Element Details
Background Section 45 of the Act, inter alia, provides that capital gains arising from a conversion of capital asset into stock-in-trade shall be chargeable to tax. However, in cases where the stock in trade is converted into, or treated as, capital asset, the existing law does not provide for its taxability or otherwise.

Hence the tax treatment on the same was a matter of controversy:

Cost of Acquisition and Period of Holding:

One view:

·         Where stock in trade is converted into capital asset, the holding period for the purposes of classifying it as long-term or short-term capital asset shall be reckoned excluding the period for which it was held as stock-in-trade prior to conversion.

·         In other words, holding period of asset converted into investment from Stock-in-trade to be reckoned from date of such conversion.

Alternate View-in favour of assessee:

Commissioner Of Income Tax vs Jannhavi Investments (P) Ltd. on 8 January, 2008.

Ques: Whether the assessee was entitled to opt for the fair market value of certain shares as on the statutory date i.e. 1st April 1981, even though the said shares were held as stock-in-trade as on that date?

Brief Facts:

·         The respondents acquired certain shares of M/s Bharat Forge Ltd. in the year 1977.

·         On the original holding they received bonus shares in the financial year 1981-82 and additional bonus shares in the financial year 1989-90.

·         All the shares were held as stock-in-trade till 6th Nov., 1987. On the sale of the shares while working out capital gain, assessee computed fair market price as on 1st April, 1981.

·         The AO held that since the assessee was holding the shares as stock-in-trade upto 2nd Nov., 1987 and as the said shares were not capital assets as on 1st April, 1981, the option adopted as fair market price as on 1st April, 1981 was not available to the assessee

Held that the Assessee was entitled to adopt cost of acquisition as on 1st April 1981. Cost of acquisition can only be the cost on the date of the actual acquisition—In the present case there was no acquisition of the shares on 6th Nov., 1987 when the same were converted from stock-in-trade to a capital asset. In other words, date of conversion is irrelevant for the purpose of computing period of holding or cost of acquisition.

In order to bring certainty regarding taxation of conversion of an inventory into a capital asset, the FA 2018 introduced a set of provisions under the (Indian Tax Laws) ITL in terms of which the FMV of an inventory, as on the date of conversion into a capital asset, shall be taxed as business income in the year of conversion.

Proposed Amendments:

  • Section:[New clause (xiia) to Section 2(24)]

    Amendment: Clause (24) of section 2 so as to include such fair market value in the definition of income;

  • Section: [New clause (via) to section 28]

    Amendment: Section 28 so as to provide that Fair market value of inventory as on the date on which it is converted into, or treated as, capital asset determined in the prescribed manner.

  • Section: [New sub section (9) to section 49]

    Amendment: Section 49 so as to provide that for the purposes of computation of capital gains arising on transfer of such capital assets, the fair market value on the date of conversion shall be the cost of acquisition;

  • Section: [New sub-clause (ba) in clause (i) of Explanation 1 of the said clause (42A)]

    Amendment: Clause (42A) of section 2 so as to provide that the period of holding of such capital asset shall be reckoned from the date of conversion or treatment.

Applicability of the amendments These amendments will apply from AY 2019-20. Therefore, for any conversions on or after 1st April 2018, the FMV of an inventory, as on the date of conversion or treatment of the inventory into a capital asset, is taxed as business income. FMV so determined is considered as the cost of acquisition of the converted capital asset. Such cost is also considered as cost for the purpose of depreciation, if such capital asset is used by a taxpayer in business or profession.
Taxing event Year of Conversion of Inventory into Capital Asset.

Text of Draft of Notification issued by CBDT on 03.05.2018 is as follows: –

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