi Metal Industries, 256 ITR 540 (Mad).
•
The liability to tax shall be in the hands of the AOP, Kothari Vora Associates, 57 ITD 171
(Pune). However, in most of the cases the gains u/s 45(4) are taxed in the hands of the
firm.
•
S. 45(4) is a charging section and the charge of taxation does not fail for want of an
amendment in s. 2(47). Suvardhan, 287 ITR 404. For a contrary decision, please see
Moped & Machines, 281 ITR 52 (M.P.).
•
The cost of acquisition, in the hands of a partner, of the distributed asset, shall be the
fair market value as on the date of distribution and the period of holding in his hands
shall commence from the date of distribution. The contrary view taken by the Kerala High
Court, in case of P.P. Menon, 183 Taxman 246 requires reconsideration.
6.3 S. 45(4) poses serious unintended and uninvited consequences and some deeper thinking is
required to remain outside the clutches of this provision. In this direction, we need to examine
the possibility of;
•
a sale of an asset to a partner at a book value instead of the distribution in the hope
that the sale does not attract the provision of s. 45(4), by keeping the implication of s.
50C in mind.
•
sale of the business of the firm on a going concern basis on conversion of a firm into a
company at a book value.
•
payment in kind by the firm to the retired partner in settlement of the dues payable on
retirement.
•
continuing the business by one of the erstwhile partners for contending that there is no
distribution of assets or that the provisions of s. 50B apply instead of s. 50C
•
claiming the benefit of exemption u/s 47(xiii) or s. 47(xiiib).
•
contending that the provisions of parallel fictions contained in ss. 50, 50B, 50C, 56(2)(viia),
etc. shall not apply to a case where s. 45(4) has been applied.
•
reconstitution by the surviving partners on the death of the partner for continuation of
business of the firm without distribution of assets.
7. Retirement
7.1 The accounts of a partner, on retirement, are required to be settled in accordance with the
provisions of the Indian Partnership Act, 1932. In determining the amount payable to the
retiring partner, the partners are required to take into consideration a fair value of the assets
and liabilities by assuming the notional transfer thereof. The surplus or the deficit is required
to be apportioned in the profit sharing ratio or in proportion to the capital held by the partners
by debiting or crediting the respective accounts of the partners. The amount remaining at the
foot of the account of the retiring partner, is the amount payable or receivable from the retiring
partner, which amount may be further adjusted by mutual understanding.
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7.2 In many cases the excess amount paid to the retiring partner, on account of the said notional
exercise, has been sought to be taxed by the Income Tax Department, in the hands of
the retiring partner, under the head capital gains. The Income Tax Department is keener to
bring to tax such difference where the partnership firm revalues the asset on or before the
retirement. The tax department has tasted success in the past in cases where the deed of
retirement provided for assignment of interest of the retiring partner to the continuing partners.
Tribhuvandas G. Patel, 115 ITR 95 (Bom), H.R. Aslot, 115 ITR 255 (Bom) and N.A. Modi,
162 ITR 420 (Bom) descending with the judgment of the Gujarat High Court in the case of
Mohanbhai Pammabhai, 91 ITR 393 (Guj.).
7.3 The said decision of the Gujarat High Court, in Mohanbhai Pammabhai’s case was confirmed
by the Supreme Court in a case reported in 165 ITR 166. The Supreme Court subsequently
has reversed the decision of the Bombay High Court in the case of Tribhuvandas G. Patel, 236
ITR 515. The court further reaffirmed its decision that no tax is payable by the retiring partner
in the case of L. Raghukumar 247 ITR 801.
7.4 Following these decisions of the apex court, it was believed that the amount received by the
retiring partner on retirement is not taxable. This understanding has been disturbed by a couple
of decisions delivered subsequent to the Supreme Court decisions. Bhishanlal Kanodia, 257
ITR 449 ( Del.) and Sevantilal C. Mehta, 83 TTJ 543 (Pune), thereby raising a doubt about the
finality of the apex court decisions.
7.5 The participants are requested to examine the correct position in law and also examine whether
the introduction of s. 45(4) has made any difference to the law developed on this subject.
They may also decide whether provisions of s. 45(4) in cases where the amount payable to
the retiring partner is paid in kind by handing over an asset at a market value.
8. Liquidation – s. 46
8.1 S. 46, contained in Chapter IV-E, provides for the tax treatment of the distribution of assets,
to the shareholders, by the company, on liquidation. It also provides for the tax treatment in
the hands of the shareholders on liquidation. Both these provisions operate in different fields.
One applies to the distribution of assets of the company and the other applies to the transfer
of shares by a shareholder.
8.2 Sub-section (1) provides that any distribution of the assets of a company to its shareholders on
liquidation shall not be regarded as a transfer by the company, for the purpose of s. 45. The
gains if any on a transfer, by the company of it assets, is accordingly exempted from tax in
the hands of the company. It also contains a specific provision for overriding s. 45 to save the
company from any possible liability to taxation u/s 45. The provision puts to rest any debate
that no transfer takes place on liquidation in the hands of a company.
8.2.1 The exemption under this provision is not restricted to gains on the transfer of a capital
asset and extends to the profits on transfer of any asset. The period of holding of an
asset by the company therefore assumes no relevance in view of the total exemption.
Even the gains computed u/s. 50 shall not be brought to tax.
8.2.2 A ‘company in liquidation’ is the one which goes in to liquidation and its being wound up.
A ‘company on liquidation’ is the one whose winding up process is completed. The right
of the shareholders for return of capital comes to an end on the later date. Jaykrishna
Harivallabhdas, 231 ITR 108 (Guj).
8.3 Sub-section (2) provides that a shareholder shall be chargeable to Income tax under the head
capital gains, in respect of the money or the market value of the other assets so received, on
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the date of distribution. It further provides that such market value, as reduced by the amount of
dividend u/s 2(22)(c), shall be deemed to be the full value of the consideration for the purpose
of section 48. It does not contain a specific provision for overriding s. 45 and does not save a
shareholder from taxation u/s 45. The provision puts to rest any debate that no transfer takes
place on liquidation in the hands of a shareholder. S. 46(2) is a charging section independent
of s. 45. M. A. Chidarambaram, 147 ITR 180 (Mad)
8.3.1 The charge here, though not specifically expressed, is for the ‘transfer’ of shares or
rights
therein, held by a shareholder. The shares are deemed to be transferred on the
date of distribution that takes place on liquidation. The shares held by a shareholder get
extinguished on liquidation of the company or on application for liquidation when it goes
into liquidation. This charge is not restricted to gains on the transfer of a capital asset
and extends to profits on transfer of any asset.
8.3.2 The cost of acquisition of the shares and improvement thereof, as indexed up to the
date on which the company goes in to liquidation, shall be the cost of the acquisition
for computation of the capital gains. The provisions of ss. 48, 49 and 55 shall apply in
determination of the cost of acquisition of the shares. The amount assessed as dividend
u/s 2(22)(c) is to be excluded from taxation u/s 46(2), Vijay Kumar Budhia, 204 ITR 355
(SC). The said dividend shall not however be excluded from the cost of acquisition of
assets in the hands of the shareholder on a subsequent sale.
8.3.3 The period of holding of an asset by the company has no relevance, in deciding the
period of holding of shares, in the hands of the shareholder. This period commences with
the date of acquisition of the shares by the shareholder and varies from a shareholder to
shareholder. It ends on the date on which the company goes in to liquidation and does
not extend to the date of distribution in view of the deeming fiction of s. 2(42A) which
provides that in deciding the period of holding of a share in a company in liquidation,
the period subsequent to the date on which the company goes into liquidation shall be
excluded.
8.3.4 It is possible that more than one capital asset is distributed at different times by the
liquidator. Each of the distributions shall attract liability to capital gains in the respective
year of receipt. Cable and Wireless Ltd. 90 ITR 84 (Bom.). The cost of acquisition of
shares would be deducted against the first possible receipts and the remaining receipts
will be taxed in its entirety. Inland Agencies (P) Ltd. 143 ITR 186 (Mad). The finding is not
supported by the express provisions of law.
8.3.5 The capital gains here shall be eligible for the benefit of exemptions u/ss. 54 to 54ED
subject to compliance of the conditions therein unless a view is taken that the receipt
of money did not represent any gains made on transfer of an asset by the assessee
and therefore the benefit of reinvestment was not allowable to the assessee. The losses
if any shall be set off as per the provisions of ss. 70, 71 and 74. The distribution to a
shareholder which is a subsidiary or holding company on liquidation of the holding or
subsidiary company will be exempt from tax u/ss. 47(iv) and (v). Similarly a receipt of the
residential premises, by a shareholder on distribution of assets of the company, should
qualify for the exemption u/s 54F, subject to compliance of the conditions of that section
unless a view is taken that the receipt on distribution does not amount to purchase of an
asset.
8.3.6 It should be possible for a company to claim exemption u/s. 46(1) on distribution of stockin-trade u/s 46(1) but difficult for a shareholder to contend that receipt is not taxable in
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his hands on the ground that the scope of the s. 46(2) which operates under Chapter
IV-E should be restricted to taxation of gains relating to a capital asset. The Supreme
Court in the case of M. Baghavati Ammal, 259 ITR 678 (S.C.) held that the term “asset”
referred to in s. 46(2) did not mean “capital assets” as defined in s. 2(14) and accordingly
the distribution of even an agricultural land attracted taxation u/s 46(2). The end result is
agreeable, the reason appears to be debatable.
8.3.7 The provisions shall apply irrespective of the fact that the shares are held as stock-in-trade
and the gains, if any, shall be taxed under the head capital gains. This understanding, in
the process, throws open issues concerning the determination of the cost of acquisition,
right to indexation and the period of holding and the claim for tax exemptions.
8.3.8 The provisions shall apply even where the stock-in-trade of the company is transferred
on distribution. Such receipt shall be taxed as the capital gains in the hands of the
shareholders. The distribution as noted earlier shall not be taxed in the hands of the
company.
8.3.9 The market value of the distributed asset should be the same as the fair market value.
The amount that is representing the full value of the consideration is represented by
the market value of the asset prevalent on the date of distribution and not the value
determined by the liquidator. Umadevi Budhia, 157 ITR 478 (Pat.). It is for consideration
whether the provisions of s. 50C shall apply in determination of the full value of the
consideration in the hands of the shareholder in a case where the asset received is the
plot of land.
8.4 S. 49(1)(iii)(c) provides that the cost of acquisition of a capital asset which became the property
of the assessee on any distribution of assets on liquidation of a company shall be deemed
to be the cost for which the previous owner (company) of the property acquired it. S. 55(2)
(b)(iii), however, provides that the cost of the capital asset received on the distribution of the
capital asset on liquidation of a company shall be the fair market value of the asset on the
date of distribution provided the assessee has been assessed to Income tax under the head
Capital Gains u/s 46 in respect of that asset. Accordingly, the cost of the previous owner will
be adopted only in cases where the distribution has not been taxed u/s. 46(2) in the hands
of the shareholders. These provisions may not apply for deciding the cost of acquisition in a
case where the asset received is held as a stock-in-trade of the shareholder.
8.4.1The period of holding of such asset, in the hands of the shareholder, though not
harmonious shall relate back to the date of acquisition of the asset by the company as
per Explanation 1(b) to s. 2(42A).
9. Slump sale – s. 50B
9.1 A business is a capital asset, by itself, capable of being acquired and transferred for a
valuable consideration. The period of holding commences with its set up and commencement
or acquisition. Unless acquired for a specific consideration, the cost of acquisition of a
business is not determinable for the purposes of computation of capital gains and in case
of this handicap, the element of capital gains, if any, on transfer of business, as a whole, for
a lump sum consideration cannot be brought to tax. Coromandel Fertilizers Ltd., 90 ITD 344
(Hyd.) and ECC Industries Ltd., 111 TTJ 11 (Del.). The capital gains however is taxable in a
case where the transfer involves sale of the itemized asset for identifiable consideration. Artex
Manufacturing Ltd., 227 ITR 260 (SC).
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9.2 A set of provisions, namely, ss. 2(19AA), 2(42C) and s. 50B have been introduced specifically
to bring to tax the capital gains on transfer of business for a lump sum consideration known as
a slump sale by the Finance Act,1999 w.e.f 1-4-2000. The new provisions stipulate the method
of computation of the cost of acquisition and in the process has triggered a controversy about
the retrospective application of s. 50B. Asea Brown Boveri Ltd., 110 TTJ 502 (Mum).
9.3 S. 50B provide that any profits or gains arising from the slump sale shall be chargeable to
income tax as capital gains, of the previous year, in which the transfer takes place. Ordinarily
the capital gains is treated as long term capital gains, unless the undertaking transferred is
owned and held for a period of not more than thirty six months.
9.4 In computing the capital gains, the full value of the consideration received or accruing as a
result of slum sale is to be reduced by the net worth of the undertaking and the expenditure
incidental to transfer. The net worth, calculated in the prescribed manner, represents the
deemed cost of acquisition and of the improvement for the purposes of s. 48. No indexation
of such cost is permissible. The net worth is the aggregate value of total assets as reduced
by the value of liabilities of the undertaking as appearing in the books of account. Any change
in the value of assets (not liabilities) on account of revaluation is to be ignored. In computing
the total value of assets, the value of depreciable assets is taken at the written down value of
the block of assets and the value of the capital assets for expenditure allowed as a deduction
u/s 35AD is taken at Nil. A report of the accountant indicating the computation of net worth
and certifying the net worth is required to be furnished in the prescribed form with the return
of income.
9.5 A slump sale is exhaustively defined by s. 2(42C) to mean the transfer of one or more
undertaking, as a result of the sale, for a lump sum consideration, without values being
assigned to the individual assets and liabilities in such sales, unless such values are ascribed
for the sole purpose of payment of stamp duty, registration fee or other similar taxes or fees.
An undertaking is defined vide s. 2(19AA) to include a part of the undertaking or a unit or a
division thereof or a business activity taken as a whole but does not include individual assets
or liabilities.
9.6 The following issues require consideration in the context of s. 50B;
84
•
Can provisions of s. 50B apply in cases where some assets and liabilities of the
undertaking are not transferred. Mahalasa Gases & Chemicals (P) Ltd., 84 TTJ 992
(Bang), Max India, 112 TTJ 726 (Asr), Rohan Software (P). Ltd. 115 ITD 302 (Mum.),
Avaya Global Connect Ltd. 122 TTJ 300 (Mum.).
•
If no, how taxable gains of such a transfer is to be calculated
•
Can the entire sale consideration be taxed.
•
How to determine the period of holding of an undertaking. ECE Industries Ltd, 116 TTJ
11 (Del.).
•
Will the provisions of ss. 50 and 50C apply in computing the capital gains on slump sale.
Sankheya Chemicals Pvt. Ltd. 8 SOT 50 (Mum), Steriplate (P) Ltd. 7 SOT 596 (Del) and
Salora International Ltd., 88 TTJ 53 (Del).
•
Will the negative net worth increase the sale consideration for slump sale. Zuari Industries
Ltd., 105 ITD 569 (Mum).
•
Will the payment made to the shareholders be included in the sale consideration in the
hands of company. Salora Industries Ltd., 88 TTJ 53 (Del).
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•
Can the benefit of exemption u/s 54EC/D be claimed by reinvestment of sale
consideration in specified securities.
10. Insurance claim – s. 45(1A)
10.1 The Supreme Court in the case of Vania Silk Mills Ltd. 191 ITR 647, held that the proceeds of
insurance claim received on destruction of an insured asset was not liable to tax in as much
as there was no transfer of asset and the claim received did not represent any consideration
for transfer. S. 45(1A) has been introduced by the Finance Act, 1999 w.e.f. A.Y. 2000-01, to
overcome the position in law laid down by the said Supreme Court decision.
10.2 The Supreme Court in that case held as under—
•
the destruction or damage of an asset does not result into a transfer.
•
extinguishment of any rights postulated the continued existence of the asset.
•
a transfer has to be effected by the assessee or by some other agency; a mere
destruction does not meet this requirement.
•
the insurance money represented the compensation for the pecuniary loss suffered by
the owner and cannot be taken as the consideration received on transfer.
10.3 The new provision, while overriding the provisions of s. 45(1), creates a charge for taxation
in the year of receipt of any money or other assets under an insurance from an insurer.
The provision to begin with, does not essentially require any transfer of a capital asset and
otherwise ignores the year of transfer for the purposes of taxation. Receipt of the money or
other assets (FMV), on account of damage to or destruction of any capital asset, is deemed to
be the full value of the consideration received as a result of the transfer of such capital asset.
10.4 The provision applies to a capital asset including a depreciable asset and the land and
building. The period of holding of such capital asset shall commence with the date of
acquisition and should end with the year of receipt, however the other view that such a period
shall end with the year of damage or destruction is not ruled out. The indexation shall be
allowed depending upon the view taken for the purposes of ascertaining the period of holding.
10.5 The section, as noted, ropes in the consideration received on the damage to an asset. A
damage surely does not invite any form of transfer and is not covered by any of the limbs of
s. 2(47). The deeming fiction contained in s. 45(1A) also extends to s. 48 for determination of
full value of the consideration. Under the circumstances, a doubt arises about the validity of a
charge for bringing to tax the receipt on damages.
10.6 The claim money, received towards damages, has a direct nexus to the expenditure incurred
for repairing the damage. This expenditure on repairs, in usual course, is an expenditure that is
allowed u/s 30 or 31 or s. 37 of the Act, in computing the business income. This expenditure
has, in any case, a direct relation to the receipt that is sought to be taxed as capital gains
and should in that case be allowed in computing the capital gains. The claim money, when
pertaining to the damage of a depreciable asset may be eligible for being adjusted in the block
of assets. In view of these different possibilities, the question for allowance of such expenditure
in computing the business income or the capital gains u/s 45(1A) requires examination by
the participants. Similarly, whether such receipt on account of damages shall or shall not be
adjusted in the value of block of assets also is an issue that requires consideration.
10.6.1 In J.R. Enterprises, 124 ITD 493, (Mum.) it was held that the receipt for damages
was to be reduced by the expenditure incurred and the balance was to be taxed u/s.
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45(1A) without adjustment in the block of assets and no gains were taxable where the
expenditure on repairs was found to be in excess of the money received. However, a
contrary view is taken in the case of Syndicate Printers Ltd., 27 SOT 404 (Del.)
10.7 The section creates a charge for taxation in the year of receipt of the claim while, s. 43(6)
requires adjustment in the written down value of the ‘moneys payable’ on account of sale of
scrap, etc. in the year of destruction of an asset. The ‘moneys payable’ for the purposes of s.
43(6) also includes the estimated value of the insurance claim regardless of the actual receipt.
10.8 The scope of the provisions is restricted to a receipt on account of damage or destruction as
a result of –
(i)
flood, typhoon, hurricane, cyclone, earthquake or other convulsion of nature; or
(ii)
riot or civil disturbance
(iii) accidental fire or explosion; or
(iv) action by an enemy or action taken in combating an enemy (whether with or without a
declaration of war).
10.9 From the above it would be seen that the provision does not cover the destruction of an
asset in an accident other than fire or explosion. A destruction caused need always not be
on account of fire or explosion. Similarly a loss of a ship, etc. need not be on account of the
flood, typhoon, etc. A collapse of a building need not be on account of any of the specified
destruction or damage. The damage caused to some reputed hotels on 26/11 was not on
account of an accidental fire and may not be termed as caused by an action of an enemy.
The loss on account of the theft and the claim received on such loss remains to be covered.
In all such cases and in many other cases, the recipient will have to be advised to carefully
examine the implication of the receipt under tax laws, more so when the ratio decidendi of the
Supreme Court’s decision was re-examined by the court in the case of Grace Collis, 248 ITR
323.
10.10 The provisions of s. 45(1A) do not override the provisions of s. 50 and likewise the provisions
of s. 50 do not override the provisions of s. 45(1A). On a harmonious construction no short
term capital gains u/s 50 shall arise on the deemed transfer u/s 45(1A) in respect of a
depreciable asset where the money received does not exceed the adjusted WDV of the block
of asset. An alternative view is that the money received will be chargeable to tax independent
of s. 50.
10.11 The CBDT while explaining the provisions of s. 45(1A) under para 27 of circular no. 779 dated
14-9-1999 has explained that the provisions of s. 50 shall apply while computing profit and
gains u/s 45(1A) and the insurance money received shall be reduced from the opening WDV.
Such adjustment perhaps is to be made in the year of receipt on ascertainment of the amount
of claim.
10.12 The applicability of provisions of s. 50C is debatable and two views are possible about their
applicability. This aspect has been considered while discussing the provisions of s. 50C.
10.13 The finding of the apex court, in the Vania Silk Mills’ case, regarding the need for the
continued existence of the asset, post extinguishment of rights therein was doubted by the
larger bench of the Supreme Court in the case of Grace Collis, 248 ITR 323 in a different
context. Subsequently the Madras High Court, in the case of Neelamalai Agro, 259 ITR 651,
after analyzing both the decisions, held that the insurance claim money was not taxable as
capital gains. Whether the insertion of s. 45(1A) has put the issue of taxation beyond doubt or
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not is required to be examined, more so, where a simultaneous amendment in s. 2(47) is not
carried out. In any case, the new provision does not override the law in respect of the claims
not covered by it.
11. Advance money received – s. 51
11.1 It is usual for an owner of a capital asset to receive an advance or money, during the course
of negotiation, for the intended transfer of such asset. In many such cases the negotiations
fail, the intended transfer does not take place, and the money received is retained (forfeited)
by the owner. Such amount, in the hands of the owner, is neither a revenue receipt nor liable
to capital gains.
11.2 S. 51, under a deeming fiction, provides for the treatment of an advance or other moneys
received and retained in respect of negotiations for transfer of a capital asset. It provides that
such receipts shall be deducted from the cost for which the asset was acquired in computing
the cost of acquisition. The term ‘other moneys’ include the deposits received for guaranteeing
performance by the purchaser as also the earnest money. Travancore Rubber and Tea Co. Ltd.,
243 ITR 158 (SC). The term ‘other moneys’ may even include the moneys received under an
agreement sale.
11.3 This section is vaguely worded. It does not clearly indicate that it will come into operation only
in cases where the negotiations have failed. It also fails to clarify that it would apply only in the
event where an executed transfer takes place, subsequent to the failed negotiations to a third
party buyer. A doubt therefore arises about the application of s. 51 in cases where the advance
retained is adjusted against the full value of the consideration on transfer to the same person
with whom the negotiations were carried out.
11.4 A doubt also arises about the applicability of s. 51 in cases where instead of the right in a
capital asset negotiated for transfer, the capital asset itself is eventually transferred to a new
person. For example, right entitlement and the right shares and the tenancy and the ownership
rights.
11.5 The amount retained on failure of negotiation shall neither be liable to tax in the year of
receipt nor in the year of the failure of negotiations. Nor shall it be adjusted against the cost
of acquisition in any of the above years. It shall however be so adjusted in the year of transfer
of the asset. In the circumstances the questions that arise for consideration is whether the
amount retained is to be deducted from the cost of acquisition before or after indexation. Will
there be any difference if the asset was acquired prior to 1-4-1981.
11.6 The amount received by way of advance in many cases far exceed the cost of acquisition,
which, with the passage of time, increases manifold. In such cases the issues that require
consideration are about the determination of the cost of acquisition for the purposes of s. 48.
Can there be a negative cost of acquisition and whether such negative cost is required to be
added to the full value of the sale consideration received on transfer of asset.
Acknowledgements
I sincerely thank the Bombay Chartered Accountants Society for a capital opportunity to present my views on
a complex subject and gain from the collective nectar of wisdom. I wish you good luck in pursuit of the noble
profession.
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Notes
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