Conversion or treatment of a capital asset as stock-in-trade [Section 45(2)] under scope and year of chargeability [Section 45] :

A person who is the owner of a capital asset may convert the same or treat it as stock-in-trade of the business carried on by him. As noted above, the above transaction is a transfer. As per section 45(2), the profits or gains arising from the above conversion or treatment will be chargeable to income-tax as his income of the previous year in which such stock-in-trade is sold or otherwise transferred by him. In order to compute the capital gains, the fair market value of the asset on the date of such conversion or treatment shall be deemed to be the full value of the consideration received as a result of the transfer of the capital asset.

Illustration A is the owner of a car. On 1-4-2015, he starts a business of purchase and sale of motor cars. He treats the above car as part of the stock-in-trade of his new business. He sells the same on 31-3-2016 and gets a profit of ` 1 lakh. Discuss the tax implication. Solution Since car is a personal asset, conversion or treatment of the same as the stock-in-trade of his business will not be trapped by the provisions of section 45(2). Hence A is not liable to capital gains tax.

 

Illustration X converts his capital asset (acquired on June 10, 1988 for ` 60,000) into stock-in-trade in March 10, 2015. The fair market value on the date of the above conversion was  Rs 5,50,000. He subsequently sells the stock-in-trade so converted for Rs 6,00,000 on June 10, 2015. Discuss the tax implication. Solution Since the capital asset is converted into stock-in-trade during the previous year relevant to the A.Y. 2015-16, it will be a transfer under section 2(47) during the P.Y.2014-15. However, the profits or gains arising from the above conversion will be chargeable to tax during the A.Y. 2016-17, since the stock-in-trade has been sold only on June 10, 2015. For this purpose, the fair market value on the date of such conversion (i.e. 10th March, 2015) will be the full value of consideration. The capital gains will be computed after deducting the indexed cost of acquisition from the full value of consideration. The cost inflation index for 1988-89 i.e., the year of acquisition is 161 and the index for the year of transfer i.e., 2014-15 is 1024. The indexed cost of acquisition is 60,000 × 1024/161 = Rs 3,81,615. Hence, Rs 1,68,385 (i.e. Rs 5,50,000 – Rs 3,81,615) will be treated as long-term capital gains chargeable to tax during the A.Y.2016-17. During the same assessment year, Rs 50,000 (Rs 6,00,000 – RS 5,50,000) will be chargeable to tax as business profits.

 

Year of chargeability – Capital gains are chargeable as the income of the previous year in which the sale or transfer takes place. In other words, for determining the year of
chargeability, the relevant date of transfer is not the date of the agreement to sell, but the actual date of sale i.e., the date on which the effect of transfer of title to the property as contemplated by the parties has taken place [Alapati Venkatramiah v. CIT [1965] 57 ITR 185 (SC)]. Thus, in the case of any immovable property of the value exceeding ` 100, the title to the property cannot pass from the transferor to the transferee until and unless a deed of conveyance is executed and registered. Mere delivery of possession of the immovable property could not itself be treated as equivalent to conveyance of the immovable property. In the case of any movable property, the title to which would pass immediately on delivery of the property in accordance with the agreement to sell, the transfer will be complete on such delivery. However, as already noted, Income-tax Act, 1961 has recognised certain transactions as transfer in spite of the fact that conveyance deed might not have been executed and registered. Power of Attorney sales as explained above or co-operative society transactions for acquisition of house are examples in this regard.