Capital gain on conversion of Capital Asset into stock in trade-section 45(2)

Capital gain on conversion of Capital Asset into stock in trade-section 45(2) Transfer includes conversion of Capital Asset into stock in trade u/s. 2(47)(iv) of the Income Tax Act. Under section 45(2) Capital gains arising from the conversion of Capital Asset into stock in trade shall be charged to tax in the previous year in which the stock in trade is sold or otherwise transferred by the assessee. For the purposes of computing Capital Gains, the fair market value of the assets on the date of conversion shall be deemed to be the sale consideration for the purpose of section 48. Capital Gains shall be computed as per the provisions of law applicable in the previous year in which the stock is sold. 1

Capital gain on conversion of Capital Asset into stock in trade-section 45(2) Example: Mr. A acquires a land on 01.08.1990, for Rs.2,00,000. he converts this land into stock in trade for dealing in plots on 01.04.2000. The fair market value as on the date of conversion of the plot into stock in trade was at Rs.7,00,000. The Stock in trade is sold on 01.03.2013 for Rs.22,00,000. compute the Capital Gains. 2

Capital gain on conversion of Capital Asset into stock in trade-section 45(2) Answer: Capital Gains arising from the transfer by way of conversion of a Capital Asset into stock in trade shall be charged to tax in the previous year in which the sock in trade is sold. Assessment year 2013-2014: Profits and gains of business Sale consideration of plot i.e. stock = Rs.22,00,000 Less(-) FMV on date of conversion = (-) Rs. 7,00,000 Profit s from business in the year in which stock is sold =Rs.15,00,000 3

Capital gain on conversion of Capital Asset into stock in trade-section 45(2) Assessment year 2013-2014: Period of holding 01.08.1990 to 31.03.2000. Capital Gains Answer Contd Full value of consideration (FMV on conversion date) Less index cost of acquisition Long Term Rs.7,00,000. Rs.2,00,000(actual cost) x 406 (C.I.I. on the date of conversion) =Rs.4,46,154 182 (C.I.I. on the date of purchase) Long term Capital Gain =Rs.2,53,846 4

Capital gain on conversion of Capital Asset into stock in trade-section 45(2) The assessee purchased jewellery on 14.04.1978 for Rs.2,00,000. (FMV as on 01.04.1981) is Rs.3,00,000. He starts a jewellery business and converts the jewellery into stock in trade on 14.07.2001. The fair market value of the jewellery on the date of conversion is Rs.18,00,000. The jewellery was finally sold for Rs.19,00,000 on 01.06.2012. Compute the tax impact. 5

Capital gain on conversion of Capital Asset into stock in trade-section 45(2) Answer: Assessment year 2013-2014 Profits from Business: Sale consideration Rs.19,00,000 Less (-) (FMV on conversion) Rs.18,00,000 Business profits Rs. 1,00,000 Capital gain continued in next slide. 6

Capital gain on conversion of Capital Asset into stock in trade-section 45(2) Answer contd Capital Gains Period of holding 14.04.1978 to 13.07.2001 Long Term Full value of consideration Rs.18,00,000 Less (-) Index cost of Acq Rs.3,00,000 x 426 = Rs.12,78,000 100 Rs. 5,22,000 Long Term Capital Gains RR 7

Transfer of Securities by depositories- Section 45(2A) Where any person has had at any time during the previous year any beneficial interest in any securities, then, any profit or gains arising from transfer made by the depository or participants of such beneficial interest in respect of securities shall be chargeable to tax as income of the beneficial owner in the previous year in which such transfer took place and shall not be regarded as income of the depository who is deemed to be the registered owner of securities by virtue of Section 10(1) of the Depositories Act 1996 and for the purpose of Section 48 and for determining period of holding FIFO Method shall be adopted (Circular No.768, Dt. 24.06.1998). 8

Transfer of Securities by depositories- Section 45(2A) - Example Date No. of shares Demat Account No. 4444 of Mr. X Company Particular 02.01.2001 500 Larsen & Toubro Ltd. 1) 200 shares purchased on 01.01.1987 @ Rs.200 each. 2) 200 shares purchased on 01.01.1992 @ Rs.300 each. 3) 100 shares purchased on 01.01.1997 @ Rs.400 each. Demat Account no. 4445 of Mr. X (All the above shares have been sent for Demat in a single Demat Requisition Form) Date 31.12.2001 No of Shares 250 Company Larsen & Toubro Particulars 1:2 Bonus shares allotted on 30.12.2001. 9

Transfer of Securities by depositories- Section 45(2A) Example Contd. Note related to the question: 250 shares of Larsen & Toubro Ltd. are sold by Mr. X on 14.01.2012 @ Rs.1200 each. He issues delivery instruction slip from Demat Account no. 4444. Compute the Capital Gains of Mr. X for Assessment year 2012-2013. 10

Transfer of Securities by depositories- Section 45(2A) Answer: (Please Refer to Slide no. 93 & 94) Since all the shares in Demat Account no.4444 have been dematerialized through a single demat requisition form, there can be no correlation between the purchase and sale of shares. Therefore circular no.704,dated 24.06.1998, shall apply and FIFO method should be followed. With respect to 200 shares of L & T purchased on 01.01.1987. Assessment year 2012-2013 Period of holding 01.01.1987 to 13.01.2012 Sale Consideration (200 x Rs.1200) Rs.2,40,000 (Long Term Capital Gains which shall be exempt u/s.10(38) provided S.T.T. has been paid.) Less Index cost of Acquisition *40000 x 785 = (-) Rs.2,24,285 140 Rs. 15,715 * The cost of Acquisition of 200 shares is @ Rs.200 each 11

Transfer of Securities by depositories- Section 45(2A) Answer - Contd. With respect to 50 shares of L & T purchased on 01.01.1992. Assessment year 2012-2013 Period of holding 01.01.1992 to 13.01.2012 Sale Consideration Rs.60,000 (50 x Rs.1200) Less Index cost of Acquisition *15,000 x 785 = (-) Rs.59,170 199 Rs. 830 (Long Term Capital Gains which shall be exempt u/s.10(38) provided S.T.T. has been paid.) * (50 shares were purchased @ Rs.300 each) 12

Transfer of Capital asset to partnership Firm by partner as capital contribution section 45(3) The profits and gains arising from the transfer of a Capital Asset by the assessee to the firm / AOP/ BOI by way of capital contribution or otherwise shall be taxable in the previous year in which such transfer takes place. The amount recorded in the books of accounts of the firm as the value of Capital Asset shall be deemed to be the sales consideration for the purposes of Capital Gains. 13

Transfer of Capital asset to partnership Firm by partner as capital contribution section 45(3) Example: Mr. X is admitted as a partner in a firm of M/s. XYZ. He transfers a Capital Asset on 01.01.2012 towards his capital contribution to the firm. The Capital Asset was acquired by Mr. X for Rs.12,00,000 on 17.06.2004. The market value of the Capital Asset transferred is Rs.60,00,000, however, the firm has recorded the value of the asset at Rs.40,00,000 in it s books of accounts. Discuss the tax consequences. 14

Transfer of Capital asset to partnership Firm section 45(3) Answer: Capital Gains in the hands of Mr. X (Partner) Assessment year 2012-2013 Period of holding 17.06.2004 to 31.12.2011 Nature of Capital Gain Full value of consideration u/s.45(3) Long Term (The amount recorded by the firm in the books) Less Indexed cost of acquisition Rs.40,00,000 12,00,000 x 785 ( Rs.19,62,500) 480 Long Term Capital Gains in the hands of Mr. X Rs.20,37,500 ( In this example section 56(2)(vii) shall not be applicable to firm as this section is only applicable to Individuals and H.U.F.) 15

Transfer of Capital asset to partnership Firm by partner as capital contribution section 45(3) Example: Mr. P is admitted in a Partnership firm of PQR. He transferred his residential building to the firm on 1.1.2012 as his capital contribution to the firm. The stamp duty valuation of the building is Rs.50,00,000, however the firm has recorded the same in its books at Rs.30,00,000. The residential building was acquired by Mr. P on 1.6.2004 for Rs.8,00,000. 16

Transfer of Capital asset to partnership Firm by partner as capital contribution section 45(3) Answer Capital Gains in the hands of Mr. P (Partner) Assessment year 2012-2013 Period of holding 01.06.2004 to 31.12.2011 Nature of Capital Gain Long Term Full value of consideration u/s.45(3) Rs.50,00,000 (The amount at which the building is valued by Stamp Authorities U/s. 50 C of Income Tax Act) Less Indexed cost of acquisition 8,00,000 x 785 ( Rs.13,08,333) 480 Long Term Capital Gains in the hands of Mr. P Rs.36,91,667 ( In this example section 56(2)(vii) shall not be applicable to firm as this section is only applicable to Individuals and H.U.F.) 17

Distribution of assets on dissolution or otherwise section -45(4) Under Section 45(4) Distribution of the assets on dissolution of a Firm shall be chargeable to tax as the income of the Firm in the previous year in which such distribution took place and the fair market value of the asset on the date of distribution shall be deemed to be the full value of the consideration received as a result of transfer. Fair market value is defined u/s. 2(22B ) of the Income Tax Act 1961. 18

Distribution of assets on dissolution or otherwise section 45(4) - Example A partnership firm ABC exists which consists the partners Mr. A, Mr. B, and Mr. C. Mr. C retires from the partnership firm from 02.6.2012 and on that day the balance standing credited to his capital account is Rs.15,00,000. The firm settles the account of the retiring partner by transferring jewellery which was acquired by the firm on 13.12.1991 at Rs.3,00,000. The fair market value of jewellery as 2.6.2012 is Rs.45,00,000. Mr C sells the said jewellery at Rs.48,00,000 on 15.6.2012. Discuss the tax consequences. 19

Distribution of assets on dissolution or otherwise section 45(4):Answer Ans:There will not be any Capital Gains in the hands of the partner u/s. 45(4) as per Hon. Supreme Court s Judgment in the case of C.I.T. v/s. R. Lingamallu Raghu Kumar (2001) 247 ITR 801 (SC) at the time of transfer of asset by firm to partner on dissolution or otherwise. Therefore Capital Gains shall arise in the hands of the Firm-ABC at the point of transfer of the Capital Asset to the retiring partner. The Full value of the consideration in the hands of the firm shall be taken at Rs.45,00,000 u/s.45(4) of the Income Tax Act. It must be noted that section 45(4) shall be applicable not only in case of dissolution but also on retirement as decided in the case of CIT V/s. A.N. Naik Associates (2004) 136 Taxman 107(Bom) 20

Distribution of assets on dissolution or otherwise section 45(4)-Tax effects in the hands of Partner on such distribution The difference between the fair market value and the credit balance standing in the books shall be treated as Income from other sources in the hands of the partner. If the partner sells the Capital Asset which he received from the firm the same shall be treated as Capital Gains in the hands of the partner. 21

Distribution of assets on dissolution or otherwise section 45(4)-Tax effects in the hands of Partner on such distribution Ans: On transfer of jewellery from the firm section 56(2)(vii) shall be applicable, in the hands of partner Mr C. In this case Mr. C is getting Rs.45,00,000 against his debit balance in the firm to the extent of Rs.15,00,000. Therefore the difference between Rs.45,00,000 less Rs. 15,00,00 = Rs.30,00,000 shall be treated as income from other sources u/s. 56(2)(vii). Capital Gain in the hands of the partner on sale of jewellery : Full value of consideration Rs.48,00,000 Less Rs.45,00,000 Short Term Capital Gains Rs. 3,00,000 Add: Income from other sources U/s. 56(2)(vii) (RS.45,00,000-Rs.15,00,000) Rs.30,00,000 Gross total Income under section 80-B(5) RS.33,00,000 22

Distribution of assets on dissolution or otherwise -section 45(4) Ans: (continued) Capital Gain in the hands of M/s. ABC Period of holding : 13.12.91 to 1.6.2009 Full value of consideration u/s. 45(4) Rs.45,00,000 Less: Indexed cost of acquisition: 3,00,000 X852 (Rs. 12,84,822) 199 33,15,578 LONG TERM CAPITAL GAINS IN THE HANDS OF FIRM 23

Distribution of assets on dissolution or otherwise -section 45(4) The accounting entry in the books of firm on distribution of assets on dissolution or otherwise to the partner: Partner s capital Account Dr. ---- xxx To Asset Account (At cost) *To Profit on distribution of asset Cr.----xxx Cr.--- xxx (The capital balance of partner less the cost of the asset distributed) (Being the asset distributed to the partner at the time of dissolution / retirement) *(It must be noted that, the profit on distribution of asset shall be calculated u/s. 45(4) and has nothing to do with the profit credited in accounts.) 24

Capital Gains on transfer by way of compulsory acquisition of Capital Asset- Section 45(5) Where a Capital Asset is compulsorily Acquired under any Law then, the Capital Gain arising from the transfer of the Capital asset shall be determined as under: The Capital Gains in regard to original compensation shall be chargeable to Tax in the previous year in which such compensation or part thereof is received - Section 45(5)(a). If the amount of compensation is enhanced by the Court, Tribunal or other Authority in that case the enhanced compensation shall be deemed to be the income of the previous year in which such enhanced compensation is received Section 45(5)(b). In case, where the Capital Gain is determined u/s. 45(5)(a) and Section 45(5)(b), is reduced subsequently by any Court, Tribunal or any other Authority, the Capital Gain shall be recomputed by taking the compensation so reduced Section 45(5)(c). 25

Capital Gains on transfer by way of compulsory acquisition of Capital Asset- Section 45(5) Notes: For computing Capital Gains on enhanced compensation the cost of acquisition and the cost of improvement shall be taken to be Nil Section 45(5)-explanation (i). However, legal expenses incurred to obtain the enhanced compensation shall be deductible. The rule of taxability on enhanced compensation shall apply even to those transfers which took place prior to 01.04.1988 Section 45(5) explanation (ii). In case, the amount of enhanced compensation is received by any other person on account of death of the transferor, the same shall be treated as Capital Gains in the hands of that other person Section 45(5) explanation (iii). For determining the nature of Capital Gains, the period of holding shall be considered from the date the asset was acquired by the assessee to the date the asset was compulsorily acquired under the Law. 26

Receipt of money or other assets from a company on liquidation section 46(2) Where a shareholder on liquidation of company receives any money or other assets from a company on liquidation, he shall be chargeable to Capital Gains in respect of money so received on the market value of the assets on the date of distribution. Such Capital Gains shall be reduced by the amount assessed as dividend as per section 2(22)(c) and the balance shall be deemed as full value of consideration. 27

Receipt of money or other assets from a company on liquidation section 46(2) -Example Mr K is a shareholder of a closely held company. The company was liquidated on 1.6.2012 and he received a machinery on 1.10.2012 whose fair market value was Rs.85 lakh. The company had accumulated profit of Rs.10 lakh. Now under section 2(22)(C) Rs.10 shall be treated as dividend income and Rs.75 lakh shall be treated as full value of consideration. 28

Special provision for computation of Capital Gains in case of depreciable assets Section 50 - w.e.f. 01.04.1998. Where the Capital Asset is forming part of a block of assets, defined u/s. 2(11) of the Income Tax Act in respect of which the depreciation has been allowed under Income Tax is transferred, in that case Capital gains shall be calculated u/s.50 of the Income Tax Act. The concept of block of asset u/s.2(11) has been introduced under Finance (No.2) Act 1998 w.e.f. 01.04.1998. 29

Special provision for computation of Capital Gains in case of depreciable assets Section 50(1). When the block does not cease to exist. Method of Computation of Capital gains u/s. 50 (1) Full value of consideration on transfer of any asset forming part of block of assets xxxxxx (Received or accruing as a result of transfer) Less Expenditure incurred wholly and exclusively in connection with such transfer As per Section 50(1)(i) xxx Less The written down value of the of the block of asset at the beginning of the previous year in which the asset is sold As per Section 50(1)(ii) xxx Less Actual cost of any asset which is acquired during the previous year- Section 50(1)(iii) xxx xxxxxxx Short term Capital Gains u/s. 50 (1) xxxxxxx 30

Special provision for computation of Capital Gains in case of depreciable assets Section 50(1). When the block does not cease to exist. On 01.04.2012, the depreciated value of block of asset having rate of depreciation @ 15% is Rs.80,000. The block consists of plant A and plant B. The assessee purchases Plant C (rate of depreciation 15%) on 28.12.2012 for Rs.30,000. He sells Plant A on 03.05.2012 for Rs.1,80,000. Compute the Capital Gains. 31

Special provision for computation of Capital Gains in case of depreciable assets Section 50(1). When the block does not cease to exist. Answer: Computation of Short Term Capital Gains u/s.50(1) Block does not cease to exist Assessment year 2013-2014. Full value of consideration on transfer of any asset forming part of block of assets 1,80,000 (Received or accruing as a result of transfer) Less Expenditure incurred wholly and exclusively in connection with such transfer As per Section 50(1)(i) Nil Less The written down value of the of the block of asset at the beginning of the previous year in which the asset is sold As per Section 50(1)(ii) 80,000 Less Actual cost of any asset which is acquired during the previous year- Section 50(1)(iii) 30,000 1,10,000 Short term Capital Gains u/s. 50 (1) 70,000 32

Special provision for computation of Capital Gains in case of depreciable assets Section 50(2). When block ceases to exist. Method of Computation of Capital gains u/s. 50 (2) Full value of consideration on transfer of any asset forming part of block of assets xxxxxx (Received or accruing as a result of transfer) Less The written down value of the of the block of asset at the beginning of the previous year in which the asset is sold As per Section 50(2) xxx Add - Asset acquired during the year which forms part of the block xxx xxxxxxx Short term Capital Gains u/s. 50 (2) xxxxxxx 33

Special provision for computation of Capital Gains in case of depreciable assets Section 50(2). When block ceases to exist. Example: X Ltd. Owns two Plants i.e. Plant A and Plant B on 01.04.2012 ( The rate of depreciation is 15%). The depreciated value as on 01.04.2012 of the block of asset is Rs.2,37,000. the company purchases Plant C on 31.05.2012 for Rs.20,000 and sells Plant A on 10.04.2012, Plant B on 12.12.2012 and Plant C on 01.03.2013, for Rs.10,000, Rs.15,000 and Rs.24,000 respectively. Determine the Capital Gains. 34

Special provision for computation of Capital Gains in case of depreciable assets Section 50(2). When block ceases to exist. Answer: Computation of Capital gains u/s. 50 (2) for Assessment year 2013-2014. Full value of consideration on transfer of all the assets forming part of block of assets 49,000 (Received or accruing as a result of transfer) Less The written down value of the of the block of asset at the beginning of the previous year in which the asset is sold As per Section 50(2) 2,37,000 Add - Asset acquired during the year which forms part of the block 20,000-2,57,000 Short term capital loss u/s. 50 (2) (2,08,000) 35

Special Provisions for full value of consideration Section 50 C. Section 50 C is applicable in the following conditions: There is a transfer of land or building or both. The asset may be a long term or a short term Capital Asset. The land or building or both may be depreciable or nondepreciable. The sale consideration is less than the value adopted by the Property Department Valuation Officer, appointed by the State Government for the purpose of payment of Stamp Duty. If all the above conditions are satisfied then the value adopted by the Stamp Duty Authority shall be taken as full value of consideration for the purposes of Capital Gains. 36

Special Provisions for full value of consideration Section 50 C. Situation Where the assessee accepts the value adopted by the Stamp Duty Authority Where the assessee disputes the value adopted by the Stamp Duty Authority under the Stamp Act. Where the assessee claims that, the value adopted by the Stamp Duty Authority is more than the fair market value (But the same has not been disputed by him under Stamp Duty proceedings. Where the assessee claims that, the value adopted by the Stamp Duty Authority is more than the fair market value (But the same has not been disputed by him under Stamp Duty proceedings. Full value of consideration for the purpose of Capital Gains Value adopted by Stamp Duty Authority shall be taken as full value of consideration. The Stamp Duty valuation as finally accepted for the Stamp Duty purposes shall be taken as full value of consideration The FMV determined by the Income Tax Valuer u/s. 55A -is less than the value determined by the State Govt. Stamp Duty valuation Authority, then the valuation by the Income Tax Valuer shall be considered as FMV. If the FMV determined by the Income Tax Valuer is more than the value adopted by the State Govt Stamp duty Authority than, the State Stamp Authority valuation shall prevail. 37

Special Provisions for full value of consideration Section 50 C Case Laws Situation Section 50C is not applicable for calculating Business income u/s. 28 Section 50C is constitutionally valid If the Assessee does not claim before the Assessing Officer that, the Stamp Duty value is more than the FMV, the Assessing Officer is justified in computing the taxable income u/s.50c without referring to the Income Tax Valuation Officer u/s.55a Related Judgments Inderlok Hotels (P.) Ltd. v/s. ITO (2009) 32 SOT 419 (Mum) CIT v/s. Thiruvengadam Investments (P) Ltd. (2010) 320 ITR 345 (Mad.) K. R. Palanisamy v/s. Union of India (2008) 306 ITR 61 (mad.) Bhatia Nagar Premises Co-op. Soc. Ltd. v/s. Union of India (2010) 234 CTR 175 (BOM) Sharad Dinesh Photographer v/s. ITO (2011) 43 SOT 452 (Mum). 38

Special Provisions for full value of consideration Section 50 C Case Laws Situation Related Judgments Lease Rights in a plot of land cannot be included u/s. 50C as lease Rights are neither land or building or both. Therefore, lease Rights in a plot of land is not covered u/s. 50C Provisions of Section 50C is applicable to the transfer of depreciable Capital Asset which are covered by Section 50. Provisions of Section 50C are applicable when the Rights to develop a property are transferred. Once a document is registered with the Stamp Authority, the value adopted by him for the purpose of Stamp Duty has to be considered u/s.50c and the Assessing Officer cannot substitute the value which the Stamp Duty Authority ought to have adopted. Atul G. Puranik v/s. ITO (2011) 132 ITD 499 (Mum) ITO v/s. United Marine Academy (2011) 130 ITD 113 (Mum). Arlette Rodrigues v/s. ITO (2011) 46 SOT 199 (Mum). Hasmukhbhai M. Patel v/s. CIT (2011) 46 SOT 419 (Ahd). 39

Special Provisions for full value of consideration Section 50 C Case Laws Situation No notice is required to be issued to invoke Section 50C Section 50 C would be applicable even if the assessment by Stamp Authority Valuer takes place subsequent to the transfer Where shares in a company which owns building are transferred, Section 50C is not applicable Related Judgments T. V. Nagasena v/s. ITO (2012) 24 Taxmann.com 30 (Bang). CIT v/s. Bagri Impex (p) Ltd. (2012) 24 Taxmann.com 327 (Kol). Irfan Abdul Kader Fazlani v/s. CIT (2013) 29 Taxmann.com 424 (Mum). 40