No Long Term Capital Gain Exemption if Asset is Converted to Stock in Trade – ITAT Delhi

A cumulative reading of the aforesaid provisions, in our mind, makes it clear that as far as the benefit of Section 10(38) is concerned, the assessee shall not be eligible for this benefit at the first stage of charge ability of capital gains because the deemed sale is the point of conversion into stock-in-trade which had not suffered STT. Further, with regards to the second part of the transaction, the assessee is not eligible for benefit under Section 10(38) because the second part of the transaction is purely a business transaction and provisions of Section 10(38) are applicable only in terms of long term capital assets. In our view, these provisions should be read in this manner and there can be no confusion or two opinions about the scheme of the provisions of conversion of capital asset into stock-in-trade as also the liability towards the capital gains tax on sale of shares held as capital asset which has suffered STT. Nowhere on the date of actual sale, the assessee was holding the impugned securities as a part of capital asset. They have already become the stock-in-trade of the business. So, we do not agree with the assessee as regards the total exemption from capital gains tax in respect of the capital assets which were converted into stock-in-trade as on 1^st April, 2005 merely because on the date of sale such stock-in-trade the assessee was required to pay STT on them. We agree with the departmental stand in respect of this issue as we do not find any merit in such contentions of the assessee.

2. As the facts and the issues in these appeals are identical, we have heard them together and are now disposing the same by this common order.

3. The main issue in both these appeals relates to the action of the Assessing Officer in denying the benefit under Section 10(38) of the Income-tax Act, 1961 which has resulted in the addition to the total income of the assessee as a long term capital gain liable to assessment. We are discussing the facts in the case of Smt. Alka Agarwal in detail and dispose both the appeals.

4. Smt. Alka Agarwal is an individual and her status is non-resident.  In the words of the Assessing Officer :-

(i) The assessee has converted personal investment in shares into stock in trade of business on 1^st April, 2005.

(ii) There has been a transfer of shares as per Section 45(2) of the Income-tax Act, 1961.

(iii) The assessee has earned capital gains on such transfer/conversion into stock in trade.

(iv) The capital gains are long term capital gains.

5. The assessee has claimed the capital gains earned during the year as exempt from tax under Section 10(38) of the Act. The AO was of the opinion that the transfer has taken place when the assessee has converted personal investment into stock in trade of the business on 1st April, 2005. These shares were actually sold during the Financial Year 2005- 06 through a stock exchange and Securities Transaction Tax (STT) was paid at the time of actual sale of shares. On this basis, the assessee invoked the provisions of Section 10(38) to claim the benefit of exemption. According to the Assessing Officer, the transfer has taken place when the assessee converted personal investments in shares into stock in trade of the business. He has reproduced the provisions of Section 10(38) and concluded that conversion of shares investment of individual into stock in trade of business is a transaction. He quoted Circular No.397 dated 16.10.1984 and also the decision of the Calcutta Bench of the Tribunal in G.D. Aggarwala Vs. DCIT – 59 ITD 230 and concluded that the assessee is liable for tax on long term capital gains on the transfer of shares. The AO discussed the legislative intention being the introduction of securities transaction tax to support his stand. The assessee was unsuccessful before the learned CIT(A).

6. The grounds taken by the assessee before us are as under:-

“1. That the authorities below had erred on facts and under the law in denying benefit u/s 10(38) of I.T.Act though STT had admittedly been paid on the transaction of sale of shares. The appellant is entitled to benefit u/s 10(38) of the I.T.Act.

Various observations made by the authorities below with regard to the above issue in their respective orders are either incorrect or are untenable.

4. That the levy of interest u/s 234B was wholly illegal and at any rate, without prejudice, the same is excessive.

7. The learned counsel for the assessee submitted a paper book containing 108 pages wherein the stand taken before the learned CIT(A) as well as before the AO is explained in relation to the issues in dispute.

8. The learned counsel for the assessee reiterated the contentions that were taken by the assessee before the learned CIT(A) and argued before us on the same lines. He has also explained at length the provisions of Section 2(14), 2(47), 45(1), 45(2) and 10(38). The main argument of the assessee is that as long as there is no dispute that the assessee has converted shares purchased in the earlier years which were held as investment into stock in trade as on 1.4.2005 and out of such shares had sold some shares during the year under consideration itself through the recognised stock exchange on which Securities Transaction Tax (STT) had duly been paid, therefore, long term capital gain on sale of such shares was exempt from tax in terms of Section 10(38)(a) and 10(38)(b) read with Section 45(2) of the Act because all these provisions talk of only sale of shares. A specific reliance was placed on Circular No.791 dated 2.6.2000 which is annexed as Annexure-A in which also, CBDT had clarified that Section 45(2) of the Act postpones the assessment of such capital gains to the year in which the stock-in-trade is actually sold or otherwise transferred by the assessee. In other words, CBDT had clarified that the date of sale/transfer as per Section 45(2) is to be taken for invoking other provisions/sections of the Act. Such interpretation of the CBDT equally applies to the case of the assessee as STT had duly been paid on the date    of sale of shares which had earlier been converted from investment into stock-in-trade. In other words, Section 10(38), the learned counsel submitted could not ignored. Rather, the same has to be read along with Section 45(2) of the act. Therefore, it was argued that the long term capital gains on the impugned transaction was exempt from tax. It was also argued that even if it were to be taken as two views are possible on the interpretation of these provisions, then one which is in favour of the assessee must be adopted as held by the Honourable Supreme Court in the case of Union of India Vs. Onkar S.Kanwar – 258 ITR 761 and also the decision in the case of CIT Vs. Poddar Cement Pvt.Ltd. and Ors. – 226 ITR 625. The learned counsel for the assessee argued that without prejudice to this main contention, the authorities below had erred on facts and law in taxing the long term capital gains at the rate of 20%. According to the assessee, it is only taxable at the rate of 10%. In terms of Section 112(1)(c) read with the proviso of the Act, the long term capital gain in the case of Non-Resident Indian is taxable at 10% only.

9. The learned DR, on the other hand, pointed out that but for the purpose of provisions of section 45(2), the assessee would have been liable to capital gains the moment there was a conversion of such shares into stock in trade, on the date of conversion itself without any necessity of any actual sale. However, as sale has not taken place and assessee has not received money in real sense, the provisions of Section 45(2) come to her aid to mitigate the tax payment liability. According to the learned DR, Section 45(2) merely postpones the time of payment of capital gains tax. According to him, through the fiction of Section 45(2), the liability gets computed and remains frozen in the year of conversion and gets triggered in the year of actual sale. Section 45(2), according to him, merely envisages that capital gains liability which has accrued at the time of conversion gets postponed and this becomes operational in the year of sale of the stock so converted. So, in the present case, the computation of income will have two components. Part one will be for the capital gains which will be computed on the basis of fair market value on the date of conversion as a sale price as reduced by the original cost of acquisition. In the second part, the assessee will be liable for tax on that business profit or will be eligible for business loss depending upon the difference between the ultimate selling price and the price at which capital asset was converted into stock in trade. As far as benefit under Section 10(38) is concerned, the assessee shall not be eligible for this benefit at the first stage of charge ability of capital gains because the deemed sale at the point of conversion into stock did not suffer securities transaction tax. Further, with regard to the second part of the transaction, the assessee is not eligible for any benefit under Section 10(38) because the second part of the transaction is purely a business transaction and Section 10(38) is applicable only to long term capital assets. Considering the aforesaid facts, the assessee’s claim for capital gains not being chargeable to tax which, according to him, is clearly untenable in law, the learned DR vehemently argued in the light of the provisions in this regard as also the various Circulars issued by the CBDT explaining the amended provisions. He drew our attention to the discussions made in the assessment order with regard to these details.

10. We have carefully considered the rival contentions and gone through the records. The provisions of Section 10(38) read as under:-

“10. In computing the total income of a previous year of any person, any income falling within any of the following clauses shall not be included –

(38) any income arising from the transfer of a long-term capital asset, being an equity share in a company or a unit of an equity oriented fund where –

(a) the transaction of sale of such equity share or unit is entered into on or after the date on which Chapter VII of the Finance (No.2) Act, 2004 comes into force; and

(b) such transaction is chargeable to securities transaction tax under that Chapter:

[Provided that the income by way of long-term capital gain of a company shall be taken into account in computing the book profit and income-tax payable under section 115] B.]

Explanation. – For the purposes of this clause, “equity oriented fund” means a fund –

(i) where the investible funds are invested by way of equity shares in domestic companies to the extent of more than [sixty-five] per cent of the total proceeds of such fund; and

(ii) which has been set up under a scheme of a Mutual Fund specified under clause (23D) :

Provided that the percentage of equity shareholding of the fund shall be computed with reference to the annual average of the monthly averages of the opening and closing figures;].”

11. These provisions apply only to transfer of long term capital assets in the form of equity shares of a company or units specified therein. The Circular No. 5/2005 dated 15.7.2005 issued by the Board has explained the provisions of exemption of long term capital gain consequent upon the levy of securities transaction tax. It is clearly explained that the said provisions have been inserted providing for exemption from income from long term capital gains arising out of transfer of any equity share in the company, or unit of an equity oriented fund, where such transfer takes place on or after the specified date. The Board has explained the provisions of taxation consequent upon the levy of securities transaction tax in Circular No.5/2005 dated 15.7.2005 as under:-

“Consequent upon the levy of Securities Transaction Tax, the following amendments have been brought in the Income-tax Act.

(i) A new clause (38) has been inserted in section 10 providing for exemption for income from the long term capital gains arising out of transfer of an equity share in company, or unit of an equity oriented fund, where such transfer takes place on or after the date on which Chapter VII of the Finance (No.2) Act, 2004 comes into force and such transaction is chargeable to Securities Transaction Tax under the said Chapter.

(ii) A new section 111A has been inserted so as to provide that short term capital gains arising out of transfer of an equity share in a company, or unit of an equity oriented fund, where such transfer takes place on or after the date on which Chapter VII of the Finance (No.2) Act, 2004 comes into force and such transaction is chargeable to Securities Transaction Tax under the said Chapter, shall be charged at the rate of 10%.

(v) A new section 88E has been inserted providing that where the total income of the assessee in a previous year includes any income chargeable under the head “Profits and gains of business or profession” arising from transactions chargeable to securities transaction tax, he shall be allowed a deduction of an amount equal to the securities transaction tax paid by him in respect of transactions chargeable to securities transaction tax, entered into in the course of his business during that previous year, from the amount of income-tax on such income arising from such transactions.”

“2. In this Act, unless the context otherwise requires,-

(47) [transfer, in relation to a capital asset, includes,-

(iv) in a case where the asset is converted by the owner thereof into, or is treated by him as, stock-in-trade of a business carried on by him, such conversion or treatment;].”

14. The aforesaid provision makes it very clear that in relation to a capital asset, there is a transfer in case where the capital asset is converted into stock-in-trade of a business carried on by him. On conversion on 1.4.2005, therefore, there was a valid transfer under the Act. Now, the provisions of Section 45(1) & 45(2) read as under:-

“45. [(1)] Any profits or gains arising from the transfer of a capital asset effected in the previous year shall, save as otherwise provided in sections [***] [54, 54B, [***] [[54D, [54E, [54EA, 54EB,] 54F [54G and 54H]]]]], be chargeable to income-tax under the head “Capital gains”, and shall be deemed to be the income of the previous year in which the transfer took place.

[(2) Notwithstanding anything contained in sub-section (1), the profits or gains arising from the transfer by way of conversion by the owner of a capital asset into, or its treatment by him as stock-in-trade of a business carried on by him shall 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 and, for the purposes of section 48, 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 or accruing as a result of the transfer of the capital asset.].”

15. As per the aforesaid provisions, when once the assessee has converted a capital asset into stock-in-trade, the capital gain arising on such transaction of transfer shall be deemed to be the income of the previous year in which transfer took effect. That was the ordinary position where the capital gain would have been liable to tax in the AY 2005-06 itself. Now, the provisions of Section 45(2) make an exception to the generality of provisions of Section 45(1). Where it is a case of conversion of stock -in-trade, the profit arising on transfer by way of conversion shall be chargeable to income tax as its income in the previous year in which such stock-in-trade is actually sold or otherwise transferred by him and for the purpose of computation of capital gain, the fair market value of the asset on the date of such conversion or treatment shall be deemed to be the full value of consideration received or accruing as a result of such conversion, meaning thereby, the year of assessability of income to tax is postponed to date on which actual sale of this stock-in-trade takes place. There can be no confusion or a debate or two opinions as regards the aforesaid provisions.

16. A cumulative reading of the aforesaid provisions, in our mind, makes it clear that as far as the benefit of Section 10(38) is concerned, the assessee shall not be eligible for this benefit at the first stage of chargeability of capital gains because the deemed sale is the point of conversion into stock-in-trade which had not suffered STT. Further, with regards to the second part of the transaction, the assessee is not eligible for benefit under Section 10(38) because the second part of the transaction is purely a business transaction and provisions of Section 10(38) are applicable only in terms of long term capital assets. In our view, these provisions should be read in this manner and there can be no confusion or two opinions about the scheme of the provisions of conversion of capital asset into stock-in-trade as also the liability towards the capital gains tax on sale of shares held as capital asset which has suffered STT. Nowhere on the date of actual sale, the assessee was holding the impugned securities as a part of capital asset. They have already become the stock-in-trade of the business. So, we do not agree with the assessee as regards the total exemption from capital gains tax in respect of the capital assets which were converted into stock-in-trade as on 1^st April, 2005 merely because on the date of sale such stock-in-trade the assessee was required to pay STT on them. We agree with the departmental stand in respect of this issue as we do not find any merit in such contentions of the assessee.

17. Having held the main issue against the assessee, the alternative claim of the assessee is now examined. The provisions of Section 112(1)(c) read as under:-

“112. (1) Where the total income of an assessee includes any income, arising from the transfer of a long-term capital asset, which is charge able under the head “Capital gains”, the tax payable by the assessee on the total income shall be the aggregate of, –

[(c) in the case of a non-resident (not being a company) or a foreign company, –

(i) the amount of income-tax payable on the total income as reduced by the amount of such long-term capital gains, had the total income as so reduced been its total income; and

(ii) the amount of income-tax calculated on such long‑ term capital gains at the rate of twenty per cent;].”

18.   Now, the assessee has claimed that in terms of the following proviso, the tax should be levied at 10%:-

“112. (1) Where the total income of an assessee includes any income, arising from the transfer of a long-term capital asset, which is chargeable under the head “Capital gains”, the tax payable by the assessee on the total income shall be the aggregate of, –

(d) in any other case [of a resident], –

(i) the amount of income-tax payable on the total income as reduced by the amount of long-term capital gains, had the total income as so reduced been its total income; and

(ii) the amount of income-tax calculated on such long‑term capital gains at the rate of [twenty] per cent.