When a capital asset is converted into stock in trade then capital gain u/s 45(2) of Income Tax Act arises in the year of sale and not in the year of conversion. But in vice versa situation i.e conversion of stock in trade into capital asset there does not arise any capital gain. If an assessee is in the business of real estate and on closure of his business he retains the existing stock in trade of immovable properties of the business with him and holds it as investment then it will become his capital asset from the time of closure of his business. In such case if he later on sells the same capital asset say after three years from the date of purchase of such asset then the gain arising therefrom will be a long term capital gain and and the benefit of indexation and paying of tax @ 20% instead the normal rate can be planned.
Similar case can also happen in case of a business of trading in shares. Even during the continuation of the business the assessee may transfer some of his stock in trade into his capital asset by deciding to hold it as an investment and can sell the same at a later stage and can pay tax on the profit as capital gain instead of business profit.
It is here to be noted that long term capital gain from equity shares sold in stock exchange and on which Security Transaction Tax has been paid, is exempt u/s 10(38) of Income Tax Act. Thus in case of conversion of shares held as stock in trade into capital asset, the benefit of exemption u/s 10(38) will be available if such converted capital asset is sold later and long term capital gain arises from it. .
In such cases, there will not be any capital gain at the time of conversion and if the assessee sells such converted asset at a later date, the profit will certainly give rise to capital gain and in order to ascertain whether such profit is long-term capital gain, the period of holding would have to be reckoned from the date of acquisition of the asset as stock in trade and not from the date of conversion into capital asset, as section 2(42A) does not lay down that the holding of the asset for the required period has to be as capital asset.
Thus the assessee can go for tax planning and save the tax by treating as the long term capital gain which is taxable @ 20% instead of normal rate and benefit of indexation can also be taken.
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Note – The Article was first Published on 13.05.2011