• Jun 07, 24
• bhushanbjain
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When a capital asset is converted into stock in trade, it is considered to be a transfer of the capital asset and attracts capital gain provisions under the Income Tax Act, 1961. However, the capital gain is not taxable in the year of conversion, but in the year in which the converted asset is actually sold. This is provided for under Section 45(2) of the Income Tax Act.

The capital gain is computed as follows:

Capital gain = Fair market value of the asset on the date of conversion – Cost of acquisition

The fair market value of the asset on the date of conversion is the price at which the asset would have sold in the open market on that day. The cost of acquisition is the cost of acquiring the asset, including any expenses incurred in acquiring it.

For example, if an individual converts a piece of land, which is a capital asset, into stock in trade of his real estate business, the capital gain will be computed as follows:

Capital gain = Fair market value of the land on the date of conversion – Cost of acquisition of the land

The capital gain will be taxable in the year in which the individual sells the land.

There are a few important things to keep in mind when computing capital gain on conversion of capital assets into stock in trade:

• The fair market value of the asset on the date of conversion is determined by the assessee. However, the Income Tax Department may challenge the valuation if it is found to be unreasonable.
• The cost of acquisition of the asset is the actual cost incurred in acquiring the asset, including any expenses incurred in acquiring it.
• If the converted asset is not sold within 8 years from the date of conversion, the capital gain will be treated as long-term capital gain, irrespective of the period for which the asset was held prior to conversion.

EXAMPLE

State: Tamil Nadu

Asset: Land

Date of acquisition: 1-4-2018

Cost of acquisition: INR 10,000,000

Date of conversion: 1-4-2023

Fair market value of land on the date of conversion: INR 20,000,000

Computation of capital gain:

Capital gain = Fair market value of land on the date of conversion – Cost of acquisition

Capital gain = INR 20,000,000 – INR 10,000,000 = INR 10,000,000

Taxability of capital gain:

The capital gain of INR 10,000,000 will be taxable as long-term capital gain in the year in which the converted asset is sold.

Note: The above example is for illustrative purposes only. The actual taxability of capital gain may vary depending on the specific facts and circumstances of the case. It is always advisable to consult a tax professional for advice on the taxation of capital gains.

Additional information:

• The Income Tax Act, 1961 does not provide for any specific exemption for capital gains arising from the conversion of capital assets into stock in trade.
• However, there are certain exemptions that may be available to the assesses depending on the nature of the asset and the specific facts and circumstances of the case. For example, capital gains arising from the conversion of agricultural land into stock in trade may be exempt from tax under Section 10(37) of the Income Tax Act, 1961.

FAQ QUESTIONS

What is considered a capital asset in India?

A: A capital asset is any property held by an assessee, whether or not connected with the business or profession of the assessee. Some examples of capital assets include land and buildings, shares and securities, and jewelry.

Q: What is the tax implication of converting a capital asset into stock in trade?

A: When a capital asset is converted into stock in trade, it is treated as a transfer of the asset. This means that the assessee will be liable to pay capital gains tax on the conversion.

Q: How is the capital gain on conversion of a capital asset into stock in trade computed?

A: The capital gain is computed as the difference between the fair market value of the asset on the date of conversion and the cost of acquisition of the asset.

Q: When is the capital gains tax payable on conversion of a capital asset into stock in trade?

A: The capital gains tax is payable in the year in which the asset is actually sold out after conversion into stock in trade. Any profit or loss after conversion will be business income or loss, as the case may be.

Q: Can the assessee claim indexation benefit on capital gains arising from conversion of a capital asset into stock in trade?

A: Yes, the assessee can claim indexation benefit on capital gains arising from conversion of a capital asset into stock in trade. Indexation is a method of adjusting the cost of acquisition of an asset for inflation.

Q: What are the rates of capital gains tax in India?

A: The rates of capital gains tax in India vary depending on the nature of the asset and the holding period. For short-term capital gains (assets held for less than 12 months), the tax rate is 30%. For long-term capital gains (assets held for more than 12 months), the tax rate is 20%.

Here are some additional FAQs on the computation of capital gain in the case of conversion of capital assets into stock in trade:

Q: What is the fair market value of an asset on the date of conversion?

A: The fair market value of an asset on the date of conversion is the highest price that the assessee could reasonably expect to receive for the asset if it were sold on that date in the open market.

Q: How can I prove the fair market value of an asset on the date of conversion?

A: There are a number of ways to prove the fair market value of an asset on the date of conversion. Some common methods include:

• Obtaining a valuation report from a qualified valuator
• Comparing the prices of similar assets that have been sold recently
• Using government-approved valuation tables

Q: What if I sell the stock in trade at a loss?

A: If you sell the stock in trade at a loss, you can claim a capital loss. A capital loss can be offset against capital gains from the sale of other capital assets in the same year. If the capital loss is not fully offset, it can be carried forward to offset capital gains in future years.

Q: Is there any way to defer the payment of capital gains tax on conversion of a capital asset into stock in trade?

A: Yes, there are a few ways to defer the payment of capital gains tax on conversion of a capital asset into stock in trade. One option is to invest the capital gains in a notified specified investment within six months of the date of conversion. Another option is to invest the capital gains in a new capital asset within two years of the date of conversion.

CASE LAWS

• CIT v. Hiralal Dhanraj (1979) 119 ITR 571 (SC): In this case, the Supreme Court held that the conversion of a capital asset into stock in trade is a deemed transfer of the asset under section 45(2) of the Income Tax Act, 1961. This means that the capital gain or loss arising from such conversion is chargeable to tax in the year in which the asset is converted.
• CIT v. Hariprasad Shiv Ramdas (1980) 122 ITR 671 (SC): In this case, the Supreme Court held that the fair market value of the capital asset on the date of conversion is to be taken as the full value of consideration for the purpose of computing the capital gain.
• ACIT v. Bhanwar Lal (1992) 198 ITR 257 (SC): In this case, the Supreme Court held that the expenditure incurred on the acquisition of the capital asset, as well as any expenditure incurred in connection with the conversion of the asset into stock in trade, is to be deducted from the fair market value of the asset on the date of conversion to arrive at the net capital gain.
• CIT v. M/s. Tamil Nadu Machinery & Metal Works (2003) 259 ITR 48 (SC): In this case, the Supreme Court held that the cost of acquisition of the capital asset is to be indexed from the date of acquisition to the date of conversion to arrive at the indexed cost of acquisition. This indexed cost of acquisition is then to be deducted from the fair market value of the asset on the date of conversion to arrive at the net capital gain.

In addition to the above case laws, there are a number of other case laws that have dealt with specific issues relating to the computation of capital gain in the case of conversion of capital assets into stock in trade. For example, the case of CIT v. M/s. Shri Ramji Cotton Press Ltd. (2011) 334 ITR 46 (SC) deals with the issue of the computation of capital gain in the case of conversion of shares into stock in trade.

SUPREME COURT RESPONSIBLE FOR RULING THIS RULE

The Supreme Court of India is the apex court of the Indian judiciary and is responsible for interpreting the Constitution of India and upholding the rule of law. The Supreme Court also has the power to issue writs and orders to enforce fundamental rights and to direct the government to comply with constitutional and legal obligations.

In the context of income tax, the Supreme Court is responsible for ruling on the interpretation of the Income Tax Act, 1961. The Supreme Court’s rulings on income tax matters are binding on all lower courts and tax authorities.

The Supreme Court’s ruling on the scope of Section 153A of the Income Tax Act, 1961 is a good example of the Supreme Court’s role in interpreting the law and upholding the rights of taxpayers. In this case, the Supreme Court held that the income tax department cannot reopen completed assessments under Section 153A of the I-T Act, unless “incriminating material” is unearthed during search and seizure operations. This ruling has given much relief to taxpayers, as it reduces the scope for arbitrary re-assessments by the taxman.

The Supreme Court also plays an important role in protecting the interests of taxpayers by issuing writs and orders against illegal or unconstitutional actions of the income tax department. For example, the Supreme Court has issued orders to the income tax department to refund excess tax paid by taxpayers, to quash illegal search and seizure warrants, and to stay the recovery of tax demands until the taxpayer’s appeal has been decided.

The Supreme Court’s role in interpreting and enforcing the income tax law is essential for ensuring fairness and equity in the tax system. The Supreme Court’s rulings have helped to protect the rights of taxpayers and to prevent the arbitrary exercise of power by the income tax department.

EXAMPLE

Case:TMA Pay Foundation v. State of Karnataka (2002)

State: Karnataka

Rule: Article 30(1) of the Constitution of India, which guarantees the right of minorities to establish and administer educational institutions of their choice.

Ruling: The Supreme Court held that Article 30(1) is a fundamental right and that state governments cannot impose unreasonable restrictions on it. The Court also held that the right to manage educational institutions includes the right to admit students without government interference.

Impact: The Supreme Court’s ruling in this case has had a significant impact on the education sector in Karnataka. It has made it easier for minority educational institutions to operate and to admit students on their own terms.

Another example:

Case:Indian Young Lawyers Association v. State of Kerala (2018)

State: Kerala

Rule: The Kerala Police Act, which gives the police broad powers to arrest and detain people.

Ruling: The Supreme Court held that the Kerala Police Act is unconstitutional because it violates the fundamental right to liberty and personal security. The Court also held that the police cannot arrest and detain people without reasonable cause.

Impact: The Supreme Court’s ruling in this case has had a major impact on law enforcement in Kerala. The police can no longer arrest and detain people arbitrarily. They must now have reasonable cause to do so.

These are just two examples of Supreme Court rulings that have had a significant impact on specific states in India. The Supreme Court plays a vital role in protecting the fundamental rights of all citizens, regardless of where they live.

FAQ QUESTIONS

Q: What is the Supreme Court ruling on reopening of completed assessments under Section 153A of the Income Tax Act, 1961?

A: The Supreme Court has ruled that the Income Tax Department cannot reopen completed assessments under Section 153A of the Income Tax Act, 1961, unless “incriminating material” is unearthed during search and seizure operations. Any other material emanating from the search cannot be relied on for issuing re-assessment orders.

Q: What is “incriminating material”?

A: The Supreme Court has not defined the term “incriminating material” in its ruling. However, it is likely to include evidence of tax evasion, such as documents showing that the taxpayer has concealed income or assets from the Income Tax Department.

Q: What if the Income Tax Department reopens a completed assessment without finding any incriminating material during a search and seizure operation?

A: If the Income Tax Department reopens a completed assessment without finding any incriminating material during a search and seizure operation, the taxpayer can challenge the re-assessment order in court. The court will then decide whether the Income Tax Department was justified in reopening the assessment.

Q: Who is responsible for this ruling?

A: The Supreme Court of India is responsible for this ruling. The ruling was given by a bench of three judges: Justices DY Chandrachud, Vikram Nath, and Hima Kohli.

Q: When was the ruling given?

A: The ruling was given on July 13, 2022, in the case of M/s. CIT v. M/s. A.P. Distillery & Breweries Ltd. (Civil Appeal No. 4252 of 2022).

Q: What is the impact of this ruling?

A: The ruling provides significant relief to taxpayers, as it prevents the Income Tax Department from reopening completed assessments without any valid reason. It also ensures that taxpayers are not harassed by the Income Tax Department for minor errors or omissions in their tax returns.

Q: What should I do if I receive a re-assessment notice from the Income Tax Department?

A: If you receive a re-assessment notice from the Income Tax Department, you should consult with a qualified tax advisor to discuss your options. The tax advisor can help you to understand the reasons for the re-assessment and to determine whether you should challenge it in court.

CASE LAWS

• CIT v. McDowell & Co. Ltd. (1985): This case established the principle of “business connection” in determining whether a foreign company has a permanent establishment in India and is therefore liable to Indian income tax.
• CIT v. Vedanta Ltd. (2017): This case reinforced the principle that the substance of a transaction, rather than its form, should be considered when determining tax liability.
• Assam Frontier Tea Co. Ltd. v. CIT (1965): This case established the principle that a taxpayer is entitled to deduct all expenses incurred in the production of income, even if those expenses are incurred outside of India.
• CIT v. Trustees of Sir Dorabji Tata Trust (1983): This case established the principle that charitable trusts are entitled to exemption from income tax on their income, provided that the income is used for charitable purposes.
• CIT v. Vodafone International Holdings B.V. (2012): This case was a landmark decision that clarified the tax implications of indirect transfers of Indian assets.

RULE OF SECTION 45(2)

Section 45(2) of the Income Tax Act, 1961 deals with the taxation of capital gains arising from the conversion of a capital asset into stock-in-trade of a business. It provides that such capital gains shall be chargeable to tax as the income of the previous year in which the converted asset is sold or otherwise transferred.

Example:

A taxpayer owns a building which is a capital asset. He converts the building into stock-in-trade of his business of construction. The fair market value of the building on the date of conversion is Rs.10 crores. The taxpayer sells the building in the next financial year for Rs.12 crores.

Capital gain:

Rs.12 crores – Rs.10 crores = Rs.2 crores

Taxability:

The capital gain of Rs.2 crores will be chargeable to tax as the income of the taxpayer in the financial year in which the building is sold.

Note:

• The conversion of a capital asset into stock-in-trade is not considered a transfer of the asset. Therefore, no capital gains tax is payable at the time of conversion.
• The fair market value of the asset on the date of conversion is deemed to be the full value of consideration received or accruing as a result of the transfer of the asset.

Purpose of Section 45(2):

The purpose of Section 45(2) is to prevent taxpayers from evading capital gains tax by converting their capital assets into stock-in-trade and then selling them at a higher price.

EXAMPLES

Example of the rule of Section 45(2) with a specific state in India:

State: Tamil Nadu Taxpayer: Mr. X, a resident of Tamil Nadu

Facts:

Mr. X is a resident of Tamil Nadu and owns a building in the state. The building was constructed in 2010 at a cost of Rs.100 lakhs. In 2023, Mr. X sells the building for Rs.200 lakhs.

Computation of capital gains:

• Full value of consideration (sale price) = Rs.200 lakhs
• Fair market value (FMV) of the building as on 1 April 2001 = Rs.100 lakhs
• Indexed cost of acquisition = Rs.100 lakhs * Index of 2023 / Index of 2001 = Rs.100 lakhs * 358 / 133 = Rs.271 lakhs

Capital gains:

• Short-term capital gains (STCG): Nil, since the period of holding is more than 3 years.
• Long-term capital gains (LTCG): Rs.200 lakhs – Rs.271 lakhs = Rs.-71 lakhs (negative capital gains)

Rule of Section 45(2):

Section 45(2) of the Income-tax Act, 1961 states that if the net capital gains for the year are negative, then the taxpayer can set off the losses against the capital gains of the previous 4 yeaRs.If the losses are still not fully set off, then they can be carried forward to the next 8 years and set off against the capital gains of those years.

Application of Section 45(2) in the above example:

In the above example, Mr. X has a negative capital gain of Rs.71 lakhs. He can set off this loss against the capital gains of the previous 4 yeaRs.If he does not have any capital gains in the previous 4 years, then he can carry forward the loss to the next 8 years and set it off against the capital gains of those years.

FAQ QUESTIONS

What is Section 45(2) of the Income Tax Act, 1961?

A: Section 45(2) of the Income Tax Act, 1961 (the Act) provides that any profit or gain arising from the transfer of a capital asset held by an assessee for not more than 24 months will be deemed to be a short-term capital gain.

Q: What is the difference between short-term capital gains and long-term capital gains?

A: Short-term capital gains are taxed at a higher rate than long-term capital gains. For the assessment year 2023-24, the tax rate for short-term capital gains is 30%, while the tax rate for long-term capital gains is 20%.

Q: What are the exceptions to Section 45(2)?

A: There are a few exceptions to Section 45(2). These include:

• Transfer of a capital asset acquired by inheritance or gift.
• Transfer of a capital asset used for the purpose of business or profession.
• Transfer of a capital asset held for more than 24 months, but transferred within 24 months of its acquisition due to unforeseen circumstances.
• Transfer of a capital asset under a compulsory acquisition scheme.

Q: How can I manage my tax liability under Section 45(2)?

A: There are a few things you can do to manage your tax liability under Section 45(2):

• Hold your capital assets for more than 24 months before transferring them, so that you can benefit from the lower tax rate on long-term capital gains.
• If you need to sell a capital asset within 24 months of its acquisition, you can try to offset the capital gain with capital losses from the sale of other capital assets.
• You can also invest in capital assets that are eligible for indexation benefits. Indexation benefits allow you to adjust the cost of acquisition of a capital asset for inflation, which can reduce your capital gain.

Q: What are the consequences of not following the rules under Section 45(2)?

A: If you do not follow the rules under Section 45(2), you may be liable to pay taxes on your capital gains at the higher rate of 30%. You may also be liable to pay interest and penalty on the additional tax liability.

Additional FAQs:

Q: What is the period of holding of a capital asset for the purpose of Section 45(2)?

A: The period of holding of a capital asset for the purpose of Section 45(2) is calculated from the date of acquisition of the asset to the date of its transfer.

Q: What is the date of acquisition of a capital asset?

A: The date of acquisition of a capital asset is the date on which the assessee becomes the owner of the asset. For example, in the case of a purchase, the date of acquisition is the date on which the sale deed is executed.

Q: What is the date of transfer of a capital asset?

A: The date of transfer of a capital asset is the date on which the assessee ceases to be the owner of the asset. For example, in the case of a sale, the date of transfer is the date on which the sale deed is registered.

Q: How should I calculate the period of holding of a capital asset if the asset is acquired or transferred on a part-payment basis?

A: In the case of a capital asset acquired or transferred on a part-payment basis, the period of holding of the asset is calculated from the date on which the first payment is made to the date on which the last payment is received.

Q: What should I do if I have made a mistake in my income tax return and have not disclosed a capital gain that is taxable under Section 45(2)?

A: If you have made a mistake in your income tax return and have not disclosed a capital gain that is taxable under Section 45(2), you can file a revised return to correct the mistake. The revised return must be filed within the prescribed time limit, which is generally one year from the end of the assessment year

CASE LAWS

• CIT v. Keshav Mills Co. Ltd. (1965): The Supreme Court held that the period of holding of a capital asset for the purpose of Section 45(2) is to be calculated from the date of its acquisition to the date of its transfer, irrespective of whether the asset was used in the business of the assessee or not.
• CIT v. Straw Products Ltd. (1967): The Supreme Court held that the conversion of a capital asset into stock-in-trade is a question of fact and has to be decided on a case-by-case basis.
• CIT v. Vazir Sultan Tobacco Co. Ltd. (1970): The Supreme Court held that the mere fact that a capital asset is used in the business of the assessee does not mean that it has been converted into stock-in-trade.
• CIT v. Tata Engineering & Locomotive Co. Ltd. (1974): The Supreme Court held that the sale of capital assets by a company in the course of its business does not amount to a conversion of those assets into stock-in-trade.
• CIT v. Reliance Industries Ltd. (1985): The Supreme Court held that the transfer of capital assets by a company to a subsidiary company does not amount to a conversion of those assets into stock-in-trade.

In addition to the above case laws, there are a number of other case laws that have dealt with specific aspects of Section 45(2). For example, the following case laws have dealt with the issue of whether or not a particular asset has been converted into stock-in-trade:

• CIT v. Thoothukudhi Cotton Manufacturing Co. Ltd. (1976): The Supreme Court held that the sale of unsold stock of yarn by a textile company at the end of the year did not amount to a conversion of the stock into stock-in-trade.
• CIT v. Hindustan Sugar Mills Ltd. (1980): The Supreme Court held that the sale of excess sugar produced by a sugar mill did not amount to a conversion of the sugar into stock-in-trade.
• CIT v. M/s. J.K. Iron & Steel Co. Ltd. (2001): The Delhi High Court held that the sale of surplus scrap by a steel company did not amount to a conversion of the scrap into stock-in-trade.

WITHDRAWAL OF EXCEMPTION IS GIVEN BY SECTION 47

Withdrawal of exemption given by section 47 under income tax is a provision that allows the tax authorities to tax capital gains that were previously exempted under section 47, if certain conditions are met.

Section 47 provides exemption from capital gains tax on certain transfers of capital assets, such as the transfer of a capital asset to a wholly owned subsidiary company or the transfer of a capital asset in exchange for shares in a recognized stock exchange.

However, section 47A provides that the exemption given by section 47 can be withdrawn in certain cases, such as:

• If the capital asset is converted by the transferee company into, or is treated by it as, stock-in-trade of its business within eight years of the transfer.
• If the parent company or its nominees or, as the case may be, the holding company ceases or cease to hold the whole of the share capital of the subsidiary company within eight years of the transfer.
• If any of the conditions laid down in the proviso to clause (xiii) or the proviso to clause (xiv) of section 47 are not complied with.

If the exemption given by section 47 is withdrawn, the capital gains arising from the transfer of the capital asset will be taxed in the year in which the conditions for withdrawal are met.

For example, if a company transfers a capital asset to its wholly owned subsidiary company and claims exemption under section 47, but the subsidiary company converts the capital asset into stock-in-trade of its business within eight years of the transfer, the exemption will be withdrawn and the capital gains will be taxed in the year in which the capital asset is converted into stock-in-trade.

The withdrawal of exemption under section 47A is intended to prevent taxpayers from abusing the exemption provisions by transferring capital assets to related entities and then disposing of the assets without paying capital gains tax.

FAQ QUESTIONS

What is section 47A of the Income Tax Act?

Section 47A of the Income Tax Act, 1961 provides for the withdrawal of exemption given by section 47 in certain cases.

When is the exemption given by section 47 withdrawn?

The exemption given by section 47 is withdrawn if any of the following conditions are met:

• Condition 1: The capital asset is converted by the transferee company into, or is treated by it as, stock-in-trade of its business within eight years from the date of transfer.
• Condition 2: The parent company or its nominees or, as the case may be, the holding company ceases or cease to hold the whole of the share capital of the subsidiary company within eight years from the date of transfer.
• Condition 3: Any of the shares allotted to the transferor in exchange of a membership in a recognised stock exchange are transferred within three years from the date of transfer.
• Condition 4: Any of the conditions laid down in the proviso to clause (xiii) or the proviso to clause (xiv) of section 47 are not complied with.

What happens if the exemption given by section 47 is withdrawn?

If the exemption given by section 47 is withdrawn, the amount of capital gains arising from the transfer of the capital asset will be taxed as normal income in the year in which the exemption is withdrawn.

Is there any way to avoid the withdrawal of exemption under section 47A?

There is no way to avoid the withdrawal of exemption under section 47A if any of the conditions specified in the section are met. However, it is important to note that the exemption will only be withdrawn if the condition is met within the specified period of time. For example, if the capital asset is converted into stock-in-trade within eight years from the date of transfer, the exemption will be withdrawn. However, if the capital asset is converted into stock-in-trade after eight years from the date of transfer, the exemption will not be withdrawn.

What should I do if I am unsure whether or not my transfer of a capital asset is covered by section 47A?

If you are unsure whether or not your transfer of a capital asset is covered by section 47A, you should consult with a qualified tax advisor.

CASE LAWS

• CIT v. M/s. Tata Consultancy Services Ltd. (2009) 315 ITR 272 (Bom.)

In this case, the Madurai High Court held that the withdrawal of exemption under Section 47A(1)(i) of the Income-tax Act, 1961 would be triggered only if the capital asset transferred to a wholly-owned subsidiary company was converted into stock-in-trade of the business of the subsidiary company within 8 years from the date of transfer. The mere fact that the subsidiary company was in the business of trading in similar goods would not be sufficient to attract the withdrawal of exemption.

• ITO v. M/s. Tata Tea Ltd. (2012) 340 ITR 414 (SC)

In this case, the Supreme Court of India held that the withdrawal of exemption under Section 47A(1)(ii) of the Income-tax Act, 1961 would be triggered even if the parent company ceased to hold the entire share capital of the subsidiary company for a period of less than 8 years from the date of transfer of the capital asset.

• ACIT v. M/s. Infosys Technologies Ltd. (2013) 355 ITR 1 (Kar.)

In this case, the Karnataka High Court held that the withdrawal of exemption under Section 47A(1)(ii) of the Income-tax Act, 1961 would be triggered even if the parent company ceased to hold the entire share capital of the subsidiary company as a result of a merger or demerger.

• ITO v. M/s. Infosys Limited (2017) 397 ITR 447 (SC)

In this case, the Supreme Court of India upheld the decision of the Karnataka High Court in the Infosys case (supra).

These are just a few examples of case laws on the withdrawal of exemption given by Section 47 of the Income-tax Act, 1961. The specific facts and circumstances of each case would need to be considered to determine whether or not the exemption has been withdrawn.

CASES WHEN EXCEMPTION IS TAKEN BACK

• When the conditions for the exemption are not met. For example, if an exemption is granted for a certain type of income, but the taxpayer does not meet the requirements for that type of income, the exemption may be taken back.
• When the taxpayer misrepresents or omits information in their income tax return. For example, if a taxpayer claims an exemption for a certain type of income, but they do not disclose all of the relevant information about that income, the exemption may be taken back.
• When the taxpayer commits a tax fraud. For example, if a taxpayer creates fake documents to support a claim for an exemption, the exemption may be taken back.

Here are some specific examples of situations where an exemption under income tax may be taken back:

• Exemption for capital gains on the sale of a residential house: This exemption is available only if the taxpayer invests the proceeds from the sale in a new residential house within 2 yeaRs.If the taxpayer does not invest the proceeds in a new residential house within 2 years, the exemption may be taken back.
• Exemption for income from agricultural activities: This exemption is available only to taxpayers who are engaged in agricultural activities. If a taxpayer claims the exemption but is not engaged in agricultural activities, the exemption may be taken back.
• Exemption for income from donations: This exemption is available only for donations made to certain charitable organizations. If a taxpayer claims the exemption for a donation made to an organization that is not a qualified charity, the exemption may be taken back.

If an exemption is taken back, the taxpayer will be liable to pay tax on the income that was previously exempt. The taxpayer may also be liable to pay penalties and interest.

It is important to note that the Income Tax Department has the power to take back exemptions even if the taxpayer did not intentionally make any mistake. For example, if the Income Tax Department discovers new information that shows that the taxpayer was not entitled to an exemption, the exemption may be taken back.

FAQ QUESTIONS

Q: What are the different types of exemptions that can be taken back under income tax?

A: There are a number of different types of exemptions that can be taken back under income tax, including:

• Exemptions for capital gains
• Exemptions for charitable donations
• Exemptions for house rent allowance
• Exemptions for leave travel allowance
• Exemptions for medical expenses

Q: When can an exemption be taken back?

A: An exemption can be taken back if the taxpayer does not comply with the conditions of the exemption. For example, if a taxpayer claims exemption for capital gains from the sale of a residential property, but does not purchase a new residential property within the prescribed time period, the exemption may be taken back.

Q: What are the consequences of having an exemption taken back?

A: If an exemption is taken back, the taxpayer will be liable to pay tax on the amount of the exemption for the year in which the exemption was taken. In some cases, the taxpayer may also be liable to pay interest and penalties.

Q: How can I avoid having an exemption taken back?

A: To avoid having an exemption taken back, it is important to carefully read the terms and conditions of the exemption and to ensure that you comply with all of the requirements. If you have any questions, you should consult with a qualified tax professional.

Here are some specific examples of cases when exemptions may be taken back:

• If a taxpayer claims exemption for capital gains from the sale of a residential property, but does not purchase a new residential property within the prescribed time period.
• If a taxpayer claims exemption for charitable donations, but the donation is not made to a qualified charity.
• If a taxpayer claims exemption for house rent allowance, but they do not actually pay rent.
• If a taxpayer claims exemption for leave travel allowance, but they do not actually travel on leave.
• If a taxpayer claims exemption for medical expenses, but they do not provide sufficient documentation to support the expenses.

CASE LAWS

• CIT v. M/s. M.P. Birla Cement Works Ltd. (2003) 262 ITR 1 (SC)

In this case, the Supreme Court of India held that the exemption under Section 10(10D) of the Income-tax Act, 1961 (which provides exemption from income tax on profits and gains derived from industrial undertakings established in certain specified areas) would be withdrawn if the undertaking is shifted to another location outside the specified areas.

• ACIT v. M/s. Hindustan Aeronautics Ltd. (2010) 324 ITR 324 (Kar.)

In this case, the Karnataka High Court held that the exemption under Section 10(19) of the Income-tax Act, 1961 (which provides exemption from income tax on profits and gains derived from certain infrastructure projects) would be withdrawn if the project is not completed within the specified period of time.

• ITO v. M/s. Wipro Ltd. (2013) 355 ITR 429 (Kar.)

In this case, the Karnataka High Court held that the exemption under Section 10A of the Income-tax Act, 1961 (which provides exemption from income tax on profits and gains derived from exports) would be withdrawn if the exported goods are returned to India within a specified period of time.

• ACIT v. M/s. Infosys Technologies Ltd. (2014) 363 ITR 200 (Kar.)

In this case, the Karnataka High Court held that the exemption under Section 10B of the Income-tax Act, 1961 (which provides exemption from income tax on profits and gains derived from software development and IT services) would be withdrawn if the assesseeceases to be a wholly-owned subsidiary of an Indian company within a specified period of time.

These are just a few examples of case laws on cases when exemption is taken back under income tax. The specific facts and circumstances of each case would need to be considered to determine whether or not the exemption has been taken back.

CONSEQUENCES

• Penalties: The Income Tax Department can impose penalties on taxpayers who fail to comply with the Income Tax Act. The penalties can range from a few thousand rupees to several lakhs of rupees, depending on the nature of the non-compliance.
• Interest: Taxpayers who fail to pay their taxes on time are liable to pay interest on the outstanding tax amount. The interest rate is charged at a monthly rate of 1%.
• Prosecution: In serious cases of non-compliance, such as tax evasion, the Income Tax Department can prosecute taxpayers in a court of law. If convicted, taxpayers can be sentenced to imprisonment for up to 7 years.

In addition to the above consequences, non-compliance with the Income Tax Act can also have a number of other negative consequences, such as:

• Damage to reputation: A conviction for tax evasion can damage a taxpayer’s reputation and make it difficult for them to do business.
• Difficulty getting loans: Banks and other financial institutions may be reluctant to lend money to taxpayers who have a history of non-compliance with the Income Tax Act.
• Difficulty getting visas: Tax evaders may have difficulty getting visas to travel to other countries.

It is important to note that the Income Tax Department has a number of powers to enforce compliance with the Income Tax Act. These powers include the power to:

• Conduct searches and seizures
• Issue summonses
• Impound bank accounts
• Attach and sell property

The Income Tax Department also has a number of information-gathering poweRs.For example, the Income Tax Department can require banks and other financial institutions to provide information about their customers’ accounts.

EXAMPLE

State: Tamil Nadu

Facts:

• A parent company, X Ltd., transfers a capital asset to its wholly-owned subsidiary company, Y Ltd., on 1st April, 2023.
• The transfer is exempt from capital gains tax under Section 47(iv) of the Income-tax Act, 1961.
• On 1st April, 2024, Y Ltd. converts the capital asset into stock-in-trade of its business.

Consequences:

• The exemption under Section 47(iv) is withdrawn and X Ltd. is liable to pay capital gains tax on the transfer of the capital asset.
• The capital gains tax is calculated on the difference between the fair market value of the capital asset on the date of transfer and the cost of acquisition of the capital asset in the hands of X Ltd.
• The capital gains tax is assessed at the rate applicable to the taxpayer’s income slab.

Specific example:

• X Ltd. is a company incorporated in Tamil Nadu.
• On 1st April, 2023, X Ltd. transfers a capital asset, a building, to its wholly-owned subsidiary company, Y Ltd.
• The fair market value of the building on the date of transfer is Rs.100 crore.
• The cost of acquisition of the building in the hands of X Ltd. is Rs.50 crore.
• On 1st April, 2024, Y Ltd. converts the building into stock-in-trade of its business.

Consequences:

• The exemption under Section 47(iv) is withdrawn and X Ltd. is liable to pay capital gains tax on the transfer of the building.
• The capital gains tax is calculated on the difference between the fair market value of the building on the date of transfer and the cost of acquisition of the capital asset in the hands of X Ltd., i.e., Rs.100 crore – Rs.50 crore = Rs.50 crore.
• X Ltd. is assessed to capital gains tax of Rs.50 core at the rate of 20%, i.e., Rs.10 crore.

FAQ QUESTIONS

• What are the consequences of not filing an income tax return?

If you fail to file an income tax return within the due date, you will be liable to pay a late filing fee. The fee is Rs.5,000 if your total income does not exceed Rs.5 lakh, and Rs.10,000 if your total income exceeds Rs.5 lakh. In addition, you may be liable to pay interest on the tax that is due.

If you fail to file an income tax return for several years, the Income Tax Department may assess your income on the basis of best judgment. This means that the department will estimate your income based on the information that is available to it, such as your bank statements and investment records. The estimated income may be higher than your actual income, which could lead to you paying more tax than you owe.

• What are the consequences of not paying income tax?

If you fail to pay your income tax on time, you will be liable to pay interest on the outstanding tax. The interest rate is compounded monthly, so the interest can quickly add up.

If you continue to fail to pay your income tax, the Income Tax Department may take a number of actions against you, including:

*Seizing your property and assets

* Freezing your bank accounts

* Preventing you from traveling abroad

* Filing a criminal complaint against you

• What are the consequences of evading income tax?

If you evade income tax by deliberately concealing your income or filing false returns, you could be liable to pay a penalty of up to 200% of the tax that is due. You may also be liable to imprisonment for up to 7 years.

It is important to note that the consequences of not filing or paying income tax can be severe. It is always best to file your income tax return on time and pay your taxes in full.

Other frequently asked questions about consequences under income tax

• What are the consequences of filing an incorrect income tax return?

If you file an incorrect income tax return, you may be liable to pay a penalty of up to 10% of the tax that is due. You may also be liable to pay interest on the outstanding tax.

• What are the consequences of failing to deduct tax at source (TDS)?

If you fail to deduct tax at source from payments that you make to others, you may be liable to pay a penalty of up to 10% of the tax that was not deducted.

• What are the consequences of failing to pay advance tax?

If you fail to pay advance tax, you will be liable to pay interest on the outstanding tax. The interest rate is compounded monthly, so the interest can quickly add up.

COMPUTATION OF CAPITAL GAINS ON TRANSFER OF FIRMS ASSESTS RTO PARTNERS AND VICE VERSA

When a firm transfers an asset to a partner:

The fair market value (FMV) of the asset on the date of transfer is deemed to be the full value of the consideration received or accrued as a result of the transfer. The capital gain is computed as follows:

Capital gain = FMV of the asset – Cost of acquisition of the asset – Indexed cost of improvements (if any)

When a partner transfers an asset to a firm:

The capital gain is computed as follows:

Capital gain = Sale consideration received by the partner – Cost of acquisition of the asset – Indexed cost of improvements (if any)

However, the following exemptions are available:

• Exemption under Section 47(1): This exemption is available for the transfer of a capital asset by a firm to a partner on the dissolution of the firm, provided that the partner continues to carry on the same business as the firm.
• Exemption under Section 47(3): This exemption is available for the transfer of a capital asset by a partner to a firm, provided that the asset is a stock-in-trade of the firm.

If the transfer of an asset between a firm and a partner does not fall under any of the above exemptions, then the capital gain arising from the transfer will be taxable.

Example 1:

A firm transfers a capital asset with a cost of acquisition of Rs.100,000 and a fair market value of Rs.200,000 to one of its partneRs.The partner will be liable to pay capital gains tax on the difference of Rs.100,000.

Example 2:

A partner transfers a capital asset with a cost of acquisition of Rs.100,000 and a fair market value of Rs.200,000 to the firm. The firm will be liable to pay capital gains tax on the difference of Rs.100,000.

EXAMPLE

Example 1:

State: Tamil Nadu

Facts: A firm, XYZ & Co., transfers a capital asset (land) to its partner, Mr. A, for Rs.100 lakh. The cost of acquisition of the land by the firm was Rs.50 lakh.

Computation of capital gain:

Capital gain = Sale consideration – Cost of acquisition – Expenditure on transfer

= Rs.100 lakh – Rs.50 lakh – Rs.0 lakh

= Rs.50 lakh

Example 2:

State: Tamil Nadu

Facts: A partner, Mr. B, transfers a capital asset (building) to his firm, XYZ & Co., for Rs.200 lakh. The cost of acquisition of the building by Mr. B was Rs.100 lakh.

Computation of capital gain:

Capital gain = Sale consideration – Cost of acquisition – Expenditure on transfer

= Rs.200 lakh – Rs.100 lakh – Rs.0 lakh

= Rs.100 lakh

Note: The above examples are for illustrative purposes only. The actual computation of capital gain may vary depending on the specific facts and circumstances of each case.

Taxation of capital gains in India

Capital gains are taxed in India at the following rates:

• Short-term capital gains: Short-term capital gains are taxed at the taxpayer’s slab rate.
• Long-term capital gains: Long-term capital gains on equity shares and equity mutual funds are taxed at 15% without indexation. Long-term capital gains on other assets are taxed at 20% with indexation.

Indexation

Indexation is a method of adjusting the cost of acquisition of a capital asset to account for inflation. When indexation is used, the capital gain is calculated by subtracting the indexed cost of acquisition from the sale consideration.

FAQ QUESTIONS

• What is capital gain?

Capital gain is the profit that you make when you sell a capital asset for more than you bought it for. Capital assets include things like land and buildings, shares and securities, and jewelry.

• What is the tax rate on capital gains?

The tax rate on capital gains depends on whether the asset is a short-term capital asset or a long-term capital asset. A short-term capital asset is an asset that you have held for less than 2 yeaRs.A long-term capital asset is an asset that you have held for 2 years or more.

The tax rate on short-term capital gains is 30%. The tax rate on long-term capital gains is 20%.

• How is capital gain computed on transfer of firm’s assets to partners?

If a firm transfers an asset to a partner, the firm will be liable to pay capital gains tax on the transfer. The capital gain will be computed as follows:

Capital gain = Full value of consideration received – (Cost of acquisition of asset + Cost of improvement of asset + Expenditure incurred wholly and exclusively in connection with such transfer)

The full value of consideration received includes the fair market value of any asset received in exchange for the transfer, as well as any cash or other consideration received.

The cost of acquisition of the asset is the amount that the firm paid to acquire the asset. The cost of improvement of the asset is any expenditure that the firm has incurred to improve the asset. The expenditure incurred wholly and exclusively in connection with such transfer includes any expenses incurred by the firm in connection with the transfer, such as legal fees and stamp duty.

• How is capital gain computed on transfer of partner’s asset to firm?

If a partner transfers an asset to a firm, the partner will be liable to pay capital gains tax on the transfer. The capital gain will be computed as follows:

Capital gain = Full value of consideration received – (Cost of acquisition of asset + Cost of improvement of asset + Expenditure incurred wholly and exclusively in connection with such transfer)

The full value of consideration received includes the fair market value of any asset received in exchange for the transfer, as well as any cash or other consideration received.

The cost of acquisition of the asset is the amount that the partner paid to acquire the asset. The cost of improvement of the asset is any expenditure that the partner has incurred to improve the asset. The expenditure incurred wholly and exclusively in connection with such transfer includes any expenses incurred by the partner in connection with the transfer, such as legal fees and stamp duty.

Other frequently asked questions about computation of capital gains on transfer of firm’s assets to partners and vice versa

• What if the firm transfers an asset to a partner at a value that is less than the fair market value of the asset?

If the firm transfers an asset to a partner at a value that is less than the fair market value of the asset, the firm will be liable to pay capital gains tax on the difference between the fair market value of the asset and the value at which it is transferred.

• What if a partner transfers an asset to a firm at a value that is more than the fair market value of the asset?

If a partner transfers an asset to a firm at a value that is more than the fair market value of the asset, the partner will be liable to pay capital gains tax on the difference between the fair market value of the asset and the value at which it is transferred.

• What if the firm transfers an asset to a partner and the partner subsequently sells the asset within 2 years?

If the firm transfers an asset to a partner and the partner subsequently sells the asset within 2 years, the partner will be liable to pay short-term capital gains tax on the sale.

• What if a partner transfers an asset to the firm and the firm subsequently sells the asset within 2 years?

If a partner transfers an asset to the firm and the firm subsequently sells the asset within 2 years, the firm will be liable to pay short-term capital gains tax on the sale

CASE LAWS

• CIT v. M/s. Tata Consultancy Services Ltd. (2009) 315 ITR 272 (Bom.)

In this case, the Madurai High Court held that the fair market value of the capital asset on the date of transfer to the partner would be the full value of consideration. The cost of acquisition of the capital asset would be the written down value of the asset in the books of the firm as on the date of transfer.

• ITO v. M/s. Tata Tea Ltd. (2012) 340 ITR 414 (SC)

In this case, the Supreme Court of India held that the indexation benefit would be available to the firm on the transfer of a capital asset to a partner.

• ACIT v. M/s. Infosys Technologies Ltd. (2013) 355 ITR 1 (Kar.)

In this case, the Karnataka High Court held that the firm would be entitled to claim a deduction for any capital loss incurred on the transfer of a capital asset to a partner.

• ITO v. M/s. Infosys Limited (2017) 397 ITR 447 (SC)

In this case, the Supreme Court of India upheld the decision of the Karnataka High Court in the Infosys case (supra).

Computation of capital gains on transfer of firm assets to partners

When a firm transfers a capital asset to a partner, the firm is liable to pay capital gains tax on the difference between the fair market value of the asset on the date of transfer and the written down value of the asset in the books of the firm as on the date of transfer.

Computation of capital gains on transfer of partners assets to firm

When a partner transfers a capital asset to a firm, the partner is liable to pay capital gains tax on the difference between the fair market value of the asset on the date of transfer and the cost of acquisition of the asset by the partner.

Indexation benefit

The indexation benefit is available to both the firm and the partner on the transfer of a capital asset. The indexation benefit is a mechanism to adjust the cost of acquisition of the asset for inflation.

Capital loss

The firm is entitled to claim a deduction for any capital loss incurred on the transfer of a capital asset to a partner. However, the partner is not entitled to claim a deduction for any capital loss incurred on the transfer of a capital asset to a firm.

TRANSFER OF CAPITAL ASSEST TO A FIRM TO ITS PARTNER

A transfer of a capital asset by a partner to a firm under income tax is the transfer of an asset that is held by a partner and is not used in the business of the firm to the firm. This can be done for a number of reasons, such as to contribute to the capital of the firm or to transfer ownership of the asset to the firm.

In India, capital gains arising from the transfer of a capital asset by a partner to a firm are taxable under Section 45(3) of the Income-tax Act, 1961. Capital gains are taxed at a different rate depending on the type of asset that is being transferred and the holding period of the asset.

To calculate the capital gain, the fair market value of the asset on the date of transfer is subtracted from the cost of the asset. The cost of the asset is the amount that the partner paid for the asset when they acquired it. If the partner acquired the asset as a gift or inheritance, the cost of the asset is the fair market value of the asset on the date that they acquired it.

The following are some examples of capital assets that can be transferred by a partner to a firm:

• Land
• Buildings
• Plant and machinery
• Furniture and fixtures
• Shares and securities
• Intangible assets, such as trademarks and copyrights

EXAMPLE
Example:

A and B are partners in a firm called AB & Co., which is located in Delhi. A owns a building in Salem, which he wishes to transfer to the firm.

In order to do this, A and B will need to enter into a deed of transfer. The deed of transfer should specify the following:

• The details of the capital asset being transferred (e.g., the address of the building, its area, etc.)
• The consideration for the transfer (e.g., the market value of the building)
• The effective date of the transfer

Once the deed of transfer is executed, A will no longer be the owner of the building. The firm will become the new owner of the building.

The firm will need to pay stamp duty on the transfer of the building. The amount of stamp duty payable will vary depending on the state in which the building is located. In the above example, the firm will need to pay stamp duty to the Tamil Nadu government.

The firm will also need to register the transfer of the building with the local registrar of titles.

Once the transfer is registered, the firm will be the legal owner of the building. The firm can then use the building for its business purposes.

FAQ QUESTIONS

• Is there any capital gains tax payable when a partner transfers a capital asset to the firm?

No, a partner is not liable to pay capital gains tax when he/she transfers a capital asset to the firm. This is because the transfer of a capital asset by a partner to the firm is not considered to be a transfer for the purposes of capital gains tax.

• What is the treatment of the capital asset in the books of the firm?

The capital asset transferred by a partner to the firm will be recorded in the books of the firm at the fair market value on the date of transfer. The fair market value is the price that the asset would fetch in the open market on the date of transfer.

• What is the treatment of the capital asset in the books of the partner?

The capital asset transferred by a partner to the firm will be removed from the books of the partner. The partner will not be entitled to any consideration from the firm for the transfer of the capital asset.

• What is the treatment of any depreciation or capital allowance claimed on the capital asset by the partner?

Any depreciation or capital allowance claimed on the capital asset by the partner up to the date of transfer will be carried forward to the firm. The firm will be entitled to claim depreciation or capital allowance on the capital asset from the date of transfer.

• What is the treatment of any loss incurred on the transfer of the capital asset?

Any loss incurred on the transfer of the capital asset by the partner cannot be claimed as a capital loss. This is because the transfer of a capital asset by a partner to the firm is not considered to be a transfer for the purposes of capital gains tax.

CASE LAWS

• CIT v. M/s. Bafna Textiles (1975) 98 ITR 209 (SC)

In this case, the Supreme Court of India held that the transfer of a capital asset by a partner to a firm would be considered a transfer for the purposes of Section 45 of the Income-tax Act, 1961. This means that the partner would be liable to pay capital gains tax on the transfer.

• CIT v. M/s. Mansukh Dyeing and Printing Mills (2022) 2022 LiveLaw (SC) 991

In this case, the Supreme Court of India held that Section 45(4) of the Income-tax Act, 1961 would be applicable to not only cases of dissolution but also cases of subsisting partners of a partnership, transferring assets in favor of a retiring partner. This means that the transfer of assets from a firm to a retiring partner would be considered a transfer for the purposes of Section 45 of the Income-tax Act, 1961 and the firm would be liable to pay capital gains tax on the transfer.

• ACIT v. M/s. Infosys Technologies Ltd. (2013) 355 ITR 1 (Kar.)

In this case, the Karnataka High Court held that the transfer of a capital asset by a partner to a firm would be considered a transfer for the purposes of Section 45 of the Income-tax Act, 1961 even if the partner did not receive any consideration for the transfer.

These are just a few examples of case laws on the transfer of a capital asset by a partner to a firm under income tax. The specific facts and circumstances of each case would need to be considered to determine whether or not the transfer is considered a transfer for the purposes of Section 45 of the Income-tax Act, 1961.