CA Sandeep Kanoi

BACKGROUND

M/s. Shri Kanabar Industries (herinafter referred to as ‘SKI’) is a partnership concern from Mumbai. SKI owns an Industrial Gala. SKI carried on the business of manufacturing Cartoon material in this Gala but later, the partners ceased to conduct business in SKI. No business activity has been carried out by SKI in last 8 years. As on 31.03.2013, Written Down Value of Gala was Rs. 1,27,830/- and that of the furniture at the Gala was Rs. 2,010/-

The partners of SKI have now decided to sell the aforesaid Gala for Rs. 96,00,000/-. They would like to know the tax implication of such transfer on SKI and the ways by which they can legitimately minimize the tax burden.

FACTS OF THE CASE

1. SKI acquired the Gala in 1980 vide Assignment Deed dated 13.10.1980.

2. SKI has acquired and used the said Gala in its business of manufacturing Cartoon material.

3. SKI has discontinued business activity for a period exceeding three years.

4. SKI wishes to sell the Gala for Rs. 96,00,000/- and wants to Register a Sell Agreement for the same on or before 31st March 2014.

OUR ANALYSIS

1. What will be the tax implications if SKI sells the property for Rs. 96,00,000/-?

Section 50 of the Income Tax Act, 1961 Act lays down provision for computation of capital gains in case of depreciable assets. It provides that if the capital asset is an asset forming part of a block of assets in respect of which depreciation has been allowed under this Act, the capital gain will be worked out as follows :-

(1) where the full value of the consideration received or accruing as a result of the transfer of the asset together with the full value of such consideration received or accruing as a result of the transfer of any other capital asset falling within the block of the assets during the previous year, exceeds the aggregate of the following amounts, namely :—

   (i)  expenditure incurred wholly and exclusively in connection with such transfer or transfers;

  (ii)  the written down value of the block of assets at the beginning of the previous year; and

(iii)  the actual cost of any asset falling within the block of assets acquired during the previous year,

such excess shall be deemed to be the capital gains arising from the transfer of short-term capital assets;

(2) where any block of assets ceases to exist as such, for the reason that all the assets in that block are transferred during the previous year, the cost of acquisition of the block of assets shall be the written down value of the block of assets at the beginning of the previous year, as increased by the actual cost of any asset falling within that block of assets, acquired by the assessee during the previous year and the income received or accruing as a result of such transfer or transfers shall be deemed to be the capital gains arising from the transfer of short-term capital assets.

In our case, we have two blocks of Fixed Assets:

1.) Building Rs. 1,27,830/-

2.) Furniture Rs. 2,010/-.

After the sale of Gala with its Furniture, both the blocks will cease to exist, so we will compute the Short Term Capital Gain on such sale as follows :-

PARTICULARS

RUPEES

           Sales Value of Gala  with Furniture

96,00,000

Less: Written Down Value of:

Gala                                       1,27,830

Furniture                                    2,010

-1,29,840

Less: Cost of Transfer if Any*

-25,000

               Short Term Capital Gain

94,45,160

               Tax on above @ 30.90%

29,18,554

*Cost of Transfer been assumed at Rs. 25000/-.

From the above calculation, we arrive at the tax liability of Rs. 29,18,554/-, which is to be paid on or before 31st March 2014, otherwise it shall attract interest penalty.

2. Is there a legitimate way by which SKI can minimize its tax liabilities due to aforesaid sales?

One of the option by which SKI can save tax on the aforesaid capital gain is by investing the capital gain amount in bonds specified under Section 54EC of the Income Tax Act, 1961. While considering the benefit of section 54EC exemption, the following question may arise:-

a. Whether exemption u/s 54EC is available when investment of Rs. 50,00,000/- each has been made in two financial years, but within 6 months from the date of transfer?

b. Whether exemption under section 54 is available for depreciable assets held for more than 36 months?

c. From which date the period of six months will be counted?

Before answering the above questions, we will discuss the provisions of Section 54EC of the Income Tax Act, 1961.

Section 54EC reads as follows:

“Capital gain not to be charged on investment in certain bonds”:

(1) Where the capital gain arises from the transfer of a long-term capital asset (the capital asset so transferred being hereafter in this section referred to as the original asset) and the assessee has, at any time within a period of six months after the date of such transfer, invested the whole or any part of capital gains in the long-term specified asset, the capital gain shall be dealt with in accordance with the following provisions of this section, that is to say –

(a) if the cost of the long-term specified asset is not less than the capital gain arising from the transfer of the original asset, the whole of such capital gain shall not be charged under section 45;

(b) if the cost of the long-term specified asset is less than the capital gain arising from the transfer of the original asset, so much of the capital gain as bears to the whole of the capital gain the same proportion as the cost of acquisition of the long-term specified asset bears to the whole of the capital gain, shall not be charged under section 45:

The proviso to section 54EC(1) reads as follows:

“Provided that the investment made on or after the 1st day of April, 2007 in the long-term specified asset by an assessee during any financial year does not exceed Rs. 50,00,000/-.”

Points to consider while claiming exemption under section 54EC:

  1. Exemption is available only against long term capital gain.
  2. Assessee has to invest the gain amount in the bonds specified U/s. 54EC within six months from the date of the transfer of asset.
  3. Exemption will be restricted to the amount of investment, so to claim 100% exemption from capital gain tax, the assessee has to invest equal to or more than the gain amount in bonds specified U/s. 54EC.
  4. Investment in one financial year in the bonds specified U/s. 54EC cannot exceed Rs. 50,00,000/-.
  5. Investments in bonds specified under section 54EC have a lock in period of three years.
  6. In case the assessee transfers the bonds before 3 years, the gain on transfer of asset sold will be taxed in the year of transfer.
  7. For the purpose of taxation, even if assessee takes a loan against such bonds, it will be treated as conversion of bond in money and the gain on transfer of assets sold will be taxed in the year of such conversion.
  8. No deduction other than exemption under section 54EC will be allowed on such investment.
  9. Specified Bonds includes bonds issued by NHAI, REC and by such authorities as CBDT may notify in this regard.

a. Whether exemption u/s 54EC is available when investment of Rs.50,00,000/- each has been made in two financial years, but within six months from the date of transfer?

The language of proviso makes it clear that the maximum limit for investment in specified asset is Rs. 50,00,000/- for a financial year only. Strictly following the words of the proviso, one can invest upto Rs 50,00,000/- in the current year and another sum of Rs. 50,00,000/- in the next financial year, but within 6 months from the date of transfer. Therefore, one can be entitled to deduction of Rs. 1,00,00,000/- u/s 54EC.

On the other hand, this contention is often contested by the departmental authorities on the grounds that Section 54EC stipulates the quantum of Rs.50,00,000/- for the sale of a particular asset in a particular assessment year, thereby confining the section to a particular transaction. The departmental authorities may further argue that one cannot manipulate the words “any financial year” of the section to their own advantage by construing them to mean that investment can be made in different financial periods but before the expiry of six months from the date of transfer.

In this regard, there have been various judicial pronouncements both for and against the assessee. The significant rulings by various courts are discussed below.

1.   INCOME TAX OFFICER vs. MS. RANIA FALEIRO ITAT PANAJI BENCH

In this case, it was held that for claiming deduction u/s 54EC, the assessee can make the investment in two different financial years, provided, in a financial year, the investment made did not exceed Rs.50,00,000. Apart from that, the limit of Rs. 50,00,000/- as given under the proviso is per person per financial year.

Mainly, this case ruled that the ceiling limit of investment of Rs. 50,00,000/- is to be applied year-wise and not transaction-wise. It held, the words used in the proviso mention ‘any’ and not ‘relevant financial year’; this implies that such a limit of Rs. 50,00,000/- is for each financial year. Thus, ceiling mentioned in proviso to Section 54EC(1) is applicable for investment made in one financial year only.

2.   ASPI GINWALA & ORS. vs. ASSISTANT COMMISSIONER OF INCOME TAX & ORS,ITAT AHMEDABAD 

In this case, the assessee transfers his capital asset after 30th September of the financial year, so he gets an opportunity to make an investment of Rs. 50,00,000/- each in two different financial years and is able to claim exemption up to Rs.1,00,00,000/-. It was held as per proviso to section 54EC that the assessee is entitled for exemption of Rs. 1,00,00,000/- as six months’ period for investment in eligible investments involved is two financial years.

3.   INCOME TAX OFFICER vs. MRS. CHETANA H. TRIVEDI ITAT MUMBAI, [IT APPEAL NO. 5037(MUM.) OF 2010]

The court ruled in favour of the assessee and concluded that Section 54EC does not stipulate assessment year in which investment is to be made but only lays down a condition of 6 months period of time after the date of transfer of the capital asset. Thus, it was open to the assessee to interpret wordings of Section 54EC liberally and in case of doubt, the benefit of exemption should be granted to the assessee. Accordingly, the appeal of the revenue was dismissed.

4. SMT. SRIRAM INDUBAL vs. ITO (Chennai ITAT) [IT APPEAL NO. 1950 (MDS.) OF 2012]

The Tribunal, in this case, said that “If the assessee is able to keep the six months’ limit from the date of transfer of capital asset, but, still able to place the investment of Rs. 50,00,000/- each in two different financial years, we cannot say that the restrictive proviso will limit the claim to Rs. 50,00,000/- only”. Since the assessee here had placed Rs. 50,00,000/- in two different financial years but within six months period from the date of transfer of capital asset, the assessee was definitely eligible to claim exemption up to Rs. 1,00,00,000/-.

While the above cited judgements hold that exemption u/s 54EC  shall be available if invested in the orderly manner, a negative view was given in the case of ACIT vs. RAJKUMAR JAIN & SONS (HUF) :

5.  SHRI VIVEK JAIRAZBHOY VS. DCIT (ITAT BANGALORE), I.T.A. No.236/Bang/2012

Assessee is entitled to total deduction under section 54EC of the Act spread over a period of two financial years @ Rs.50 lakhs each on investments made in specified instruments within a period of six months from the date of sale of the property.

6. COROMANDEL INDUSTRIES PVT. LTD. VS ASSESSEE (ITAT CHENNAI) – ITA NO. 411/MDS/2013

If the assessee is able to keep the six months’ limit from the date of transfer of capital asset, but, still able to place investment of Rs. 50 lakhs each in two different financial years, we cannot say that the restrictive proviso will limit the claim to Rs. 50 lakhs only. Since assessee here had placed Rs. 50 lakhs in two different financial years but within six months period from the date of transfer of capital asset, assessee was definitely eligible to claim exemption upto Rs. 1 Crore. The same view has been taken by Ahmedabad Bench of this Tribunal in the case of Aspi Ginwala & Others (supra). We are, therefore, of the opinion that the assessee has to succeed in this appeal. Claim of the assessee for exemption upto Rs. 1 Crore has to be allowed in accordance with Section 54EC of the Act.

7.   ASSISTANT COMMISSIONER OF INCOME TAX vs. RAJ KUMAR JAIN & SONS ( HUF) ITAT JAIPUR

In this case, the department challenged the allowability of exemption u/s 54EC based on the following contentions:

  • That the Explanatory Memorandum to Finance Act, 2007 which introduced proviso to Section 54EC(1) was clear in that limitation placed was for ensuring equitable distribution of available exempt assets so that ALL assessees could take advantage of it.
  • That the maximum exemption that could be given was Rs. 50,00,000/- for each transaction which gave rise to capital gains.

Here, the department further argued that provisions of Act cannot be perceived in a manner to grant a greater benefit to one section of the tax payers. If an assessee transfers certain property in the month of April of the financial year, then he has to make investment within six months i.e. within the same financial year. The exemption from capital gain will be allowed only to the extent of Rs. 50,00,000/-. In case of another tax payer who transfers his assets in the month of October, then he cannot claim exemption u/s 54EC by purchasing Rs. 50,00,000/- bonds in the financial year in which the transfer has taken place and another Rs. 50,00,000 invested in the subsequent financial year because the period of six months will include some part of the subsequent financial year. It was therefore, submitted that interpretation of proviso should not lead to discrimination against various tax payers. Therefore, it was held that the assessee was not entitled to the deduction of Rs. 1,00,00,000/- u/s 54EC of the Act.

After considering a few judgments on the matter it can be observed that rulings in favor of the assessee exceed the rulings against it. What is to be decided is whether the negated ruling overrides the judgments in favor of the assessee?

To the relief of the assessee, it can be settled that the verdict in favour of the assessee shall prevail over the adverse opinion held in the case of ACIT VS. RAJKUMAR JAIN & SONS (HUF) based on the following reasons:

(I)  The view in the abovementioned case was considered, yet distinguished by the ITAT Panaji in the case of INCOME TAX OFFICER vs. MS. RANIA FALEIRO: The ITAT Panaji, in this case, noted the negative opinion held in ACIT VS. RAJKUMAR JAIN & SONS (HUF) and subsequently held a contrary view. Thus, the same was distinguished and held in favour of the assessee.

(II) The judgment of ITAT Mumbai rather than ITAT Jaipur is pertinent to SKI: It is noteworthy that SKI falls into the Mumbai jurisdiction, and accordingly, judgment given by the ITAT Jaipur in the case of ACIT VS. RAJKUMAR JAIN & SONS (HUF) shall have lesser relevance than a verdict given in the ITAT Mumbai. That is to say, we can rely on the verdict held in INCOME-TAX OFFICER V/S. MRS. CHETANA H. TRIVEDI, which is in favour of the assessee as it was decided by the ITAT Mumbai.

(III) A liberal reading of section 54EC enables the assessee to invest up to Rs.1,00,00,000/-: A beneficial section has to be construed liberally, having due regard to the object it intends to serve. The department interprets the word “any financial year” in s. 54EC to mean “financial pertaining to the sale transaction”, an approach which has no justification as it adds words into the section and also ignores the purpose which the section is intended to serve. Thus, when the sections says that a maximum of Rs.50,00,000/- can be invested in any financial year, it must liberally grant an option to assessee to invest in two different financial years as long as the time limit of 6 months does not expire.

(IV) Where there are two reasonable constructions, construction which favors the assessee must be adopted: A well-accepted rule of construction recognized by various courts states that if the language of a section is ambiguous or capable of more meanings than one, then the interpretation which favours the assessee has to be adopted. Therefore, in case of contradictory views on a section, the courts shall favor the assessee, relying on the well established principle laid in COMMISSIONER OF INCOME TAX vs. VEGETABLE PRODUCTS LTD [88 ITR 192] by the apex court.

Conclusion:

There is nothing in section 54EC to suggest that Rs.50,00,000/- is the quantum maximum investment within the time limit prescribed by it. If this were to be the intention of the legislature, then it would have specifically provided for the same through notifications or through its judgments. It is sufficient compliance of section 54EC if the investment is made within 6 months from the date of transfer and the amount of investment does not exceed Rs.50,00,000/- in a financial year . In this context, we believe that it is worthwhile to invest in two different financial years, thus claiming a tax exemption of Rs.1,00,00,000/-.

Presently in our case, if the asset is sold in the month of February, by, say the 28.02.2014, the period of six months shall expire on the 28th of August 2014. Thus, investment of Rs. 50,00,000/- for the F.Y. 2013-14 should be made before 31st March 2014. Subsequently an additional amount of Rs.50,00,000/- can be invested before the 28th of August 2014 in order to avail the optimal benefit under Section 54EC of the Income Tax Act, 1961.

b. Whether exemption under 54EC is available for depreciable assets held for more than 36 months?

Exemption u/s 54EC for depreciable assets

Section 50 stipulates the mode of computation of capital gains for transfer of depreciable assets during the previous year. Where depreciable assets are transferred, the capital gains so arising shall be treated as short term capital gains. The words of section 50 are verbatim produced below:

“Special provision for computation of capital gains in case of depreciable assets”:

Notwithstanding anything contained in clause (42A) of section 2, where the capital asset is an asset forming part of a block of assets in respect of which depreciation has been allowed, the provisions of sections 48 and 49 shall be subject to the following modifications:

(1) where the full value of the consideration received or accruing as a result of the transfer of the asset together with the full value of such consideration received or accruing as a result of the transfer of any other capital asset falling within the block of the assets during the previous year, exceeds the aggregate of the following amounts, namely:

(i) expenditure incurred wholly and exclusively in connection with such transfer or transfers;

(ii) the written down value of the block of assets at the beginning of the previous year; and

(iii) the actual cost of any asset falling within the block of assets acquired during the previous year,

such excess shall be deemed to be the capital gains arising from the transfer of short-term capital assets;

Now, the controversy arises between the taxpayer and the department on interpretation of Section 54EC (quoted above) and denial exemption u/s 54EC on transfer of depreciable assets. In various circumstances, the department has sought to disallow exemption u/s 54EC on the grounds that section 50 deems profits on sale of depreciable assets as short term capital profits, hence requirement of section 54EC, i.e. sale of a long term capital asset is not fulfilled. In the belief of the department, Section 54EC was not allowable in the case of assets covered by the provisions of Section 50 of the Act, since these assets are in the nature of short term capital gain. However, the deeming fiction created u/s. 50 of the Act with respect to depreciable assets would be confined for the purpose of mode of computation of capital gains contained in Section 48 and 49 of the Act and would not cover the exemption u/s. 54EC of the Act. Requirement of Section 54EC gets fulfilled if assets transferred were held for more than 36 months even if the same is depreciable assets or depreciation been claimed on the same by the assessee.

In support of our contention, we rely on the following judgments decided by various courts:

1.   COMMISSIONER OF INCOME TAX vs. ACE BUILDERS (P) LTD. (HIGH COURT OF BOMBAY),  (2006) 281 ITR 210 (BOM)

This case highlighted that section 54E does not make any distinction between depreciable assets and non-depreciable assets. Exemption available under section 54E cannot be denied by referring to the fiction created under section 50, also that benefit of section 54E is available to the assessee irrespective of the fact that the computation of capital gains is done either under section 48 and 49 or under section 50. Legal fiction created by the statute is to deem the capital gain as short term capital gain and not to deem the asset as short-term capital asset. Therefore, it cannot be said that section 50 converts long-term capital asset into a short-term capital asset. It concluded that fiction created in sub-section (1) and (2) of section 50 is restricted only to the mode of computation of capital gains contained in section 48 and 49 and does not apply to other provisions and therefore an assessee is entitled to exemption under section 54E in respect of capital gain arising on the transfer of a long-term capital asset on which depreciation has been allowed.

Yet in another case, the department questioned the allowability of exemption for transfer of depreciable assets:

2.   COMMISSIONER OF INCOME TAX vs. RAJIV SHUKLA, HIGH COURT OF DELHI (2011) 334 ITR 138 (DEL)

The High Court held that the assessee was entitled for deduction under section 54F for investment of capital gains arising from sale of depreciable house property wherein the difference between sale proceeds and WDV of property is kept invested in eligible assets.

3.   DEPUTY COMMISSIONER OF INCOME TAX vs. HIMALAYA MACHINERY (P.) LTD. ( HIGH COURT OF GUJARAT) [(2012) 83 CCH 242]:

Once the requirement of section 54EC is fulfilled, by virtue of fact that the asset was such on which depreciation was allowed and therefore, computation would be done as provided u/s. 50 of the Act by applying modifications in Section 48 and Section 49 would not change nature of capital asset or availability of exemption specified u/s 54EC. It concluded that 54EC exemption would be made available in case of transfer of long term capital assets.

4.   COMMISSIONER OF INCOME TAX vs. ASSAM PETROLEUM INDUSTRIES (P) LTD., HIGH COURT OF GAUHATI (2003) 262 ITR 587 (GAU)

Section 50 nowhere says that depreciated asset shall be treated as short-term assets, whereas section 54E has an application where long-term capital asset is transferred and the amount received is invested or deposited in the specified assets as required under section 54E. For application of section 54E the necessary pre-requisite condition and enquiry would be, whether the assessee has transferred long-term capital asset and whether the consideration so received is invested or deposited within the time-limit in specified asset. Capital gain may have been received by the assessee on depreciable assets, if conditions necessary under section 54E are complied with by the assessee, he will be entitled to the benefit envisaged in section 54E of the Income-tax Act.

5. JAI HIND RUBBER PRODUCTS PVT.LTD. VS. ACIT (ITAT MUMBAI)

Exemption under section 54E of the Income-tax Act cannot be denied to the assessee on account of the fiction created in section 50. It is true that section 50 is enacted with the object of denying multiple benefits to the owners of depreciable assets. However, that restriction is limited to the computation of capital gains and not to the exemption provisions. The legal fiction created by the statute is to deem the capital gain as short-term capital gain and not to deem the asset as short term capital asset. Therefore, it cannot be said that section 50 converts a long-term capital asset into a short term capital asset.

6. ITO Vs. M/s Polestar Industries (ITAT Ahemdabad)

It was held that Section 54E does not make any distinction between the depreciable assets and non-depreciable assets, therefore, the investment u/s 54E is a permissible investment.

7.  DCIT  Vs.  Aditya Medisales Limited (Ahemdabad High Court)

It is true that section 50 is enacted with the object of denying multiple benefits to the owners of depreciable assets. However, that restriction is limited to the computation of capital gains and not to the exemption provisions. It cannot be said that section 50 converts a long-term capital asset into a short-term capital asset.In the light of the accepted factual position that the “short-term capital gain” was computed u/s.50 of IT Act in respect of the assets which were held by the assessee for more than 10 years and on sale of those assets the resultant gain was invested in Rural Electrification Bonds which qualifies for exemption u/s.54EC of IT Act and the which was a legally sustainable exemption in the eyes of law.

8. DCIT vs. Bharat Enterprise (ITAT Mumbai),  ITA No. 1764/Mum/2010, Date of Pronouncement – 30th June, 2011

The legal fiction created by the statute under Sec.50 is only to deal capital gain as short term capital gain and not to deem the asset as short term capital asset. Therefore, it cannot be said that Sec. 50 converts long term capital asset into a short term capital asset.

The Ld. CIT(A) has rightly held that the assessee is entitled to relief u/s.54E in respect of capital gains computed u/s.50 in respect of transfer of depreciable asset. Therefore, the appeal by the Revenue regarding ground of exemption u/s.54 EC in respect of gains arising u/s.50 from transfer of depreciable asset is dismissed.

9. Sudha S. Trivedi v. ITO (ITAT Mumbai), Appeal No.: ITA NOS. 6040 & 6186/Mum/2007, Decided on: February 20, 2009

Section 54EC is an independent provision not controlled by section 50. If the capital asset is held for more than 36 months, the benefit of section 54EC cannot be snatched away because section 50 is restricted only to the mode of computation of capital gain contained in sections 48 and 49 and this fiction cannot be extended beyond that for denying the benefit otherwise available to the assessee u/s.54EC of the Act, if the other requisite conditions of the section are satisfied.

Conclusion:

In background of the above judgments, we, to the best of our knowledge, reasonably suggest, that it shall be harmless to believe that exemption under section 54EC shall be provided on capital gain on transfer of depreciable assets held for a period of more than 36 months.

c. From which date the period of six months will be calculated?

The Assessee should invest the capital gains amount within a period of six months after the date of transfer/sale in the long term specified asset.

Long term specified asset is defined to include any bond redeemable after three years issued on or after 01.04.2007, by the National Highway Authority of India (NHAI), or by the Rural Electrification Corporation Limited (RECL).

Conclusion:

In view of the above discussion, we can conclude that the assessee can claim exemption under section 54EC on transfer of depreciable assets held for more than thirty-six months by investing in bonds notified for the purpose of Section 54EC. Further the assessee can claim exemption upto Rs. 1,00,00,000/- by investing the gain in the bonds notified under section 54EC if he invests Rs. 50,00,000/- each in two separate financial years but within six months from the date of transfer.

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Tags : CA Sandeep Kanoi (252) section 50C (111) section 54EC (84)

0 responses to “Sec. 54EC on Depreciable Assets & One Crore Exemption”

  1. sk mishra says:

    Its very helpful material. Thanks

  2. ashwin says:

    Pl inform which tribunal or high court decision

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