Rationale behind introduction of Section 47A of Income Tax Act, 1961
Lacuna in the law that have been plugged by introduction of Section 47A & amendment of Section 47 of the act in order to nullify the following tax planning ,–
1) Before section 47A , there was a standard law that if a holding company transfers any capital assets to its 100% owned indian subsidiary company , then capital gains arises on such transfer shall be exempted from taxation us 47 & vice a versa when we read this clause from the view point that subsidiary transfer it’s capital assets to its indian holding company , then capital gains shall be exempted.
Lacuna 1 –
Now , X limited holds a land an capital assets which it wants to sold /or in other senses X limited wants to transfer the entire control on this land to Mr P , @ Sales Consideration of 100 Lacs . The cost of Acquisition is say Rs 1,00,000/-.
If X limited make a direct sales/transfer to Y limited , then this transfer shall be covered us 45 & Capital gains of Rs 99,00,000/- shall be attracted subject to indexation.
Now , X limited floats a indian company Y limited & acquired 100% shares of it @ Rs 10/-
Now , X limited transfer this land to Y limited & this transfer is exempted.
However , still Mr P couldn’t be able to get his control over land.
Now, X limited sold it’s entire holding of Y limited to Mr P @ Rs 9/-
Now , imagine the balance sheet of Y limited …
* Mr P is sole owner of company Y limited , purchase value of shares shall be Rs 9/- each
* He have full control over the land
* No capital gains in the hands of holding company when land is sold to Subsidiary company by virtue of Section 47
* Even X limited is now able to book the short term Capital Losses on sales of share of Y limited to Mr P
Hence , in order to nullify the planning Section 47A introduced & there it is mentioned that if the transferor fails to hold the entire holding of subsidiary company , then capital gains exempted shall be taxable in the hands of transferor company.
Hence , now when X limited transfer it’s holding to Mr P , then capital gains of Rs 99 Lacs shall be taxable in the hands of X limited. However , for Y limited , the cost of Acquisition shall now be dealt in accordance with section 49(4) rather than section 49(1) ie cost to the previous owner.
Hence , in the given case , cost of Acquisition shall be Rs 99,00,000/- in the hands of the subsidiary company.
Lacuna 2 –
After this lacuna had been plugged by the law makers , now , come to the rationale behind the introduction of Section 47A , clause with regard to conversion of capital assets into stock in trade by the transferee.
Say , A limited transfer the land which cost of acquisition is Rs 4,00,000/- to 100% owned indian subsidiary company B limited @ Rs 85,00,000/-
now subsidiary company B limited convert the Capital Assets into Stock in trade on the same date & FMV also be Rs 85,00,000/- & B limited sold this land after 2 years @ Rs 125 Lacs
Holding limited continue to hold the share of subsidiary company. Now , implications are
* capital gains shall be exempted in the hand of A limited by virtue of Section 45(2) to the tune of Rs 81,00,000/- (subject to indexation , if any )
* Section 45(2) is not attracted in the hands of the company B limited , since Section 45(2) attract only when the person who convert the capital assets into stock in trade & the person who is the actual owner of the assets both must be same.
In the given case , since A limited is the actual owner of the assets and the assets is converted by B limited & hence 45(2) is not applicable in this case.
* When this land is sold by B limited , what is actually sold ia the stock in trade and income shall be taxable us 28
* One may think that while computing the business income the cost of acquisition should be taken as per Section 49(1) ie cost to the previous owner.
Means cost of acquisition should be taken as Rs 4,00,000 as per Section 49(1)
But the interpretation is not as per law, since the income of the B limited shall be taxable under the hand business profession & Section 49(1) belongs to the chapter of PGBP.
Hence, in the given case, the cost of acquisition shall be Rs 85,00,000/- and business income shall be taken @ Rs 40,00,000/- (i.e.125 lacs – 85 lacs )
* Hence, First holding company is able to exempted it’s 81,00,000/- capital gains
* & For subsidiary company only 40 lacs is subject to taxes under Section 28
* Means an assets which is purchased @ Rs 4,00,000/- sold to Rs 125 Lacs means 121 Lacs should be subject to taxation but as per this planning only 40 Lacs is covered under Taxation.
* Means complete avoidance of tax of Rs 81 Lacs .
↔️ Hence, to nullify this planning , amendment had been carried in Section 47A & the capital gains which were exempted by virtue of the Section 47 ie 81 lacs is now be taxable in the hands of holding company in the year in which such transfer tools place.
Lacuna 3 –
A limited now float a 100% owned company B limited whose primary business is development of real estate properties.
* Now, when this land is sold to B limited , entire capital gains of A limited is exempted.
* Section 47A not attracted since B limited received the land as a stock in trade
* Income shall be taxable under the head PGBP, and hence cost of acquisition us 49(1) shall not be applicable while calculating income to be taxable in the hands of chapter of PGBP.
Hence , again there is complete avoidance of capital gains as mentioned in Lacuna 3
Now , proviso to Section 47 have been introduced & it will be read as that their is no exemption when the holding company transfers a capital assets to its 100% owned indian subsidiary company or Vice a Versa us 47.
Hence entire 81 Lacs shall now be taxable at the first instance .
On the similar note , 43C have been introduced for amalgamation..
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For the benefits of reader a short glimpse of provisions is presented in my personal language as per my capabilities. It shall not to be used for any legal advice /opinion and shall not to be used to rendering any professional opinion. Readers are advised to kindly go through to original government publications and published case laws and judicial pronouncements. Errors may creep in and hence it will be highly appreciable to highlight such errors or providing suggestions for effective improvements.