Ascertainment of Cost in Specified Circumstances for Capital Gain [Section 49] :
A person becomes the owner of a capital asset not only by purchase but also by several other methods. Section 49 gives guidelines as to how to compute the cost under different circumstances.
(1) In the following cases, the cost of acquisition of the asset shall be deemed to be cost for which the previous owner of the property acquired it. To this cost, the cost of improvement to the asset incurred by the previous owner or the assessee must be added:
Where the capital asset became the property of the assessee:
(i) on any distribution of assets on the total or partition of a HUF;
(ii) under a gift or will;
(iii) by succession, inheritance or devaluation;
(iv) on any distribution of assets on the liquidation of a company;
(v) under a transfer to revocable or an irrevocable trust;
(vi) under any transfer by a holding company to its 100% subsidiary Indian company or by as ubsidiary company to its 100% holding Indian company, referred to in section 47(iv) and 47(v), respectively,
(vii) under any transfer referred to in section 47(vi) in a scheme of amalgamation, by the amalgamating company to the amalgamated Indian company;
(viii) by transfer referred to in section 47(via) of shares held in an Indian company in a scheme of amalgamation, by the amalgamating foreign company to the amalgamated foreign company;
(ix) by transfer referred to in section 47(viaa) of a capital asset by a banking company to a banking institution, in a scheme of amalgamation of the banking company with the banking institution;
(x) by transfer of a capital asset, being a share of a foreign company, which derives directly or indirectly its value substantially from the share of shares of an Indian company, held by the amalgamating foreign company to the amalgamated foreign company, in the scheme of amalgamation referred to under section 47(viab)
(xi) by transfer of a capital asset in the scheme of demerger referred to in under section 47(vib), by the demerged company to the resulting company where the resulting company is an Indian company
(xii) by any transfer of a capital asset in a business reorganization under section 47(vica), by the predecessor co-operative bank to the successor co-operative bank;
(xiii) by any transfer by a shareholder in a business reorganisation, referred to under section 47(vicb), of a capital asset being a share or shares held by him in the predecessor cooperative bank, if the transfer is made in consideration of the allotment to him of any share or shares in the successor co-operative bank;
(xiv) by transfer in the scheme of demerger referred under section 47(vicc), of a capital asset, being a share in a foreign company, which derives, directly or indirectly, its value substantially from the share or shares of an Indian company, held by the demerged foreign company to the resulting foreign company.
(xv) any transfer under section 47(xiiib) of a capital asset or intangible asset by a private company or unlisted public company to a LLP or any transfer of a share or shares held in the company by a shareholder as a result of conversion of the company into an LLP;
(xvi) on succession of a firm or sole proprietorship concern by a company in a business carried on by it, fulfilling the conditions mentioned in section 47(xiii) and section 47(xiv), respectively;
(xvii)by conversion by an individual of his separate property into a HUF property, by the mode referred to in section 64(2).
The cost of acquisition of the asset is the cost for which the previous owner acquired the asset as increased by the cost of any improvement of the assets incurred or borne by the previous owner or the assessee, as the case may be. Accordingly, section 2(42A) provides that in all such cases, for determining the period for which the capital asset is held by the transferee, the period of holding of the asset by the previous owner shall also be considered.
| Note: The issue as to whether indexation benefit in respect of a gifted asset shall apply from the year in which the asset was first held by the assessee or from the year in which the same was first acquired by the previous owner was taken up by the Bombay High Court in CIT v. Manjula J. Shah 16 Taxman 42 (Bom.).
As per Explanation 1 to section 2(42A), in case the capital asset becomes the property of the assessee in the circumstances mentioned in section 49(1), inter alia, by way of gift by the previous owner, then for determining the nature of the capital asset, the aggregate period for which the capital asset is held by the assessee and the previous owner shall be considered. As per the provisions of section 48, the profit and gains arising on transfer of a long-term capital asset shall be computed by reducing the indexed cost of acquisition from the net sale consideration. The indexed cost of acquisition means the amount which bears to the cost of acquisition the same proportion as Cost Inflation Index (CII) for the year in which the asset is transferred bears to the CII for the year in which the asset was first held by the assessee transferring it i.e., the year in which the asset was gifted to the assessee in case of transfer by the previous owner by way of gift. In the present case, the assessee had acquired a capital asset by way of gift from the previous owner. The said asset when transferred was a long-term capital asset considering the period of holding by the assessee as well as the previous owner. The assessee computed the long-term capital gain considering the CII of the year in which the asset was first held by the previous owner. The Assessing Officer raised an objection mentioning that as per meaning assigned to the Indexed cost of acquisition, the CII of the year in which the asset is first held by the assessee need to be considered and not the CII of the year in which the asset was first held by the previous owner. In the present case, the Bombay High Court held that by way of ‘deemed holding period fiction’ created by the statute, the assessee is deemed to have held the capital asset from the year the asset was held by the previous owner and accordingly the asset is a long term capital asset in the hands of the assessee. Therefore, for determining the indexed cost of acquisition under section 48, the assessee must be treated to have held the asset from the year the asset was first held by the previous owner and accordingly the CII for the year the asset was first held by the previous owner would be considered for determining the indexed cost of acquisition. Hence, the Bombay High Court held that the indexed cost of acquisition in case of gifted asset has to be computed with reference to the year in which the previous owner first held the asset and not the year in which the assessee became the owner of the asset. As per the plain reading of the provisions of section 48, however, the indexed cost of acquisition would be determined by taking CII for the year in which in which asset is first held by the assessee. |
Illustration
Neerja was carrying on the textile business under a proprietorship concern, Neerja Textiles. On 21.07.2015 the business of Neerja Textiles was succeeded by New Look Textile Private Limited and all the assets and liabilities of Neerja Textiles on that date became the assets and liabilities of New Look Textile Private Limited and Neerja was given 52% share in the share capital of the company. No other consideration was given to Neerja on account of this succession. The assets and liabilities of Neerja Textiles transferred to the company included an urban land which was acquired by Neerja on 19.7.2011 for Rs 9,80,000. The company sold the same on 30.03.2016 for Rs 15,00,000.
Discuss the tax implication of the above mentioned transaction and compute the income chargeable to tax in such case(s).
Answer
Taxability in case of succession of Neerja Textiles by New Look Textile Private Limited
As per provisions of section 47(xiv), in case a proprietorship concern is succeeded by a company in the business carried by it and as a result of which any capital asset is transferred to the company, then the same shall not be treated as transfer and will not be chargeable to capital gain tax in case the following conditions are satisfied:
(1) all the assets and liabilities of sole proprietory concern becomes the assets and liabilities of the company.
(2) the shareholding of the sole proprietor in the company is not less than 50% of the total voting power of the company and continues to so remain as such for a period of 5 years from the date of succession.
(3) the sole proprietor does not receive any consideration or benefit in any form from the company other than by way of allotment of shares in the company.
In the present case, all the conditions mentioned above are satisfied therefore, the transfer of capital asset by Neerja Textiles to New Look Textiles Private Limited shall not attract capital gain tax provided Neerja continues to hold 50% or more of voting power of New Look Textiles Private Limited for a minimum period of 5 years.
Taxability in case of transfer of land by New Look Textiles Private Limited
As per the provisions of section 49(1) and Explanation 1 to section 2(42A), in case a capital asset is transferred in the circumstances mentioned in section 47(xiv), the cost of the asset in the hands of the company shall be the cost of the asset in the hands of the sole proprietor. Consequently, for the determining the period of holding of the asset, the period for which the asset is held by the sole proprietor shall also be considered.
Therefore, in the present case, the urban land shall be a long-term capital asset since it is held for more than 36 months by New Look Textile Private Limited and Neerja Textiles taken together. Cost of acquisition of land in the hands of the company shall be Rs 9,80,000 i.e., the purchase cost of the land in the hands of Neerja.
Computation of capital gain chargeable to tax in the hands of New Look Textile Private Ltd.
| Particulars | Rs |
| Net Sale Consideration | 15,00,000 |
| Less: Indexed cost of acquisition 9,80,000× 1081/1081 (Refer Note below) | 9,80,000 |
| Long-term capital gain | 5,20,000 |
Note: The year of transfer and the year in which the company first held the asset are the same in this case, which is the reason why the numerator and the denominator for calculating the indexed cost of acquisition would remain the same. Therefore, in effect, there is no benefit of indexation in this case. However, as per the view expressed by Bombay High Court in CIT v. Manjula J. Shah 16 Taxman 42, in case the cost of acquisition of the capital asset in the hands of the assessee is taken to be cost of such asset in the hands of the previous owner, the indexation benefit would be available from the year in which the capital asset is acquired by the previous owner. If this view is considered, the indexed cost of acquisition would have to be calculated by taking the CII of F.Y.2011-12, being the year in which the capital asset was acquired by the previous owner, Neerja, as the denominator, in which case, the capital gains chargeable to tax would undergo a change. The long-term capital gains in such a case would be Rs 1,50,471 (Rs 15, 00,000 – Rs 13,49,529).
(2) Where shares in an amalgamated company which is an Indian company become the property of the assessee in consideration of the transfer of shares held by him in the amalgamating company under a scheme of amalgamation, the cost of acquisition to him of the shares in the amalgamated company shall be taken as the cost of acquisition of the shares in the amalgamating company [Section 49(2)].
This also applies in relation to business reorganization of a co-operative bank as referred to in section 44DB. The cost of acquisition of shares in the amalgamated co-operative bank, which became the property of the assessee by virtue of a transfer as a result of business reorganisation shall be the cost of acquisition to him of the shares in the amalgamating cooperative bank.
(3) It is possible that a person might have become the owner of shares or debentures in a company during the process of conversion of bonds or debentures, debenture stock or deposit certificates. In such a case, the cost of acquisition to the person shall be deemed to be that part of the cost of debentures, debenture stock, bond or deposit certificate in relation to which such asset is acquired by that person [Section 49(2A)].
(4) Where the capital gain arises from the transfer of specified security or sweat equity shares referred to in section 17(2)(vi), the cost of acquisition of such security or shares shall be the fair market value which has been taken into account for perquisite valuation [Section 49(2AA)].
(5) If a shareholder of a company receives rights in a partnership firm as consideration for transfer of shares on conversion of a company into a LLP, then the cost of acquisition of the capital asset being rights of a partner referred to in section 42 of the LLP Act, 2008 shall be deemed to be the cost of acquisition to him of the shares in the predecessor company, immediately before its conversion [Section 49(2AAA)].
(6) Where the capital gain arises from the transfer of specified security or sweat equity shares, the cost of acquisition of such security or shares shall be the fair market value which has been taken into account while computing the value of fringe benefits under clause (ba) of sub-section (1) of section 115WC [Section 49(2AB)].
The value of fringe benefits would be the fair market value of the specified security or sweat equity shares on the date on which the option vests with employee as reduced by the amount actually paid by, or recovered from the employee in respect of such security or shares. Fair market value means the value determined in accordance with the method prescribed by the CBDT. This fair market value would be taken as the cost of acquisition of the specified security or sweat equity shares. It may be noted that the amount recovered from the employee is not to be deducted for determining the cost of acquisition.
Note – It may be noted that fringe benefit tax is not applicable from A.Y.2010-11 and therefore, the fair market value of the specified securities and sweat equity shares would be taxed as a perquisite in the hands of the employees w.e.f. A.Y.2010-11. Therefore, if specified securities or sweat equity shares have been subject to FBT in the hands of the employer upto A.Y.2009-10, the provisions of section 49(2AB) would apply for determination of the cost of acquisition at the time of transfer. However, if the specified securities or sweat equity shares have been taxed as a perquisite in the hands of the employees w.e.f. A.Y.2010- 11, the provisions of section 49(2AA) would apply for determination of the cost of acquisition at the time of transfer of such securities/shares by the employee.
(7) The cost of acquisition of the capital asset, being share or shares of a company acquired by a non-resident assessee, consequent to redemption of GDRs [referred to in section 115AC(1)(b)] held by him would be the price of such share or shares prevailing on any recognized stock exchange on the date on which a request for such redemption was made. [Section 49(2ABB)]
(8) The cost of acquisition of the units acquired by the assessee in consolidated scheme of mutual fund in consideration of transfer referred in section 47(xviii) shall be deemed to be the cost of acquisition to him of the units in the consolidating scheme of mutual fund [Section 49(2AD)].
(9) In the case of a demerger, the cost of acquisition of the shares in the resulting company shall be the amount which bears to the cost of acquisition of shares held by the assessee in the demerged company the same proportion as the net book value of the assets transferred in a demerger bears to the net worth of the demerged company immediately before such demerger [Section 49(2C)].
This also applies in relation to business reorganization of a co-operative bank as referred to in section 44DB. The cost of acquisition of the shares in the resulting co-operative bank shall be the amount which bears to the cost of acquisition of shares held by the assessee in the demerged co-operative bank, the same proportion as the net book value of the assets transferred in a demerger bears to the net worth of the demerged co-operative bank immediately before demerger i.e.,
Cost of acquisition of shares in the resulting co-operative bank = A * B/C
A = Cost of acquisition of shares held in the demerged co-operative bank
B = Net book value of the assets transferred in a demerger
C = Net worth of the demerged co-operative bank i.e. the aggregate of the paid up share capital and general reserves as appearing in the books of account of the demerged company immediately before the demerger.
(10) Further, the cost of acquisition of the original shares held by the shareholder in the demerged company shall be deemed to have been reduced by the amount as so arrived under the sub-section (2C) [Section 49(2D)].
This also applies in relation to business reorganization of a co-operative bank as referred to in section 44DB. The cost of acquisition of the original shares held by the shareholder in the demerged co-operative bank shall be deemed to have been reduced by the amount so arrived at in (6) above.
For the above purpose, “net worth” means the aggregate of the paid up share capital and general reserves as appearing in the books of account of the demerged company immediately before the demerger.
Normally speaking, capital gains must be computed after deducting from the sale price the cost of acquisition to the assessee. The various provisions mentioned above form an exception to this general principle.
(11) Where the capital gain arises from the transfer of such property which has been subject to tax under section 56(2)(vii) or section 56(2)(viia), the cost of acquisition of the property shall be deemed to be the value taken into account for the purposes of section 56(2)(vii)/(viia). [For illustration, see Chapter 8 “Income from Other Sources” under section 56(2)(vii)]