TAX PLANNING FOR CAPITAL GAINS
Dr. Girish Ahuja M.Com., Ph.D, FCA Chartered Accountant Capital gain arises on the transfer of a capital asset. Therefore there are two prerequisites for capital gain to arise viz .— .— (a) There should be a capital asset (b) Such capital asset should be transferred during the previous year. Capital asset is widely defined as property of any kind held by the assessee whether connected with his business or not but does not include any stock-intrade, personal effects, rural agricultural land, etc. 1. Although jewellery is a capital asset but utensils and other items of precious metal may be a personal effect In the definition of jewellery, only ornaments made ornaments made of precious metal are included. Thus, items other than ornaments, made of precious metals can be treated as personal effects provided they are commonly and ordinarily used or intended to be used for personal or household use. Silver utensils of the type which were used in the kitchen or in the dining room of the assessee were held to be personal effects and not capital assets. [ CIT v Sitadevi N. Poddar (1984) (1984) 148 ITR 506 (Bom)]. But silver bars, sovereign, bullion and silver coins were held not to be effects meant for personal use even if they are placed before Goddess Lakshmi at the time of Puja. [Maharaja [Maharaja Rana Hemanth Singhji (H E G) v CIT (1976) (1976) 103 ITR 61 (SC)]. Items of silverware including dinner plates of different sizes, finger bowls, jugs were held to be personal effects. [ CIT v v Benarashilal Benarashilal Kataruka (1990) Kataruka (1990) 185 ITR 493 (Cal)]. But at the same time, a large number of the same type of silver articles cannot be treated as having been held for personal use and the assessing authority has to find out as to what are the articles which should reasonably be held by the assessee for personal use. [Ramanathan [ Ramanathan Chettiar R v CIT (1985) (1985) 152 ITR 493 (Mad)]. Gold caskets, gold tray, gold cups, saucers, spoons and photo frames were not regarded as personal effects intended for personal or household use. [ Poddar (G S) v CWT (1965) (1965) 57 ITR 207 (Bom)].
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The expression intended for personal or household use did not mean capable of being intended for personal use or household use. It meant normally commonly and ordinarily intended for personal or household use. It was further observed that merely because the gold caskets were kept in the showcase, they could not be treated as part of furniture. In order to be a personal effect, it is not essential that the person himself should use it every day, it is enough if it is used on ceremonial occasions or as and when desired by the assessee. 2. Capital gain v Business income Whether a particular asset is stock-in-trade or capital asset does not depend upon the nature of the article, but the manner in which it is held. The same item may be stock-in-trade in the hands of the assessee who deals in that item. But it will be capital asset in the case of an assessee who uses it for earning income or holds as an investment. For example, a dealer in real estate holds a piece of land or house property as stock-in-trade. But it will be a capital asset in the hands of a person who holds it as an investment and derives income from leasing or renting of the property. Even stock-in-trade may become capital asset in certain circumstances and vice versa. versa. If an assessee who deals in certain goods or commodities as trader, on closure of the business, retains the existing stocks as investment, the stocks will become capital asset in his hands from the time of closure, not withstanding that they were stock-in-trade earlier in his hands. Even in the course of a business, an assessee may try to transfer some of the stock-in-trade from his trading activity and decide to hold them as investment. The stocks so held would assume the character of capital asset from the date of such holding. This may usually happen in the case of dealer in shares and real estate. But in all these cases, the finding will be one of fact depending upon the intention and conduct of the assessee supported by direct and circumstantial evidence. Similarly, when a capital asset is converted into stock-in-trade, the same will no longer be capital asset. However, this situation is covered by section 45(2). Investment in land or sale of land after plotting — whether business income or capital gain: gain: Normally, the purchase of land represents investment of money in land. [CIT [CIT v v Jawahar Development Association (1981) Association (1981) 127 ITR 431 (MP)]. A transaction of purchase purchase and sale sale of land cannot cannot be assumed, assumed, without without more, to be a venture in the nature of a trade. It is well settled that the mere fact that property was purchased with the intention of selling it at a profit is not conclusive on the question whether an isolated transaction of purchase and resale is an adventure in the nature of trade. If there are relevant facts besides the fact of purchase and resale, it is open to come to the
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conclusion that the transaction is one in the nature of trade. [ Gurdial Naraindas & Co. Co. v CIT (1963) (1963) 50 ITR 633 (Bom)]. The activity of an assessee in dividing the land into plots and not selling it as a single unit as he purchased, goes to establish that he was carrying on business in real property and it is a business venture. [Raja [ Raja J. Rameshwar Rao v CIT (1961) (1961) 42 ITR 179 (SC)]. Ordinarily, where a person acquired land with a view to selling it later after developing it and actually divided the land into plots and sold the same in parcels, the activity could only be described as a business adventure. Generally speaking, the original intention of the party in purchasing the property, the magnitude of the transaction of purchase, the nature of the property, the length of its ownership and holding, the conduct and subsequent dealings of the assessee in respect of the property, the manner of its disposal and the frequency and multiplicity of transactions afforded valuable guides in determining whether the assessee was carrying on a trading activity and whether a particular transaction should be stamped with the character of a trading adventure. [CIT [ CIT v v Trivedi (V.A (V.A.) .) (1988) 172 ITR 95 (Bom)]. In order to hold that an activity is in the nature of an adventure in the nature of trade there must be positive material to prove that the assessee intended to trade in such an activity and in the absence of evidence the sale of immovable property consisting land could give rise only capital accretion. If the land owner developed the land, expended the money, laid roads convert the land into house sites and with the view to get better price it will not be considered as an adventure in the nature of trade to give any business profit. [CIT v A. Mohammed Mohideen (1989) 176 ITR 393 (Mad)] Assessee had purchased a plot of land in 1958. In view of of the Urban Land (Ceiling (Ceiling and Regulation) Act, 1976, she applied for construction of group housing on the excess land and sold the land to a developer and builder. The Assessing Officer held that the instalments received from the builder is business income. The Tribunal held that it is not business income as there was no adventure in the nature of trade. On reference, the Delhi High Court upheld the decision of the Tribunal and held as under: "The plot was purchased in the year 1958 and after the operation of law, namely, the Urban Land (Ceiling and Regulation) Act, 1976, it was not possible for the assessee to retain the land. It was very clear that on the assessee's part there was only an intention to transfer the land and not the portion that may be constructed by the builder on a future date. Clause 3 of the agreement merely provided the mode of payment. On the facts and in the circumstances of the case, the Tribunal was
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right in holding that there was no adventure in the nature of trade and thereby deleting business income of Rs. 11,87,387 from the income of the assessee." [ CIT v Radha Bai (2005) 272 ITR 264 (Del)]. Where some land, which was contributed by partners as capital and used as brick field and later given for development, upholding the finding of the Tribunal, it was held that the firm did not acquire the land, with a view to sell it at a profit. It was treated in the accounts as a fixed asset given to other for outright development without the assessee itself plotting it out, so that it had continued to be a capital asset. There was no scope, it was found, for holding it either as business or even an adventure in the nature of trade. [ CIT v v Mohakampur Ice & Cold Storage (2006) 281 ITR 354 (All)]. What was necessary was to find out the intention of the assessee at the time of the purchase of land. Where the land was never purchased by the assessee. She acquired the same on the basis of a will on the death of her husband. She sold the same in parcels because the huge area could not be sold in one transaction. Such an activity could not amount to trade or business within the meaning of the Act. [CIT v v Sushila Devi Jain (2003) Jain (2003) 259 ITR 671 (P&H)]. Shares held as personal investment by a share broker : broker : Where the assessee, a share broker purchased certain shares as personal assets and had been showing the same in his wealth-tax returns, it was held that the profit on such shares should be taxable as capital gains and not as business income as these shares were capital assets and not stock-in-trade of the business. [ ACIT ACIT v Kethan Kumar A. Shah Shah (2000) 108 Taxman 23 (Ker). See also CIT v Rewa Shankar A. Kothari (2006) 155 Taxman 214 (Guj)]. A company can hold shares as stock-in-trade for the purpose of doing business of buying and sale of such shares, while at the same time it can also hold other shares as its capital for the purpose of earning dividend income. Thus, where the finding was that the shares in question were never treated by the assessee as stock-in-trade and they were held for earning dividend only, it was held that the Tribunal was right in law in holding that the profit on sale of such shares was to be treated as capital gains. [CIT [ CIT v N.S.S. Investments Pvt. Ltd. Ltd. (2005) 277 ITR 149 (Mad)] Where it was an admitted position that the land in question was held as a capital asset by the assessee and not as a business asset and it had also been noticed that the assessee had relinquished the land in lieu of forest department allowing use of their land for laying down the drainage and the question was as to whether loss arising on such transfer could be allowed as a business loss, it was held that the loss arising on account of transfer of land to the forest department in lieu of the
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use of forest land for laying the drainage for discharge of effluent, was capital loss and could not be allowed as a business loss. [Shreyans [ Shreyans Industries Ltd. v Jt. CIT (2005) 277 ITR 433 (P&H)] 3. Transfer in a development agreement Development agreement is not an agreement for sale simpliciter . It is an executory agreement, whereby the developer undertakes to put up a superstructure on that part or portion of land retained by the owner in consideration of transfer of remaining part. Development agreement is not a sale simpliciter , because there is an element of builder's contract with the only difference that the consideration is not cash, but in kind i.e. constructed i.e. constructed portion on the retained land. An agreement for sale can be enforced in a court of law by a decree ordering specific performance, with the court itself acting as the transferor, where the owner does not carry out the obligations either under the agreement for sale or the court decree. In development agreement one cannot expect construction to be undertaken by the developer, once a breach has occurred, so that there is only damages for the party, who has suffered the breach. There cannot be specific performance in the sense ordinarily understood in enforcement of agreement for sale. All the same, a development agreement was treated as an agreement for sale in Ashok Leyland Finance Ltd. v Appropriate Authority (1997) (1997) 230 ITR 398 (Mad). A similar view was taken in Ashis Mukherji v v Union of India (1996) India (1996) 222 ITR 168 (Pat) and Ansal Properties and Industries Ltd. v Appropriate Authority (1999) 236 ITR 793 (Del). But in Mahabodhi Society of India v Union of India (1994) India (1994) 209 ITR 412 (Cal), it was held that it is not an agreement for sale, which can come within the purview of Chapter XXC. Calcutta High Court has also recognised development agreement as a business agreement. [Madgul [ Madgul Udyog v CIT (1990) 184 ITR 484 (Cal) approved in CIT v Podar Cements Pvt. Ltd. Ltd. (1997) 226 ITR 625 (SC)]. Treatment of development agreement under Chapter XXC as an agreement for sale cannot possibly mean that in every case, the development agreement can be taken as an agreement for sale simpliciter , though this was the inference drawn by the authorities and sometimes conceded by the taxpayer to purchase peace. It is in the above context, that one has to take care to avoid the inference of transfer on mere signing of the agreement. A development agreement may be silent as to the date of possession, in which case it can be assumed that there is no possession, which accompanies development agreement. It is advisable that development agreement specifically stipulates possession with owner till obligations undertaken undertak en by the developer is discharged with only right of entry for developer or his nominees to discharge the obligations undertaken in the agreements.
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If the development agreement had granted an unqualified, uninterrupted and irrevocable right of possession to the developer, it will be difficult to avoid liability in the year in which development agreement was executed, though there is a possible argument that the possession is not in the capacity of a buyer, but only as a builder, the property itself is not for enjoyment by the developer but by the prospective flat owners. Such an argument can be taken and defended, notwithstanding the possible hassles with the Income-tax Department. Even if such a stand is taken, liability cannot be postponed till completion of the agreement, if there are registered sales prior to completion. Proportionate profit therefrom will have to be accounted. If on a bare reading of a contract in its entirety, an Assessing Officer comes to the conclusion that in the guise of the agreement for sale, a development agreement is contemplated under which the developer applies for permissions from various authorities either under power of attorney or otherwise and in the name of the assessee, then the Assessing Officer is entitled to take the date of the contract as the date of the transfer in view of section 2(47)(v 2(47)( v ). ). In this very case, the date on which developer obtained a commencement certificate is not within the accounting year ending 31-3-1996. At the same time, if one reads the contract as a whole it is clear that a dichotomy is contemplated between the limited power of attorney authorizing the developer to deal with the property as an irrevocable license to enter upon the property after the developer obtains the requisite approvals of various authorities. In fact the limited power of attorney may not be given but once under the agreement a limited power of attorney is intended to be given to the developer to deal with the property then the date of contract would be the relevant date to decide the date of transfer under section 2(47)(v 2(47)( v ) and in which event the question of substantial performance of the contract thereafter does not arise. This point has not been considered by any of the authorities below. No judgment has been shown to exist on this point. Therefore, although there is concurrent finding of fact there is no merit in the argument of the assessee that the court should go only by the date of actual possession and not by the date on which the irrevocable license was given. If the contract read as a whole indicates passing of or transferring of complete control over the property in favour of the developer then the date of the contract would be relevant to decide the year of chargeability. [Chaturbhuj Dwarkadas Kapadia v CIT (2003) 260 ITR 491 (Bom)]. But, the agreement/contract on its own may not allow possession to be taken instantaneously, but it may spell out a transaction by which the possession will pass at the future point of time. Under the terms of a contract, normally, a series of acts or transactions that would at one point of time or the other take place in furtherance of the contract will be recorded. What is contemplated by section
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2(47)(v 2(47)(v ) is a transaction which has direct and immediate bearing on allowing the possession to be taken in part performance of the contract of transfer. It is at that point of time that the deemed transfer takes place. True, entering into the agreement/contract is a transaction in a broad sense but, when the agreement envisages an event or act on the happening or doing of which alone the possession is allowed to be taken in part performance of the contract, the transaction of the nature contemplated by sub-clause (v ( v ) cannot be said to have occurred before that date. The date of entering into the agreement cannot be the determining factor in such a case, even though the agreement envisages a future transaction pursuant to which possession will be allowed to be taken. However, it needs to be clarified that it is not possible to lay down a rigid proposition that an agreement, as such, can never be construed as a transaction allowing allowing possession to be taken in part-performance. [Jasbir [ Jasbir Singh Sarkaria, In re (2007) 164 Taxman 108 (AAR-New Delhi)]. 4. Transfer is a pre-requisite for taxing capital gain Capital gain arises only when there is a transfer of capital asset. If the capital asset is not transferred or if there is any transaction which is not regarded as transfer, there will not be any capital gain. However w.e.f. assessment year 2000-2001 section 45(1A) has been inserted to provide that in case of profits or gains from insurance claim due to damage or destruction of property, there will be capital gain on such deemed transfer although no asset has been actually transferred in such case. Judicial decisions — Whether W hether a transaction constitute transfer transfer or not (1) Redemption of bonds constitutes transfer as there is extinguishment of right by operation of contract and also a relinquishment of right in the asset in lieu of which the assessee received cash from the competent authority. Thus, in either of the situations, the case was covered by the definition of section 2(47). [ Pervij Wang Chuk Basi v v JCIT (2007) (2007) 290 ITR (AT) 266 (Mum)]. The maturity or redemption of zero coupon bonds shall be treated as transfer. (2) Mere delivery on the Sale of motor vehicle is a transfer : In the case of sale of motor vehicles, mere delivery of of the physical possession is sufficient to constitute transfer, the entries in the R.C. book will be made only after the transferee becomes the owner under Motor Vehicles Act, 1988. [ CIT v Salkia Transport Associates (1983) Associates (1983) 143 ITR 39 (Cal)]. (3) Conversion of preference shares into equity shares is a transfer : Although the conversion of debentures into equity shares is not regarded as transfer but if the preference shares are converted into equity shares, it will be regarded as a transfer and there will be capital gain to the shareholder on the date of allotment of equity
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shares in exchange of preference shares and the full consideration in this case shall be fair market value of equity shares on the date of its allotment. [ CIT v Trustees of HEH the Nizams Second Supplementary Family Trust (1976) Trust (1976) 102 ITR 248 (AP)]. Conversion of preference share into ordinary shares amounts to transfer in hands of the shareholders. [CIT [ CIT v v Motors and General Stores P. Ltd. (1967) Ltd. (1967) 66 ITR 692 (SC)] (4) Where an assessee gives up the right to claim specific performance for purchase of immovable immovable property it is relinquishment relinquishment of a capital asset and thus transfer : The assessee had entered into an agreement to purchase certain property. Both parties reserved the right to specific performance of the agreement. Nearly four years thereafter, again another agreement was entered into in the nature of deed of cancellation, by which the assessee agreed for termination of the earlier agreement and allowed the owner of the land to sell the said property to any person and at any price of his choice. As a consideration for this, the assessee was paid a sum of Rs. 6,00,000 apart from being refunded the advance of Rs. 40,000. The question that arose for consideration was as to whether the amount of Rs. 6,00,000 received by the assessee from the vendor could be treated as capital gains in the hands of the assessee. [K.R. [ K.R. Srinath v Srinath v Asstt. CIT (2004) (2004) 268 ITR 436 (Mad)]. (5) Redemption of preference shares by a company is a transfer in the hands of shareholders and they will be liable to capital gain for the same. [ Anarkali [ Anarkali Sarabai Sarabai v CIT (1997) (1997) 90 Taxman 509 (SC)]. (6) Succession of the firm by a company is not a transfer if following conditions are satisfied : Any transfer of a capital asset or intangible asset by a firm to a company as a result of succession of the firm by a company in the business carried on by the firm is not a transfer provided the following following conditions are satisfied: (a) all the assets and liabilities of the firm or AOP/BOI as the case may be, relating to the business immediately before before the succession become the assets and liabilities of the company; (b) all the partners of the firm immediately before the succession become the shareholders of the company in the same proportion in which their capital accounts stood in the books of the firm on the date of the succession; (c ) the partners of the firm do not receive any consideration or benefit, directly or indirectly, in any form or manner, other than by way of allotment of shares in the company; (d ) the aggregate of the shareholding sh areholding in the th e company of the partners of the firm is not less than 50% of the total voting power in the company and their shareholding continues to be as such for a period of 5 years from the date of the
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succession [Section succession [Section 47( xiii xiii )]; )]; and (e) the demutualisation demutualisation or corporatisation corporatisation of a recognized recognized stock exchange in India is carried out in accordance with a scheme of corporatisation which is approved by the SEBI; (7) Succession of the sole proprietary concern by a company is not a transfer if following conditions are satisfied : Where a sole proprietary concern is succeeded by a company in the business business carried on by it as a result of which the sole proprietary concern sells or otherwise transfers any capital asset or intangible asset to the company, it will not be regarded as transfer provided the following conditions are satisfied: (a) all the assets as sets and liabilities of the sole sol e proprietory concern co ncern relating relat ing to the business immediately before the succession become the assets and liabilities of the company; (b) the shareholding of the sole proprietor proprietor in the company is not less than 50%, of the total voting power power in the company and his shareholding continues to remain as such for a period of 5 years from the date of the succession; and (c ) the sole proprietor proprie tor does not receive recei ve any consideration consideratio n or benefit, directly direc tly or indirectly, in any form or manner, other than by way of allotment of shares in the company [Section 47( xiv xiv )]; )]; (1) Transfer can be made m ade to the t he existing company but the t he partners/ partners / proprietor should hold at least 50% of the equity capital of the company and their/his share holding should continue to remain as such. s uch. (2) The exemption in case of succession by the company is allowed to a proprietary firm or partnership firm carrying on business. It is not allowed in case of profession. (3) Section 47( xiii xiii ) and ( xiv xiv ) exempts the capital gain in transfer of capital asset. Stock in trade is not a capital asset and as such if it is transferred at profits, it will be taxable as business income in the hands of a firm or sole proprietary firm as the case may be. (8) There is no transfer in family settlement : settlement : Where a family settlement/ arrangement is arrived at in order to avoid continuous friction and to maintain peace among the family members, the family arrangement is governed by the principles which are not applicable to dealing between strangers. So, such bona fide fide realignment of interest, by way of effecting family arrangements among the family members would not amount to transfer. [CIT [ CIT v A.L. v A.L. Ramanathan Ramanathan (2000) 245 ITR 494 (Mad)]. In this case the court followed the decision of the Supreme Court in general law laid down in the case of Kale v Deputy Director of Consolidation (1976) AIR 1976 SC 807. See also CIT v Kay Arr Enterprises (2008) 299 ITR 348 (Mad)]
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(9) Capital (9) Capital loss not allowed unless there is a transfer : transfer : Capital loss can arise only when the capital asset is transferred. There cannot be a capital loss if the capital asset has become valueless. [Natarajan [ Natarajan (C.A.) C.A.) v CIT v CIT (1973) (1973) 92 ITR 347 (Mad); CIT v R. Chidambaranatha Mudaliar (1999) (1999) 240 ITR 552 (Mad)]. Similarly, there is no capital loss if the earnest money paid by the intending purchasers is forfeited. [Sterling Investment Corporation Ltd. (1980) Ltd. (1980) 123 ITR 441 (Bom)]. (10) Giving up the right to obtain conveyance of immovable property amounts to transfer of a capital asset : Where the assessee had paid the earnest money and acquired right to obtain conveyance of immovable property, such earnest money paid shall be cost of acquisition of such right and if such right is given up, there is a transfer of a capital asset and the compensation received for giving up such right is the consideration price. [CIT [ CIT v Vijay Flexible Container (1990) 186 ITR 693 (Bom)]. (11) No capital gain if a firm is incorporated as a limited company under Part IX of Companies Act, 1956 : Where a partnership firm is incorporated as a company under the provisions of Part IX of the Companies Act, Neither section 45(1) nor section 45(4) shall be attracted even though there was transfer of assets from firm to newly constituted company. [CIT [ CIT v Texsprin Engg. & Mfg. Works (2003) Works (2003) 263 ITR 345 (Bom)]. 5. Capital assets can either be short-term capital asset or long-term capital asset (A) Short-term capital asset: A capital asset held by an assessee for not more than 36 months immediately preceding the date of its transfer is is known as a short term capital asset. However, the following assets shall be treated as short-term capital assets if they are held for not more than 12 months (instead of 36 months mentioned above) immediately preceding the date of its transfer: (a) Equity or Preference shares held in a company. (b) Any other security security listed listed in a recognised stock exchange in India. (c ) Units of the Unit Trust T rust of o f India or units of a Mutual Fund specified spec ified u/s 10(23D). (d ) Zero coupon c oupon bonds. b onds. (B) Long-term capital asset: It means a capital asset which is not a short-term capital asset. In other words, if the asset is held by the assessee for more than 36 months or 12 months, m onths, as the case may be, such an asset will be treated as a longterm capital asset. Thus, period of holding of a capital asset is relevant for determining whether capital asset is short-term or long-term. Exclusion/inclusion of certain period for computing the period of holding of an asset
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Case
Exclusion/Inclusion Exclusion/Inclusion of period (i ) Shares held in a Exclude the period company in liquidation subsequent to the date of liquidation (ii ) Property acquired in any Include the holding period mode given under section of previous owner also. 49(1) (e.g. (e.g. by way of gift will, etc.) (iii ) Shares in an Indian Include Include the holding period Amalgamated Company of shares in the acquired in a scheme of Amalgamating Company Amalgamation by the Assessee. (iv ) Shares in Indian Include Include the holding period Resulting company of shares in the Demerged acquired in case of Company by the Assessee demerger (v ) (a) Trading or clearing Include the period for which rights of recognised stock the person was a member exchange pursuant to its of the recognised stock demutualisation or exchange in India corporatisation (b) equity shares in a —do— company acquired by a person pursuant to the demutualisation or corporatisation of recognised stock exchange Holding period in case of share or any other security The period of holding, in the following circumstances will be computed as under: 1. Right to subscribe to shares The period shall be or any other securities (may be reckoned from the called as financial assets date of allotment of subscribed to by the assessee such on the basis of right to subscribe financial asset. to such financial assets. 2. Right to subscribe to share or —do— any other securities acquired by
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a person in whose favour the right has been renounced by the existing holder. 3. Period of holding of the right The period shall be by a person who has renounced reckoned from the the right. date of offer of such right by the company or institution to the date of renouncement , which in normal circumstances will be short-term. 4. Period of holding of a The period will be financial asset allotted without reckoned from the any payment and on the basis of date of allotment of holding of any other financial such financial asset asset e.g. asset e.g. bonus shares. (not from the date of allotment of the original shares). (C) Judicial decisions for determining period of holding (i ) Property constructed on a land purchased earlier : In case of property is constructed on a site purchased much earlier, the question arises whether the period of holding the asset i.e., i.e., the property, should be reckoned from the date of completion of the construction of the property or from the date of acquisition of the land. The correct position is that the asset consists of two components: (1) Land and (2) Building. When the property is sold, the period of holding has to be reckoned separately for the land and the building. The consideration received can also be split into two parts relating to each component. In CIT v CIT v Vimal Chand Golecha (1993) Golecha (1993) 201 ITR 442 (Raj), the land was purchased in 1962 and building was constructed thereon in the accounting years relevant to assessment years 1968-69, 1969-70 and 1970-71. The building was sold in 1970. It was held that the gains attributable to land were assessable as long-term capital gains. The gains attributed to the building were however, short-term capital gains. Similar decision was held in the cases of CIT v v Lakshmi B. Menon (2003) Menon (2003) 264 ITR 76 (Ker) and CIT v v C.R. Subramanian (2000) Subramanian (2000) 242 ITR 342 (Kar)]. Agreeing with the above Rajasthan High Court Court view, it has been held that land land can be considered a separate capital asset even if a building is constructed thereon.
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Thus, where the land is held for more than a prescribed period, the gains arising from the sale of the land can be considered as long-term long-term capital gains even though the building thereon, being a new construction, is held for a period less than the prescribed one [CIT [CIT v v Dr. D.L. Ramachandra Rao (1999) Rao (1999) 236 ITR 51 (Mad). Also see CIT v v Citibank N.A. (2004) N.A. (2004) 260 ITR 570 (Bom)]. In the above cases, the burden will be on the assessee to satisfy how much of the sale proceeds should be apportioned for the land and how much of the sale proceeds pertained to the structure. [CIT [ CIT v Estate of Omprakash Jhunjhunwala (2002) 254 ITR 152 (Cal)]. It may be noted that split between land and superstructure was also to be made for the purpose of depreciation as held by the Supreme Court in CIT v CIT v Alps Theatre (1967) 65 ITR 377 (SC). Hence, the decisions of the above High Courts fall in line with the views of the other precedents. (ii ) Period of holding of share in the co-operative housing society : society : While computing the capital gain tax in case of transfer of his shares by a person who is a member of cooperative housing society, the relevant date would be date on which the member acquires the shares in the cooperative housing society and the date on which member had sold his shares therein. Thus, where the assessee acquired shares in the society on 6-9-1979 and was allotted flat on 15-11-1979. He was given possession of flat in October 1981, and sold the shares of the society along with the flat, on 4-12-1982, the capital gains arising from the sale were long term capital gains, shares having been held for more than 36 months. [CIT [ CIT v Anilben v Anilben Upendra Shah (2003) Shah (2003) 262 ITR 657 (Guj)]. Similarly, the assessee became a member in Venus Apartments (Galaxy Cooperative Housing Society). He was allotted a flat in the building of the society by resolution dated 4-11-1980, passed by the managing committee of the society. On the date of allotment, i.e., i.e., 4-11-1980, the property was under construction and came to be completed on 12-9-1983. Physical possession was handed over to the assessee on 12-9-1983. On 30-4-1984, the flat was sold by the assessee for a consideration consideration of Rs. 3,75,000. The assessee worked out long-term capital gains at Rs. 1,59,395. The Assessing Officer did not accept the stand of the assessee that the assessee had become the owner of the property as per resolution dated 4-111980. According to the Assessing Officer the assessee had held the property for a period of less than 36 months and as such was liable to short-term capital gains tax, it was held that the assessee in the present case was allotted a share by the co-operative housing society on 4-11-1980, and the sale of the same took place on 30-4-1984, i.e., i.e., after a period of 36 months. The Tribunal was therefore justified in holding that the capital gains arising were long-term capital gains and the
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assessee was entitled to deduction from such gains as per law. [CIT [ CIT v Jindas Panchand Gandhi (2005) (2005) 279 ITR 552 (Guj)] (iii ) Period of holding of shares where call money is paid after allotment : allotment : Where the shares are acquired by the assessee from a company and the payment is made to the company even after allotment of shares as and when the call is made by the company, the period of holding of of such shares shall be considered from the date of allotment of shares even though the call money has been paid after allotment of such shares. (iv) Right to acquire any house property : Where a flat is booked with a builder under a letter of allotment or an agreement for sale, this would represent only a right to acquire a flat and if such right is acquired more than 36 months back, it becomes a long-term asset. However, when the possession of the flat is taken, the period of holding would once again commence from the date of the possession of the flat as the small right to acquire a flat merged into larger right and small right upon a merger would loose its existence. (v ) Holding need not be as capital asset : asset : The entire period of holding i.e., i.e., from the date of initial acquisition upto the date of transfer has to be taken into account in order to decide whether it is a long-term capital asset although it may not have been held as capital asset initially. [ Keshavji Karsondas v (1994) 207 ITR 737 Karsondas v CIT (1994) (Bom)]. 6. Computation of capital gain The income chargeable under the head 'Capital gains' shall be computed, by deducting from the full value of the consideration received or accruing as a result of the transfer of the capital asset, the following amounts, namely:— (i ) expenditure incurred wholly wholl y and exclusively exclusivel y in connection connectio n with such a transfer; (ii ) the the cost of acquisition of the asset and the cost of any improvement thereto. However, in the case of long-term capital gain, the cost of acquisition and cost of improvement mentioned above will be substituted by the words 'indexed cost of acquisition' and 'indexed cost of improvement' respectively. respectively. (A) Judicial decision on consideratio c onsideration n price (1) Receipt of consideration in instalments : Even if the full value of consideration agreed upon is received in instalments in different years, the entire value of consideration has to be taken into account for computing the capital gains which become chargeable in the year of transfer. (2) Capital gains arise on accrual basis: basis : Capital gain is attracted, the moment the assessee has acquired the right to receive the price. It is not necessary that the consideration should have been actually received. What the parties did
15
subsequently will not have any bearing on the liability of the assessee to tax of the year in which the right to receive the consideration arises. [T.V. [ T.V. Sundaram Iyengar & Sons Ltd. v Ltd. v CIT (1959) (1959) 37 ITR 26 (Mad)]. (B) Judicial decision on cost of acquisition (1) Interest on money borrowed for acquiring capital assets will form part of cost of asset : Interest on loan taken for acquiring a capital asset will become part of the cost of acquisition. [CIT [ CIT v Mithlesh Kumari (1973) 92 ITR 9 (Del)]. However, interest payable on provident fund loan (interest so payable is credited to the provident fund account of the assessee) is not deductible interest on expenditure [Vashisht Bhargava v ITO ITO (1975) 99 ITR 148 (Del)]. As regards interest on the asset acquired by the assessee carrying on business or profession, interest before the asset is put to use shall form part of cost of the asset but any interest due or paid after the asset is put to use shall be treated as revenue expense. (2) Sum paid for discharge of mortgage: mortgage : Where the property has been mortgaged by the previous owner during his lifetime and the assessee, after inheriting the same, has discharged the mortgage debt, the amount paid by him for the purpose of clearing off the mortgage shall be regarded as cost of acquisition under section 48 read with section 55(2) of the Act. [ Arunachalam Arunachalam (RM ) v CIT (1997) 227 ITR 222 (SC)] The position is, however, different where the mortgage is created by the owner after he has acquired the property. The clearing off of the mortgage debt by him prior to transfer of the property would not entitle him to claim deduction under section 48 of the Act because in such a case he did not acquire any interest in the property subsequent to his acquiring the same. [Jagadish [ Jagadish Chandran (V.S.M.R.) V.S.M.R.) v CIT (1997) (1997) 227 ITR 240 (SC)]. (3) Cost of acquisition of bonus shares or any other financial asset allotted without payment payment : The cost of acquisition in relation to the financial assets (i.e. ( i.e. share share or any other security) allotted to the assessee on or after 1-4-1981 without any payment and on the basis of holding of any other financial asset , asset , shall be taken to be nil. Therefore, the cost of bonus shares/security shall be taken to be nil and the entire sale consideration received on the transfer of the bonus shares/security shall be treated as capital gains. However, in case bonus shares have been allotted to the assessee before 1-4-1981, 1-4-1981, although the cost of such bonus shares is nil but the assessee may opt for market value as on 1-4-1981 1-4-1981 as the cost of acquisition of such bonus shares. The cost of acquisition of original shares shall be the amount actually paid to acquire the original shares. (4) Cost of acquisition of an asset acquired from the previous owner in any mode given u/s 49(1): 49(1): In this case, the cost of acquisition is taken as the cost to the
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previous owner and it is this cost which will have to be indexed. For the purpose of indexation the year in which the asset was first held by the assessee (not the previous owner) is to be considered. The indexation will be done as under: Cost of acquisition to the previous owner CII of the year of transfer CII of the year in which the asset is first held by the assessee However, in the case of Mrs. Pushpa Sofat (2002) 81 ITD 1 (Chd)(SMC), the indexation of cost was allowed from the date of acquisition of the asset by the previous owner and not the date when the asset was acquired by the assessee from the previous owner under any mode given under section 49(1). Similarly in Kamal Mishra v ITO ITO (2008) 19 SOT 251 (Del) it was held that the indexation of cost will be allowed with reference to the year in which the previous owner acquired the asset. 7. Treatment of advance money received Where any capital asset, was on any previous occasion, the subject of negotiations for its transfer, any advance or other money received and retained by the assessee in respect of such negotiations, negotiations, shall be deducted from the cost for which the asset was acquired or or the written down value or the fair market value, value, as the case may be, in computing the cost of acquisition. It may be observed that only when the advance or other money has been (a) received, and (b (b) retained or forfeited by the assessee, assessee, then only it has to be deducted from the cost of the asset. If such an advance was received and retained by any previous owner, the same shall not be deducted from the cost of the asset. If the advance money forfeited was received by the assessee before 1-4-1981 and the assessee has assumed the F.M.V. of the asset as on 1-4-1981 as the cost of acquisition, such advance money received (though before 1-4-1981) shall also be deducted as in the section it is written that it will be deducted from the fair market value. value. A situation may arise where advance money forfeited is more than the cost of 'acquisition'. In such a case, the excess of the advance money forfeited over the cost of 'acquisition' of such asset shall be a capital receipt not taxable [ Travancore Rubber & Tea Co. Ltd. v Ltd. v CIT (2000) (2000) 243 ITR 158 (SC)]. For purposes of section 51, no distinction is made between moneys received and retained by way of 'advance' and 'other money'. The phrase 'other money' would cover, for example, deposits made by the purchaser for guaranteeing due performance of the contracts and not forming part of the consideration. The monies received on the previous occasions and retained by the vendor/assessee cannot, therefore, be treated as a revenue receipt. [Travancore [ Travancore Rubber & Tea Co. Ltd. v
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CIT (2000) (2000) 243 ITR 158 (SC)]. The provisions of section 51 seems to be illogical after the introduction of the concept of indexed cost of acquisition as in this case the cost of acquisition will be first reduced by the amount of advance money received and thereafter it will be indexed. Treatment in the hands of vendee: vendee : Forfeiture of earnest money by the vendor, if due to default on the part of the vendee, will not amount to relinquishment of a right in that asset. Therefore the amount forfeited will not be allowed as a capital loss under head capital gains. [CIT [ CIT v Sterling Investment Corporation Ltd . (1980) 123 ITR 441 (Bom)]. On the other hand, if the vendor commits a default and the vendee receives some compensation besides the refund of the earnest money paid by him, such compensation shall be subject to capital gains as it will amount to relinquishment of a right by the vendee. Where the assessee had paid the earnest money and acquired right to obtain conveyance of immovable property, such earnest money paid shall be cost of acquisition of such right and if such right is given up, there is a transfer of a capital asset and the compensation received for giving up such right is the consideration price. [CIT [CIT v v Vijay Flexible Container (1990) 186 ITR 693 (Bom)]. 8. Capital gain on transfer of a capital asset by way of distribution on the dissolution of a firm, AOP/BOI The profits or gains arising from the transfer of a capital asset in specie specie to the partners/members thereof by way of distribution on the dissolution of a firm or firm or other association of persons or body of individuals (not being a company or a cooperative society) or otherwise, otherwise, shall be chargeable to tax as the income of the firm, association or body, of the previous year in which the said transfer takes place. In such a case, there will be a capital gain to the firm/AOP, etc. For the purposes of computation of capital gain, the fair market value of the asset on the date of such transfer shall be deemed to be the full value of the consideration received or accruing as a result of transfer, instead of the value at which it is given to the partner/ member. Interpretation of the words "dissolution or otherwise": otherwise ": The Act has used the words "dissolution or otherwise" in the aforesaid case. The word "otherwise" used above should take colour from the preceding word i.e. i.e. dissolution. In other words, the word "otherwise" should mean something like dissolution. For example, if a firm consists of two partners X & Y, and Y retires from the firm, it will not be a case of retirement but of dissolution as the firm in this case shall have to be dissolved. The same will be the situation if Y dies in the above case. Similarly, if a firm is
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succeeded by a company, it will be a case of dissolution, as the firm in this case, shall cease to exist. However, if such succession is as per section 47( xiii ), ), it will not be regarded as transfer and thus there will not be any capital gain on such succession. However, the Bombay High Court held that the scope of word 'otherwise' in section 45(4) is not ejusdem generies with generies with the expression 'dissolution of a firm or body or association of persons'. The expression 'otherwise' has to be read with the words transfer of capital assets and section 45(4) would get invoked even in cases of subsisting partners of a partnership firm, transferring assets in favour of a retiring partner in which case the fair market value as on date of transfer should be taken as full value of consideration. The expression 'otherwise' would cover any possible situation of transfer of capital asset by the firm to the partner. [ CIT v A.N. Naik Associates (2004) Associates (2004) 265 ITR 346 (Bom)] It may be noted that the distribution of capital asset in the course of dissolution is not specifically included in the definition of the term 'transfer'. Instead, a direct charge is sought to be created by introducing a deeming fiction in the form of section 45(4) for bringing to tax the deemed capital gains on such distribution. It is this act of bypassing the provision of section 2(42) by the Legislature that has become the subject matter of an interesting controversy amongst the Courts as well. One view of the matter is that section 45(4) is a charging section that brings in an effective charge in the circumstances provided therein, independent of section 2(47). This view is supported by the decisions of the Karnataka High Court given below and the Goa Bench of the Bombay High Court given above. The other view of the matter holds that without a specific amendment in section 2(47) ( i.e. amending the definition of 'transfer'), section 45(4) has no independent application. application. This view is supported by a decision of the Madhya Pradesh High Court in the case of Moped and Machines given below. The facts of the case were as under: The assessee was a firm that consisted of two partners R and P. P expired in April 1990. The Assessing Officer held that since the firm stood dissolved after the death of one of the partners it was liable to pay tax on capital gains. The Commissioner (Appeals) and the Tribunal held that there was no transfer. On appeal the Hon'ble Court, dismissing the appeal, held that in the instant case unless the capital gain has arisen from the transfer of capital asset within the meaning of section 2(47) of the Act, there was no transfer of assets within the meaning of section 45(4) of the Income-tax Income-tax Act, 1961. [ CIT v v Moped and Machines (2006) 281 ITR 52 (MP)].
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The issue once again came up before the Karnataka High Court recently in the case of Suvardhan v CIT (2006) (2006) 287 ITR 404 (Karn). The assessee in that case was a registered firm which came into existence by way of partnership deed dated 23-7-1986. The partnership consisted of three persons. On July 1, 1988, one of the partners retired and the other two continued the partnership in terms of the partnership deed dated 17-10-1988. A survey was conducted in the business premises of the assessee. It came to light that the firm had been dissolved and the business had been taken over by one of the partners, Smt. Anuradha Maruthi Gokarn. It was also noticed that the partnership was dissolved on 1-4-1992, and the assets and liabilities had been taken over by the said lady. The Assessing Officer proposed to apply section 45(4) of the Act. Notice was issued. The assessee filed a nil return. Thereafter, the Assessing Officer conducted the assessment under section 144 of the Act charging capital gains in the hands of the firm in respect of the assets transferred by the firm. On behalf of the assessee-firm, attention of the Court was invited to section 45(4) and section 2(47) of the Act to contend that the order of the Tribunal required reconsideration. It was contended that both the provisions were required to be read together and that on such a combined reading it was clear that the case on hand was a case of 'no transfer'. The revenue pleaded that a reading of the said section 47 of the Act would show that several transactions were considered as no transfer for the purpose of section 45 of the Act. Prior to amendment, section 47(ii 47(ii ) read as under: "any distribution distribution of capital assets on the dissolution of a firm, BOI or other AOP". This was omitted by the Finance Act, 1987 w.e.f. 1st April, 1988. Therefore any transaction resulting in distribution on dissolution of a firm has to be considered as 'transfer' in terms of section 47, in the light of omission of clause ( ii ) of section 47. The Court observed that a reading of section 45(4) showed that the profits or gains arising from the transfer of capital assets by way of distribution of capital assets on the dissolution of a firm was chargeable to tax as the income of the firm, in the light of the fact that a transfer had taken place. The Court also took notice of the assessee's contention that the term 'transfer' had been defined under section 2(47) of the Act and that if section 2(47) was read, with section 45(4), there was no transfer at all, and in any case if there was any transfer, it was not by the assessee, but by the retiring partner. The Karnataka High Court further distinguished the judgement of the Madhya Pradesh High Court in CIT v CIT v Moped and Machines 281 Machines 281 ITR 52 relied upon by the assessee by observing that in the said judgement, there was no reference to omission of clause (ii ( ii ) of section 47 as it stood prior to 1-4-1988; that in the said
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judgement, what was considered was the provisions of section 45(4) and section 2(47), as it stood then; that therefore, the said judgement would not be applicable to the issue involved in the case on hand; that on the other hand, the decision of the Bombay High Court in the case of CIT v A.N. v A.N. Naik Associates (2004) Associates (2004) 265 ITR 346 (Bom) was found to be applicable, as in the said decision, the Bombay High Court had noticed the effect of the omission of the said clause ( ii ) of section 47 by the Act of 1987. The Karnataka High Court, in respectful agreement with the judgement of the Bombay High Court, noted that when the Parliament in its wisdom had chosen to remove a provision which provided for the cases of 'no transfer', there was no need for any further amendment to section 2(47), in the light of removal of clause ( ii ) to section 47, the transaction was liable to capital gains tax at the hands of the authorities. The issue remains unresolved as is evident by the conflicting decisions of the Courts on the subject and is sure to haunt the corridors of the Court. However, the better view appears that section 45(4) is a charging section, as the same is introduced for plugging the mischief as is noted by the Bombay High Court. Cases which create real difficulty are the cases of partnership consisting of two partners only. It is in such cases that a difficulty arises, where one of the partners dies or is declared insolvent or retires. In such cases, the firm shall stand automatically dissolved on death or insolvency or on retirement by operation of the law. In such cases of severe hardships, the recent decision of the Madras High Court in the case of CIT v Vijaya Metal Industries Industries (2002) 256 ITR 540 (Mad), provides a major breakthrough. In that case, the assessee partnership consisted of two partners, which was dissolved on death of one of the partners. The business of the partnership firm was continued by the surviving partner with the assets of the partnership firm. The Income-tax Department applied the provisions of section 45(4) and brought to tax the deemed capital gain by holding that the transfer took place on dissolution of the firm. The Tribunal held that though the dissolution of firm took place by operation of law, it was not followed by transfer of capital assets by way of distribution of such assets. The Madras High Court confirmed the decision of the Tribunal. It was held that the relevant date for ascertaining the year in which the tax is to be levied under section 45 is the year in which the transfer takes place. place. That year may or may not be the year in which the dissolution of the firm takes place. The year in which the capital gain is to be brought to tax is "the previous year in which the said transfer takes place". [CIT [CIT v Vijayalakshmi Metal Industries Industries (2002) 256 ITR 540 (Mad)].
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The decision in the case of Vijaya Metal Industries provides Industries provides a much needed relief. With this one thing is certain that the dissolution by itself will not result in distribution of assets of the firm. The distribution will take place only on taking of a positive action by the parties concerned for distributing the assets. Till such time, the assets may be treated as jointly held by the parties. 1. Where depreciable asset is distributed, there will always be short-term capital gain/loss based upon the particular block of assets. On the other hand, if nondepreciable asset is distributed, it will be long-term capital gain or short-term capital gain, depending upon the period of holding by the firm. 2. Although, for the purpose of computation of capital gains in the hands of firm/ AOP, the sale consideration shall be the market value of the asset as on the date of its distribution but the cost of acquisition of this asset to the partner/member shall be the value at which it was transferred to partner/member . partner/member . Merely because a partner has advanced some money over and above capital he has agreed to subscribe does not convert suit for dissolution of partnership and winding up of affairs of partnership into an action to recover a debt but it remains a suit for declaration to dissolve partnership and winding up of its affairs. In such a case accounts are to be settled as per mode indicated in section 48 alone consequent upon dissolution of firm and not independently for recovery of amount. [Delhi Safe Deposits Co. Co . v CIT (2004) 269 ITR 66 (Del)]. Judicial decisions 1. There cannot be any dispute on the proposition that every dissolution must be in point of time anterior to the final winding up of the firm. Generally there will be a time gap between the two events. The firm was dissolved on 5-12-1987 but the sale of the assets as a going concern had taken place only on 20-11-1994. For the completion of the process of winding up the Legislature has engrafted section 47 in the Partnership Act for continuance of the partnership by creating a legal fiction. Therefore, though the firm stood dissolved on 5-12-1987, for the limited purpose of winding up of the affairs it continued till its assets and business were sold as a going concern on 20-11-1994. Therefore the firm continued to hold the properties as owner till November 20, 1994. There was no distribution of capital assets of the firm despite its dissolution and therefore the firm could not have been made liable for paying capital gains tax in terms of section 45(4). [ CIT v Mangalore Ganesh Beedi Works (2004) 265 ITR 658 (Karn)]. 2. It is to be noted that cash settlement to a partner on his retirement from the firm cannot be considered as a distribution of assets to him for the purpose of section 45(4) of the Income-tax Act. However, distribution of assets to a partner on his retirement will definitely come within the purview of section 45(4) as the terms or
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otherwise used in section 45(4) includes retirement of a partner. [ CIT v Naik Associates ( Associates ( AP AP ) (2003) 265 ITR 346 (Mum)]. 3. No capital gain if a firm became limited company under Part IX of Companies Act, 1956 : Where a partnership firm is treated as company under the provisions of Part IX of the Companies Act, neither section 45(1) nor section 45(4) shall be attracted even though there was transfer of assets from firm to newly constituted company. [CIT [CIT v Texspin Engineering Engineering & Manufacturing Manufacturing Works (2003) Works (2003) 263 ITR 345 (Bom)]. 4. Distribution of stock in trade amongst partners at the time of dissolution : Section 45(4) deals with distribution of capital assets assets at the time of dissolution. Stock in trade is not a capital asset and as such if stock in trade is distributed amongst the partners, then as per A.L.A. Firm v CIT (1991) (1991) 189 ITR 285 (SC) case, in taking accounts for purposes of dissolution, the firm and the partners, being commercial men, would value the asset including the stock in trade only at real basis ( i.e. market value) and not at cost or on their value appearing in the books of account. The settlement of accounts of the partners must be not on a notional basis but on a real basis. Thus, once the stock in trade is valued at market price, the surplus, if any, has to be taxed as business income of the firm. However, the Supreme Court in the case of Shakti Trading Co. v Co. v CIT (2001) (2001) 250 ITR 871 (SC), observed that the principle that closing stock has to be taken at the market value is applicable only where there was dissolution and also discontinuance of the business of the firm. But, where there is no discontinuance of the business, the closing stock should be valued at cost or market price whichever is lower. 5. Firm is liable to capital gains tax on firm's assets taken out by partners by bookentries and transferred by them: them: Where an immovable asset of the firm is, during its subsistence, taken out by the partners by making mere entries in the books of the firm and such asset is sold out by them, the capital gains arising from such transfer is exigible to capital gains in the hands of the firm. This is so because such transaction amounts to release of a share in specific immovable property of the firm and, therefore, such a transfer cannot legally be made without a registered document. [CIT [CIT v J.M. Mehta & Bros. (1995) Bros. (1995) 214 ITR 716, 719-20 (Bom)]. 9. Capital gain where a right to receive the compensation is in dispute The Supreme Court in the case of CIT v Hindustan Housing and Land Development Trust (1986) 161 ITR 524 held that where the right to receive the payment is in dispute as to whether the assessee is entitled to receive the same or not then such receipt shall not be treated as having accrued to the assessee till the dispute is not settled. Thus, in a case where additional compensation awarded to the assessee has been made subject matter of appeal by the Government then
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such amount shall be taxable as capital gain only: (a) in the year in which additional compensation is received, or (b) in the year in which the dispute is finally settled whichever is later . Further, the Allahabad High Court in the case of CIT v v Laxman Das (2000) 246 ITR 622 also decided that the same treatment should be given for interest in respect of such disputed compensation. compensation. Amendment made by the Finance Act, 2003 (W.e.f. A.Y. 2004-05): 2004-05): To nullify the above judgment, the Finance Act, 2003 has inserted a new clause ( c ) in section 45(5) to provide that where the amount of the compensation or consideration is subsequently reduced by any court, Tribunal or other authority, the capital gain of that year, in which the compensation or consideration received was taxed, shall be recomputed and the rectification shall be made under section 154 read with section 155(16) by the Assessing Officer accordingly. Hence, the capital gain shall now be taxable even if the compensation amount is in dispute as the assessee shall be entitled to get the assessment amended if compensation is later on reduced. Taxability of interest awarded on enhanced compensation Where along with additional compensation interest is also awarded and both the additional compensation and interest are in dispute then the interest will also not be taxable till the dispute is settled. But once the dispute is settled, such interest shall not be taxable in lump sum if the assessee is following mercantile system of accounting. Such interest shall be, on the other hand, spread over the period on an annual basis right from the date on which the asset was compulsorily acquired by the Government to the date on which the Court makes an order for enhanced compensation. compensation. [Rama Bai v CIT (1990) (1990) 181 ITR 400 (SC)]. 10. Capital gain arises on certain self-generated self-generated assets Generally there is no capital gain on transfer of self-generated assets as the cost of acquisition of such assets cannot be computed. But certain amendments have been made in the Income-tax Act and now capital gain arising on the transfer of the following assets is chargeable to tax: (i ) goodwill of a business. There will, however, be no capital gain on sale of goodwill of a profession; (ii ) trademark trademark or brand name associated with the business; (iii ) right to manufacture, manufactur e, produce or process any article or thing, for a consideration e.g. patent, copyright, formula, design; (iv ) right to carry on any business; (v ) tenancy rights;
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(vi ) route permits; (vii ) loom hours. The cost of acquisition of the above self-generated assets shall be taken as nil. However, other self-generated assets like goodwill of a profession, etc. are still not subject to capital gains as for such assets cost cannot be identified or envisaged as per Supreme Court decision in CIT v CIT v B.C. Srinivasa Setty (1981) (1981) 128 ITR 294 (SC). Further, an asset, in the improvement of which it is not possible to envisage a cost, has also been held to be not subject to capital gain by the Bombay High Court in Evans Fraser and Co. Ltd. v CIT (1982) (1982) 137 ITR 493 (Bom) but the Kerala and Karnataka High Court took the contrary view. [Parthas [ Parthas Trust v CIT 173 ITR 615 (Ker); Emerald Valley Estates Ltd. v Ltd. v CIT (1996) (1996) 222 ITR 799 (Kar)]. Where lands sold by assessee was inherited but last previous owner owner of such asset had acquired it by conquest (i.e. (i.e. without paying any price for the acquisition) and the case of the assessee was that even after applying the Explanation to Explanation to section 49(1), the cost of acquisition in the hands of the last previous owner who acquired it by a mode of acquisition other than that referred to in clause ( i ) to (iv (iv ) of subsection (1) of section 49 could not be ascertained, it was held that as cost of acquisition of asset was not ascertainable, capital gain could not be computed and as such assessee was not liable to any capital gains tax. [ CIT v CIT v Mandharsinhji P. Jadeja (2005) Jadeja (2005) 148 Taxman 110 (Guj)] 11. Capital gain on the transfer of land, forming part of building which is depreciable, depreciable, can be long-term Section 50 provides for determination of the cost of construction of superstructure and it does not apply to land as land is not a depreciable asset. Hence, if the building comprising of the land is sold, the capital gain on superstructure shall be short-term capital gain in terms of section 50 and the capital gain on land, if held for more than 36 months, shall be long-term capital gain. This is because the land is independent and identifiable capital asset and it continues to remain so even after construction of the building thereon. [CIT [ CIT v CITI Bank NA (2003) NA (2003) 261 ITR 570 (Bom)]. 12. Exemption of capital gains under various sub-clauses of section 10, section 11(1A) and section 13A The Act has exempted capital gain in the hands of various categories of persons under sections 10, 11(1A) and 13A. These exemptions are given to the specific categories of persons. However, the following clauses to section 10 have been inserted to allow exemption of capital gain to all categories of persons or more than one person. (A) Long-term capital gain on eligible equity shares exempt if the shares are
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acquired within a certain period: Any income arising from the transfer of a longterm capital asset, being an eligible equity share in a company shall be exempt provided these are acquired on or after 1-3-2003 but before 1-3-2004 and held for a period of 12 months of more. m ore. "Eligible equity share" means,— (i ) any equity share in a company being a constituent of BSE-500 Index of the Stock Exchange, Mumbai as on the 1-3-2003 and the transactions of purchase and sale of such equity share are entered into on a recognised stock exchange in India; (ii ) any equity share in a company allotted through a public issue on or after the 1-3-2003 and listed in a recognised stock exchange in India before 1-3-2004 and the transaction of sale of such share is entered into on a recognised stock exchange in India.'. (B) Exemption of capital gains on compensation received on compulsory acquisition of agricultural land situated within specified urban limits: With a view to mitigate the hardship faced by the farmers whose agricultural land situated in specified urban limits has been compulsorily acquired, acquired, the Finance (No. 2) Act, 2004 has inserted a new clause (37) in section 10 so as to exempt the capital gains (whether short-term or long-term) arising to an individual or a Hindu undivided family from transfer of agricultural land by way of compulsory acquisition where the compensation or the enhanced compensation or consideration, as the case may be, is received on or after 1-4-2004. 1-4-2004. The exemption is available only when such land has been used for agricultural purposes during the preceding two years by such individual or a parent a parent of his or by such Hindu undivided family. Where the compulsory acquisition has taken place before 1-4-2004 but the compensation is received after 31-3-2004, it shall be exempt. But if part of the original compensation in the above case has already been received before 1-42004, then exemption shall not be available even though balance original compensation is received after 31-3-2004. However, enhanced compensation received on or after 1-4-2004 against agricultural land compulsory acquired before 1-4-2004 shall be exempt. (C) Exemption of long-term capital gain arising from sale of shares and units: Any income arising on or after 1-10-2004 from the transfer of a long-term capital asset, being an equity share in a company or a unit of an equity oriented fund shall be exempt provided— (a) such equity shares are sold through recognised stock exchange, exchange, whereas units of an equity oriented fund may either be sold though the recognised stock exchange or may be sold to the mutual fund. (b) such transaction is chargeable to securities transaction tax.
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"Equity oriented fund" means a fund— (i ) where the investible funds are invested by way of equity shares in domestic companies to the extent of more than 65% of the total proceeds of such fund; and (ii ) which has been set up under a scheme of a Mutual Fund specified specifie d under clause (23D): The percentage of equity share holding of the fund shall be computed with reference to the annual average of the monthly averages of the opening and closing figures. 13. Exemption of capital gains under sections 54, 54B, 54EC and 54F (A) Profit on transfer of house property used for residence [Section 54] : 54] : Benefit of section 54 is confined to sale of a residential house after 36 months and reinvestment in a residential house. Reinvestment benefits is available both for purchase and construction of the house. Purchase has to be either one year before or two years later. Construction has to be completed within three years of the sale of the asset in respect of which benefit of reinvestment is claimed. There have been many decisions on purchase/construction of the house. Further, certain clarifications have also been issued in this regard. These have been summarized as under: (1)House (1) House include part of the house: house : House property does not mean a complete independent house. It includes independent residential units also, like flats in a multi-storeyed complex. The emphasis is not on the type of the property, but, on the head under which the rental income is assessed. [ CIT ( ( Addl Addl .) .) v Vidya Prakash Talwar (1981) (1981) 132 ITR 661 (Del)]. (2)Release (2) Release deed may also be treated as purchase: purchase : Where a property is owned by more than one person and the other co-owner or co-owners release his or their respective share or interest in the property in favour of one of the co-owners, it can be said that the property has been purchased by the releasee. Such release also fulfils the condition of section 54 as to purchase so far as releasee-assessee is concerned [CIT [CIT v v T.N. Aravinda T.N. Aravinda Reddy Reddy (1979) (1979) 120 ITR 46 (SC)]. (3) Addition of floor to the existing existing house eligible eligible for exemption exemption under under section 54: 54 : The assessee sold his residential property and invested the capital gain within the stipulated time in the construction of a new floor on another house owned by him by demolishing the existing floor, it was held that he was entitled to exemption under section 54. [CIT [CIT v v Narasimhan (PV ) (1990) 181 ITR 101 (Mad)]. (4)No (4) No exemption under section 54 if land only is sold : sold : The house property concerned must be building or land appurtenant to building. The basic test was whether the land appurtenant to building could be used independent of the user of the building. If so, it cannot be said to be land appurtenant to building. Further, the
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basic requirement is that the capital gain should arise from the transfer of building or land, the income of which is chargeable under the head Income from house property. If the land alone is sold, the provisions of section 54 will have no application inasmuch as the income from land is not chargeable under the head Income from house property. [CIT [ CIT v v Zaibunnisa Begum (1985) Begum (1985) 151 ITR 320 (AP)]. (5)Successor (5) Successor is entitled to benefit of exemption in case of death of the assessee: assessee: In case of assessee's death during the stipulated period, benefit of exemption under section 54(1) is available to legal representative if the required conditions are satisfied by the legal representative. [ Ramanathan (CV ) v CIT (1980) 155 ITR 191 (Mad)]. (6)Purchase (6) Purchase of limited interest in the house eligible for exemption under section 54: 54: Where an assessee had sold the residential house and acquired only 15% interest in another house and such other house was already used for residence prior to purchase, it was held that the benefit should be available to the assessee. [CIT v Chandaben Maganlal (2000) 245 ITR 182 (Guj)]. In coming to the conclusion, the High Court followed its own earlier decision in CIT v Tikyomal Jasanmal (1971) 82 ITR 95 (Guj). In that case, what was purchased was a unit of house property, while in the present case before the High Court, it was a limited interest in the property. (7)Construction (7) Construction in another property not eligible for exemption : An assessee gifted some land to his wife. He, thereafter constructed a building on the said land. The Government acquired the land and building and paid compensation for land to the wife and for the building to the assessee (husband). It was held that capital gain on land was assessable in the hands of the husband by virtue of section 64 but he was not entitled to exemption under section 54 in respect of capital gain on the acquisition of the land of the wife as the capital gain to the wife did not arise on transfer of a residential house. [T.N. [ T.N. Vasavan v CIT (1992) (1992) 197 ITR 163 (Ker)]. (8)House (8) House of the firm used by partners: partners : Where a firms property is used for residence of partners and thereafter distributed to the partners upon dissolution of the firm and the partner sells the same, exemption can be claimed by the partner under section 54. For this purpose, period for which this property was held by the firm shall also be taken into account for determining the question whether the house property in exemption was a long-term capital asset or not. [ CIT v M.K. Chandrakanth (2002) Chandrakanth (2002) 258 ITR 14 (Mad)]. (9)There (9) There can be both purchase and construction: construction : Where the assessee had partly invested the capital gains on the purchase of another house and partly on the construction of additional floor to the house so purchased within the prescribed time limit, it was held that the Income-tax Officer was not justified in restricting
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exemption to investment on purchase only, holding that the exemption under section 54 was admissible either for purchase or for construction but not for both. [Sarkar (B.B.) B.B.) v CIT (1981) (1981) 132 ITR 661 (Del)]. (10) Construction can start before the sale of asset : The construction of the new house may start before the date of transfer, but it should be completed after the date of transfer of the original house. [ CIT v v J.R. Subramanya Bhat (1987) (1987) 165 ITR 571 (Karn)]. The very fact that purchase of another house as also the construction can take place before the sale means that cost of purchase or new construction need not flow from the sale proceeds of the old property. [ CIT v CIT v H.K. Kapoor (Decd ) 1998 234 ITR 753 (All) and CIT v M. Vasudevan Chettiar (1998) (1998) 234 ITR 705 (Mad)]. (11) Allotment of a flat by DDA under the Self-Financing Self-Financ ing Scheme shall be treated as construction of the house [Circular No. 471, dated 15-10-1986]. Similarly, allotment of a flat or a house by a cooperative society, of which the assessee is the member, is also treated as construction of the house [Circular No. 672, dated 16-12-1993]. Further, in these cases, the assessee shall be entitled to claim exemption in respect of capital gains even though the construction is not completed within the statutory time limit. [ Sashi Varma v CIT (1997) (1997) 224 ITR 106 (MP)]. Delhi High Court has applied the same analogy where the assessee made substantial payment within the prescribed time and thus acquired substantial domain over the property, although the builder failed to hand over the possession within the stipulated period. [CIT [ CIT v v R.C. Sood (2000) (2000) 108 Taxman 227 (Del)]. (12) As per a circular of CBDT, CBDT, the cost of the the land is an integral integral part part of the cost of the residential house, whether purchased or constructed. [Circular No. 667, dated 18-10-1993]. (13) Where an assessee who owned owned a house property property,, sold the same and purchased another property in the name of his wife, exemption under section 54 shall be allowable. [CIT [ CIT v v V. Natarajan (2006) Natarajan (2006) 154 Taxman 399 (Mad)]. (14) Where the assessee utilised the sale consideration consideration for other other purposes and borrowed the money for the purpose of purchasing the residential house property to claim exemption under section 54, it was held that the contention that the same amount should have been utilised for the acquisition of new asset could not be accepted. [Bombay [Bombay Housing Corporation v Asst. CIT (2002) 81 ITD 454 (Bom). Also followed in Mrs. Prema P. Shah, Sanjiv P. Shah v ITO (2006) 282 ITR (AT) 211 (Mumbai)]. (15) Where non-resident Indian sold property in India and purchased residential property in U.K. and claimed deduction under section 54, it was held that it was not necessary that residential property showed be purchased in India
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itself. [Mrs. [Mrs. Prema P. Shah, Sanjiv P. Shah v ITO (2006) 282 ITR (AT) 211 (Mumbai)]. However, in another case, the Tribunal held that the words purchase/ construction of a residential house', in section 54F on plain and simple reading, mean that the purchase/construction of a residential house must be in India and not outside India. Therefore, the benefit under section 54F is not allowable for a residential house purchased/constructed outside India. [Leena [ Leena J Shah v Asstt. CIT (2006) 6 SOT 721 (Ahd)]. (B) Capital gain on transfer of land used for agricultural purposes [Section 54B] : 54B] : Any capital capital gain (short-term or long-term), long-term), arising to an assessee (only individuals), individuals), from the transfer of any agricultural land which has been used by the assessee or his parents for at least a period of 2 years immediately preceding the date of transfer, for agricultural purposes, shall be exempt to the extent such capital gain is invested in the purchase of another agricultural land within a period of 2 years after the date of transfer to be used for agricultural purpose, provided the new agricultural land purchased, is not transferred within a period of 3 years from the date of its acquisition. Section 54B is applicable only to individuals and not to any other assessee this is because the section uses the expression used by "his or a parent of his" which clearly indicate that the "assessee" refers to an individual. [CIT [ CIT v v Devarajalu (G.K.) G.K.) (1991) 191 ITR 211 (Mad)]. (C) Capital gain on transfer of long-term capital assets not to be charged on investment in certain bonds [Section 54EC] : Any long-term capital gain, arising to any assessee, from the transfer of any capital asset on or after 1-4-2000 shall be exempt to the extent such capital gain is invested within a period of 6 months after the date of such transfer in the long-term specified asset provided such specified asset is not transferred or converted into money within a period of 3 years from the date of its acquisition. Exemption under section 54EC not available in respect of deemed capital gains on amount received on liquidation of a company : company : Section 54E (now section 54EC) permits reinvestment benefit, if the sale proceeds/capital proceeds/capital gains on sale of long-term capital assets are invested in the manner required by the section. Where a shareholder is made liable for deemed capital gains on amount received on liquidation of a company, is he eligible for reinvestment benefit under section 54E (now 54EC)? It was held that section 54E (now 54EC) would have application only where there is an actual transfer and not in a case, where there is only a deemed transfer. [CIT [CIT v v Ruby Trading Co. Pvt. Ltd. (2003) Ltd. (2003) 259 ITR 54 (Raj)].
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Benefit under section 54EC, etc. available even on transfer of depreciable assets : Although as per section 50 the profit arising from the transfer of depreciable asset shall be a gain arising from the transfer of short term capital asset, hence shortterm capital gain but section 50 nowhere says that depreciable asset shall be treated as short-term capital asset. Section 54E [or say 54EC or 54F, etc.] is in independent provision which is not controlled by section 50. If the conditions necessary under section 54E are complied with by the assessee, he will be entitled to the benefit envisaged in section 54E, even on transfer of depreciable assets held for more than 36 months. [CIT [ CIT v v Assam Petroleum Industries Industries (P.) P.) Ltd. (2003) Ltd. (2003) 131 Taxman 699 (Gau). See also CIT also CIT v ACE Builders Pvt. Ltd. (2005) Ltd. (2005) 144 Taxman 855 (Bom)]. On the same analogy benefit under section 54EC or 54F shall be available in the case of depreciate asset if these are held for more m ore than 36 months. (D) Capital Gain on transfer of asset, other than a residential house [Section 54F] : 54F] : Any long-term long-term capital gain, arising to an individual or HUF, from the transfer of any capital asset, other than residential house property , shall be exempt in full, if the entire net sales consideration is invested in purchase of one residential house within one year before or before or two years after the the date of transfer of such an asset or in the construction of one residential house within three years after the date of such transfer. Where part of the net sales consideration is invested, it will be exempt proportionately. The above exemption shall be available only when the assessee does not own more than one residential house property on the date of transfer of such asset exclusive of the one which he has bought for claiming exemption under section 54F. Perusal of section 54F(4) shows that the assessee has to utilize the amount for the purchase or construction of the new asset before the date of furnishing the return of income under section 139. There is no mention of any sub-section of section 139. Hence, one cannot interpret the section 139 mentioned should be read as section 139(1). Similar language is appearing in section 54(2). The Gauhati High Court, in the case of CIT v Rajesh Kumar Jalan (2006) (2006) 286 ITR 274, has has held that section 139 mentioned in section 54F(4) will not only include section 139(1) but will also include all sub-section of section 139. In the instant case, it was not disputed that sale consideration had been utilized before the date of filing of the return under section 139(4). [Nipun Mehrotra v ACIT (2008) 110 ITD 520 (Bang)] Section 54 and 54F are comparable in many respects. Hence, the law and precedents relating to section 54 as to whether the house property on which investment is made is residential or not, the law relating to time limits, the
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precedent that construction could start earlier though completed within three years are all equally applicable for section 54F. Hence, for judicial decisions for section 54F, refer to the judicial decisions given under section 54.
