Mere change in ownership doesn’t convert a stock-in-trade into a capital asset

ITAT BANGALORE

C. Ramaiah Reddy v/s.  DCIT

IT Appeal No.122 (Bang.) of 2011

[Assessment year 2006-07]

MAY 25, 2012

ORDER

Jason P. Boaz, Accountant Member

This appeal by the assessee is directed against the order of the Commissioner of Income Tax (Appeals)-III, Bangalore dated 26.11.2010 for the Assessment Year 2006-07.

2. The facts of the case, in brief, are as under :

2.1 The assessee, in the real estate business, filed his return of income for Assessment Year 2006-07 on 20.11.2006 declaring income of Rs. 1,37,71,300. The Assessing Officer noted from the profit and loss account filed along with the return of income, that the assessee had shown purchase and sale of sites at Rs. 8,39,64,963 and Rs. 9,29,30,900 respectively and profit thereon of Rs. 1,13,18,182 which was declared as income from business. The Assessing Officer called for details of the cost of sites shown in the profit and loss account and the assessee submitted copy of the Memorandum of Family Agreement and Oral partition dated 6.3.2004, wherein the detailed list of assets and properties, which were received by the assessee consequent to his family agreement and partition are listed. It was submitted by the assessee that erstwhile joint family of the assessee was carrying on real estate business and the assets received were part of the stock-in-trade of the real estate business of the erstwhile joint family of the assessee and the value of properties adopted while making the family arrangement on 6.3.2004 have been adopted as cost and debited to the profit and loss account. The Assessing Officer was of the view that the lands sold by the assessee were treated as stock-in-trade in his books and as the same were sold in the relevant period, capital gains was attracted under section 45(2) of the Income Tax Act, 1961 (herein after referred as ‘the Act’), but no such capital gains was offered to tax. The Assessing Officer sought the assessee’s explanation as to why no capital gains was offered to tax in the return of income. The assessee submitted that there was no liability to capital gains. It was contended that the cost of the properties that were sold, was the amount fixed in the family agreement received by the assessee as the assessee had received the balance capital in real estate business of the erstwhile joint family, which comprised of the properties held as stock-in-trade by the family. Hence, the assessee submitted before the Assessing Officer, the income declared in the return of income under the head ‘business’ was justified. The Assessing Officer did not accept the contention of the assessee and held that once family partition had taken place and the assets were received by the assessee, the character of such assets in the hands of the assessee is only capital assets and the nature and character of the property in the hands of the erstwhile joint family is not material. The Assessing Officer observed that after partition, it was the choice of the assessee to either continue to hold the assets received as capital assets or convert them into stock-in-trade. In the instant case, since the assessee treated the lands received under family arrangement, which are capital assets, as stock-in-trade in his books and offered business income on sale of those lands, there was a conversion of capital assets into stock-in-trade. In other words, the Assessing Officer was of the view that the assessee had treated the lands received, which were stock-in-trade of the erstwhile family which immediately after partition became capital assets in the hands of the assessee, into stock-in-trade after partition when he started carrying on the business. Since such stock-in-trade was sold during the relevant period, there is a conversion of capital asset into stock-in-trade and capital gains under section 45(2) is attracted in this year a such stock-in-trade was sold. The value at which the lands were allotted in the family arrangement was admittedly the fair market value, which is to be treated as the sale consideration received on conversion and the original cost of the assets in the hands of the joint family is to be adopted as cost for the purpose computing capital gains under section 45(2) of the Act in terms of section 49(1) of the Act. The Assessing Officer accordingly computed the Long Term Capital Gains (LTCG) under section 45(2) of the Act amounting to Rs. 6,78,41,691 and completed the assessment by an order under section 143(3) of the Act on 31.12.2008.

2.2 Aggrieved the assessee, filed an appeal before the CIT(A). The learned CIT(A) concurred with the view of the Assessing Officer that tax at the LTCG under section 45(2) of the Act was in order. The learned CIT(A) was of the view that the assessee had received certain assets on partition, which had to be regarded as capital assets in the hands of the assessee on partition. He also held that the assessee had converted such capital assets into stock-in-trade, on his continuing to carry on the business allotted to him on partition. As the assets so converted were sold during the relevant period, capital gains would arise thereon. The learned CIT(A) also upheld the view of the Assessing Officer that the value at which the lands were introduced in the partition deed was the fair market value and the same had to be treated as sale consideration received by the assessee on conversion of capital assets into stock-in-trade.

3. Aggrieved the assessee is in appeal before the ITAT. The grounds of appeal raised in this appeal are as under :

” 1. The orders of the authorities below in so far as they are against the appellant, are opposed to law, equity, weight of evidence, probabilities, facts and circumstances of the case.

2. The authorities below are not justified in assessing Long Term Capital Gains of Rs. 6,78,41,691 by invoking the provisions of section 45(2) of the Act by erroneously holding that the stock in trade received by appellant on partition of the erstwhile joint family were capital assets and that they were converted into stock in trade after the partition and therefore the appellant was liable to be assessed under the head Capital Gains under section 45(2) of the Act under the facts and in the circumstances of the appellant’s case.

2.1 Without prejudice to the above, the Long term capital gain computed is highly excessive and is liable to be reduced substantially.

3. The learned CIT(A) is not justified in directing the ld. A.O to examine the claim of the appellant relating to the income from sale of property offered in the Assessment Year 2007-08 while considering the addition of Rs. 45,24,460 as short term capital gains instead of deleting the same straightway under the facts and in the circumstances of the appellant’s case.

4. Without prejudice to the right to seek waiver with the Hon’ble CCIT/DG, the appellant denies himself liable to be charged to interest under section 234B of the Act, which under the facts and in the circumstances of the appellant’s case and the levy deserves to be cancelled.

5. For the above and other grounds that may be urged at the time of hearing of the appeal, your appellant humbly prays that the appeal may be allowed and justice rendered and the appellant may be awarded costs in prosecuting the appeal and also order for the refund of the institution fees as part of the costs.”

4. The learned counsel for the assessee submitted that the main issue to be decided relates to grounds of appeal Nos.2 and 2.1. He submitted that grounds of appeal raised at S.No.3 has become infructuous as the learned CIT(A) had directed the Assessing Officer to examine the claim of the assessee while giving effect to his order and which has been done. The learned counsel for the assessee drew our attention to the Assessing Officer’s order dt.10.3.2011 giving effect to the CIT(A)’s order, which is at page 90 of paper book, and submitted that since the Assessing Officer has granted the assessee the relief it sought, this ground of appeal does not survive. In this view of the matter, the ground of appeal at S.No.3 is disposed off as infructuous.

5. On a perusal of the grounds of appeal, we find that grounds at S.No.1 and 5 are general in nature and do not call for any specific adjudication thereon.

6. The grounds of appeal raised at S.No.4 challenges the charging of interest under section 234B of the Act. The charging of interest under section 234B is consequential and mandatory. The Assessing Officer has no discretion in the matter and his action is in order. The Assessing Officer is, however, directed to recomputed the interest chargeable, if any, while giving effect to this order.

7.1 The only effective grounds of appeal to be considered by us in this appeal relate to Ground Nos.2 and 2.1.

7.2 The learned counsel for the assessee contended that the Assessing Officer has made three propositions to bring the transaction within the ambit of section 45(2) of the Act and for invoking section 49(1) of the Act. He submitted that the first proposition of the Assessing Officer is that the nature of assets held by the erstwhile joint family of the assessee is not relevant. The second proposition of the Assessing Officer is that the character of the assets received on a family partition is always a capital asset qua the recipient member. Thirdly, the Assessing Officer also held that the assessee had converted the capital assets received on partition into stock-in-trade. The learned counsel for the assessee submitted these findings of the Assessing Officer are erroneous as it cannot be held that assets received by the assessee on partition would always be in the nature of capital assets. The learned counsel for the assessee drew our attention to the Memorandum of Family Arrangement and Oral Partition dt.6.3.2004 at page 103 of the paper book. It was contended that the Assessing Officer was wrong in holding that there was a conversion of capital asset into stock-in-trade by the assessee when the fact of the matter was that the erstwhile joint family of the assessee was carrying on real estate business and all the assets sold were held as stock-in-trade of such erstwhile family. It was submitted that the entire business as a whole was valued by taking the fair market value of the assets and the assessee was allotted the balance of capital in real estate business after providing for the allotment to the other co-parceners and members of the erstwhile joint family. The learned counsel for the assessee placed reliance on the decision of the Hon’ble Apex Court in the case of Kalooram Govindram v. CIT, (MP) reported in 57 ITR 335 and the decision of the ITAT Mumbai ‘A’ Bench in the case of Atul G. Puranik v. ITO reported in 58 DTR (Mum) (Trib) 208 (2011). The learned counsel for the assessee finally contended that if at all there was any capital asset received by the assessee on partition, it would have to be considered that the business of real estate being carried on by the erstwhile joint family, was the capital asset received by the assessee. Since the business as a whole, being the capital asset, was not transferred by the assessee, but only the assets were sold, there was no justification to assessee capital gains by invoking the provisions of section 49(1) of the Act.

7.3 The learned Departmental Representative supported the orders of the Assessing Officer and the learned CIT(A). Referring to the provisions of section 49(1) of the Act, the learned Departmental Representative submitted that the original cost of assets received on partition must be considered while computing the capital gains under section 45(2) of the Act. It was submitted that the assessee received the assets, although stock-in-trade of the erstwhile joint family, upon partition and therefore they assume the character of capital assets in the hands of the assessee first and the assessee’s carrying on the same business amounts to converting such assets into stock-in-trade. The learned Authorised Representative contended that the assessee was carrying on real estate business and therefore the Assessing Officer had correctly accepted the business income declared by the assessee. However, since the assessee had not declared capital gains under section 45(2) of the Act on the conversion of capital assets into stock-in-trade, the Assessing Officer was correct in computing the capital gains thereon and adopting the cost in accordance with the provisions of section 49(1) of the Act. He also submitted that the value of properties at the time of partition was the fair market value and the same had to be adopted for computing capital gains under section 45(2) of the Act.

7.4 We have heard both parties and have perused and carefully considered the material on record. The issue before us relates to the assessment of LTCG in the hands of the assessee in accordance with the provisions of section 45(2) and 49(1) of the Act. In the order of assessment, the Assessing Officer held that the assessee had received certain assets on partition of the joint family, which include business and its stock-in-trade, which were to be regarded as capital assets in the hands of the assessee. The Assessing Officer then held that the assessee had converted the said capital assets into stock-in-trade, as he continued the real estate business and since the assessee sold the said assets in the relevant period, he was liable to tax for capital gains in accordance with the provisions of section 45(2) of the Act. The contention of the assessee is that this view of the Assessing Officer is based on presumptions as there has been no conversion of capital assets into stock-in-trade by the assessee and that all the assets received by the assessee on partition was the balance of the capital in the real estate business of the erstwhile joint family, which comprised several assets in the nature of stock-in-trade and therefore neither section 49(1) nor section 45(2) of the Act were attracted or applicable.

7.5 At the outset it is necessary to set out certain undisputed facts. Firstly the assessee in the instant case was a member of a Hindu Undivided Family (HUF) and there was a family partition on 6.3.2004. Secondly, it is also not in dispute that the family was carrying on real estate business and at the time of partition, the assets of the joint family including the stock-in-trade were valued at fair values and based on the same, allotment of properties were made. Thirdly, it is also not in dispute that the assessee is continuing to carry on the real estate business carried on by the erstwhile joint family and that the income from the sale of properties is to be assessed under the head ‘business income’. It is in this background of undisputed facts, that we have to see as to whether liability under section 45(2) of the Act is attracted or arises in the hands of the assessee, for the relevant period, by invoking the provisions of section 49(1) of the Act.

7.6 In order to resolve the said question it is necessary to consider whether the assets received by the assessee at the time of partition are capital assets or stock-in-trade. Both, the Assessing Officer and the learned CIT(A) have held that this aspect is not relevant. This is precisely because they proceeded on the assumption that every asset received on partition constitutes capital assets. Such a proposition is, however, incorrect. This is because of the nature of assets held by the joint family is certainly relevant and in fact the same is material to resolve and decide the dispute.

7.7 In order to ascertain the nature of assets held by the erstwhile joint family of the assessee, it is necessary to consider the background of the assessee and the issues arising in the assessee’s case in the earlier years. In the paper book furnished by the learned Departmental Representative, the orders of this Tribunal in the case of the assessee for the block period 1.4.1985 to 5.12.1995 in IT(SS)A No.10(Bang)/2008 dt.17.10.2008 is at pages 23 to 45 thereof. In para 15 of this order, it is held as under :

” A cursory perusal of the details would indicate that all the properties held by the assessee are ancestral properties and if any purchase is made, this also through sale of ancestral properties. The business of brick industry, development of lands/constructions are carried on by the assessee only by ploughing back the wealth he obtained from HUF nucleus. From the facts it is also well founded that there was no other income to the assessee from any other source, other than from HUF. The learned City Civil Judge also held that the properties mentioned in the schedule to the suit are joint family properties. We have, therefore, no hesitation in holding that the entire properties are only HUF properties including the value declared in the return filed inform No.28. The growth and expansion therefrom are directly emanating from HUF assets do not require further discussion as considered for assessment as individual, as agitated in other grounds.”

From the above decision of the Tribunal in the assessee’s own case, it is seen that the assessee in block assessment proceedings claimed that all the properties held by him and the income arising therefrom belong to the joint family (HUF) and not to him in his individual capacity. The Tribunal after consideration of the material placed before it, held that the entire properties held by the assessee belonged to his joint family, as the same were ancestral in character and any purchase and sale of property was only by ploughing back the wealth obtained from the HUF nucleus. The assessee in his individual capacity did not have income from any source. In fact, in the course of search proceedings, it was also stated by the assessee that he was doing real estate business and this aspect is clear from paras 7 to 11 of the order of the Tribunal in the assessee’s own case (supra). Thus, it can be clearly inferred and concluded from the findings of the Tribunal in the assessee’s own case for the block period that the joint family of the assessee was the owner of various properties, which have since come to the assessee’s share upon partition, the same being held by the joint family as business assets forming part and parcel of its real estate business.

7.8 This conclusion reached by us is further corroborated and fortified by the recitals in the Memorandum of family arrangement and oral partition dt.6.3.2004 (page 103 of assessee’s paper book), which is relied on by the Assessing Officer and learned CIT(A) in order to hold that the assets received by the assessee on partition were capital assets while computing the capital gains under section 45(2) of the Act. It is relevant to reproduce clause (2) of the Memorandum of Family Arrangement and Oral Partition which reads as under :

” 2. The FIRST PARTY thereafter wards effected an Oral Family Arrangement in which all the properties of the joint family as aforesaid, especially, the capital of the family in real estate business after making a fair and market value valuation of all the properties held as stock-in-trade of the real estate business have been partitioned by him orally and in the said partition, he allotted and provided a portion of the capital various members towards their rights or assorted or assumed rights in all the assets of the family to ward of all possible litigations and bickering among the members thereof in future.”

From a reading of the aforesaid clause (2), it becomes clear that all properties of the joint family, especially the capital of the family in the real estate business in the Memorandum dt.6.3.2004. It is only thereafter that the assessee was allotted the balance of the capital of the family in the real estate business in accordance with the terms and conditions of clause 3 of the Memorandum of Family Arrangement and Oral Partition which reads as under :

” 3. The FIRST PARTY has been allotted the balance of the capital of the family in real estate business being excess of assets over liabilities (after making revaluation of all the assets forming part of stock-in-trade of real estate business along with all other assets pertaining to the said business like cash in hand, bank balances, etc.) after allotting and providing a portion of such capital to parties No.2 to No.5 in the oral family arrangement and partition towards their respective shares to be owned and enjoyed by him in severality to the exclusion of parties No.2 to No.5 absolutely.”

7.9 We also find from a perusal of the terms and conditions of clauses 4 to 7 of the Memorandum of Family Arrangement and Oral Partition dt.6.3.2004 that the following persons were allotted substantial sums towards their share and rights in the assets of the erstwhile joint family. The allotment which was made from out of the family capital in real estate business that was allotted to the assessee or ‘First Party’ are as under :

A combined reading of the various clauses of the Memorandum of Family Arrangement and Oral Partition reveals that the assessee was allotted the balance of the capital of the family in real estate business after providing for the allotment to be made to the other four members of joint family as listed out above. It is also seen that this capital of the family in real estate business has been arrived at after making a fair market valuation of all the assets forming part of stock-in-trade of the real estate business of the erstwhile joint family. Therefore, it is clear that the cost of the assets allotted to the assessee is by making a market valuation at the time of partition based on which he assumed certain liabilities to be paid to other members of the erstwhile joint family.

7.10 From the facts and circumstances of the case on this issue, as discussed in the preceding paragraphs, 7.3 onwards and the clear wording of the Memorandum of Family Arrangement and Oral Partition, we are of the considered view that the assessee was allotted the family’s real estate business. In coming to this view, we are fortified by the decision of this Tribunal in the assessee’s own case for the block period, referred to earlier in this order. We, therefore, hold that the assessee, on partition of the joint family, had received the balance capital of the family in the real estate business comprising various assets, which were in the nature of stock-in-trade and it cannot be considered that the various assets or properties received by the assessee on partition are capital assets and these capital assets were converted into stock-in-trade of the real estate when the assessee continued to carry on the business of the erstwhile joint family. We also find, as rightly contended by the assessee, that if at all there was any capital asset received on partition, such a capital asset would be the real estate business carried on by the erstwhile family.

8. The Assessing Officer’s application of the provisions of section 45(2) of the Act to the instant case is to be examined. The provisions of section 45(2) of the Act are attracted only when there is a conversion of a capital asset into stock-in-trade. As already observed by us, there is no material on record to support the view taken by the Assessing Officer that the assessee received certain capital assets on partition of the joint family which were later converted to stock-in-trade by the assessee. A perusal of both the order of the Tribunal in the assessee’s case in the block assessment coupled with the Memorandum of Family Arrangements and Oral Partition dt.6.3.2004 clearly establishes that the erstwhile joint family of the assessee was carrying on real estate business and was holding several properties as stock-in-trade. These properties which were hitherto being held as stock-in-trade, were allotted to the assessee on partition. It is also evident that the assessee continued to carry on the said real estate business after the partition. In these circumstances, it is clear that, there is no conversion of capital assets to stock-in-trade either by the assessee or the joint family. In this view of the matter, we hold that the provision of section 45(2) of the Act are not applicable in the instant case and consequently the computation of capital gains made by the Assessing Officer is cancelled.

9. The learned Departmental Representative had advanced certain arguments with reference to the provisions of section 49(1) of the Act, to contend that the original cost of the assets has to be adopted as cost in the hands of the assessee which appear to be farfetched. Section 49(1) of the Act starts with the phrase. “when the capital asset becomes the property of the assessee …..” and therefore will be applicable only when the capital asset becomes the property of the assessee on distribution on the total or partial partition of the HUF. Section 49(1) of the Act will have no application in case the assets received on partition are not capital assets in the hands of the HUF, as in the instant case where they are stock-in-trade. We have already held that the view of the Assessing Officer, that the assets received by the assessee on partition were capital assets is not borne out by any material on record and therefore the provisions of section 49(1) of the Act are not applicable. In this regard, the reliance placed by the assessee on the decision of the Mumbai Bench of the Tribunal in the case of Atul G Puranik (supra) is relevant. At para 10.3 thereof, it is held as under :

” 10.3 However, in order to apply the mandate of s.49(1), it is sine qua non that the capital asset acquired by the assessee in any of the modes prescribed in cls.(i) to (iv) should become the subject matter of transfer and only in such a situation where such capital asset is subsequently transferred, the cost to the previous owner is deemed as the cost of acquisition of the asset. It is apparent from the language of sub-s. (1) itself which opens with the words “Where the capital asset became the property of the assessee” and after enumerating certain situations, provides that “the cost of acquisition of the asset shall be deemed to be the cost for which the previous owner of the property acquired it.” The phrase ‘the asset’ used in the later part of the provision relates to the capital asset which became the property of the assessee in the given circumstances. The natural corollary which, therefore, follows is that the cost to the previous owner is considered as the cost of acquisition only of the capital asset, which becomes the property of the assessee in the modes given in cls.(1) to (iv). But once such capital asset is transferred and another capital asset is acquired, there is no applicability of s.49(1) to such converted asset.”

10. Finally for consideration is whether the assessee was justified in adopting the cost of assets sold at the values fixed at the time of partition. In this connection, the Hon’ble Apex Court in the case of Kalooram Govindram (supra) thereof has observed as under :

” The entire argument is based on a misapprehension of the scope of partition under Hindu law. Coparcenary is a creature of Hindu law. The concept involves “community of interest, unity of possession and common enjoyment.” Each coparcener’s right extends to the whole joint family property; though each one of them has interest in the whole family property, he has no definite share therein. Partitioning is the ascertainment of individual shares and it can be brought about by an unambiguous declaration of their intention to divide, i.e. by a conscious alteration of their status. Such a declaration brings about a division in status. At that stage the members of an erstwhile joint family become tenants-in-common. The next step is the division by metes and bounds whereunder separate properties are allotted towards the said definite shares of the individuals. Whether the said process involves transfer or not within the meaning of the Transfer of Property Act, it certainly confers on a divided member an absolute title to a specified property, whereas before the partition he had only some interest in the entire joint family property. Though in one sense his interest in the property of the larger joint family has become crystallized into a specific property, in substance he acquires a title to a specific property. Even from a practical standpoint the legal fiction of “is prejudicial to the interests of Revenue-existing title” cannot be stretched too far. Take the following illustration : A and B were members of a joint Hindu family in 1930 and continued to be so till 1960, when a partition was effected between them. They had 4 houses in4 villages; and the original cost of each of the houses was Rs. 100. If a partition had taken place in 1930 or thereabout, each one of the two brothers would have got 2 houses each, and the partition would have been equitable and fair. But during these 30 years one village developed into a town and the value of the house therein had increased to Rs. 500. There was no appreciable rise in price in regard to the other 3 houses and they together would fetch only Rs. 500 in the market. In the result at the partition that was effected in 1960 the house in the town was given to one of the brothers and the other three houses together were given to the other brother. What would be the cost of the house in the town to the brother to whom it was allotted ? Clearly it would be Rs. 500, though the original cost of the house at the time it was built or purchased was only Rs. 100. Because of the uneven rise in prices of the different houses, instead of two houses he got only one house at the partition. The cost to him, therefore, would be the cost at which the property was valued at the partition or at which it was auctioned for the purpose of partition. Take another illustration : Instead of partitioning the properties by evaluation thereof, the houses were sold to a third party. So far as the third party was concerned the cost price would be the price at which he purchased them. If instead, the properties were sold by auction between the brothers and the difference in prices was adjusted by cash payment, it would be incongruous to say that in the former the cost of the houses would be the cost actually paid by the third party purchaser and in the latter the cost of the houses would not be the price for which they were auctioned but the nominal price they bore in a remote past. Other illustrations may be visualized. Barring the cases of fraud, collusion and inflation and deflation of values for ulterior purposes, cost of an asset to a divided member must necessarily be its cost to him at the time of partition, whether mentioned in the partition deed or ascertained aliunde.”

From the ratio of the judgment of the Hon’ble Apex Court cited above, it is clear that the value of the properties fixed at the time of partition or determined aliunde would be the cost to be adopted in the hands of the recipient of the properties. However, the specific provisions of section 49(1) of the Act have been enacted in the Income Tax Act, 1961, to fix the cost of the capital asset acquired on partition to be the cost at which it was acquired by the previous owner. In other words, the judgment of the Hon’ble Apex Court would not be applicable in a case of capital assets received on partition in the light of the provisions of section 49(1) of the Act. However, since the provisions of section 49(1) of the Act, does not apply to other assets, viz. stock-in-trade etc., the ratio of the judgment of the Hon’ble Apex Court would be applicable and it is the cost at which the assessee acquired the property in the partition that has to be taken. Therefore, the judgment of the Hon’ble Apex Court would be squarely applicable to the facts of the instant case and the assessee is justified in adopting the said cost for computing income from business.

11. In the result, the assessment of LTCG by invoking the provisions of section 45(2) of the Act is cancelled as there is no material or record to support the conclusions of the Assessing Officer and learned CIT(A) that the assessee received certain capital assets on partition which were converted into stock-in-trade by the assessee.

12. In the result, the assessee’s appeal is allowed.