Taxation of Joint Venture Business

Presently we have been witnessing a very different trend in relation to the real-estate development. Earlier, a builder would go for outright purchase of a piece of land from the land-lord and develop the same at his own cost and risk. The scenario in this regard is undergoing a change. The land-lord also desires to have a share in the profit of the project being undertaken by the builder and developer. On his part, the builder and developer desire(s) to share his risk in the development of the project. This change in the trend in relation to real-estate development, is giving rise to a new concept of Joint Venture between the land-lord and the builder / developer, for the purpose of the development of immovable properties.

It is often the case that the builder / developer is either a limited company or a partnership firm, whereas the land owner is either an individual or an HUF or a partnership firm.

The question which is often being asked is as to the status of such a Joint Venture for the purpose of income-tax and the tax-treatment of various tax-incentives in the case of such a Joint Venture. Such tax-incentives are provided under Section 80-IA(4)(iii) and Section 80-IB(10) of the Income-Tax Act, 1961. Another issue which often arises is regarding the tax-liability of a member of an association of persons (AOP), if such a Joint Venture is assessed in the status of an AOP.

In order to answer all the aforesaid queries, the relevant provisions of the Income-Tax Act and case-law, will have to be closely examined. The same are discussed as follows:-

1. Definitions of the words ‘assessee’ and ‘person’– Section 2(7) and Section 2(31) of the Income-Tax Act

As per Section 80-IA(1), the benefits of Section 80-IA, are available to an assessee. Similarly, as per Section 80-IB(1), the benefits of Section 80-IB are available to an assessee. The word “assessee”, is defined under Section 2(7), as a person by whom any tax or any other sum of money is payable under this Act, etc.

The word ‘person’ is defined under Section 2(31), which is reproduced as follows:-

Section 2 (31)“person” includes—

(i) an individual

(ii) a Hindu undivided family

(iii) a company,

(iv) a firm

(v) an association of persons or a body of individuals whether incorporated or not,

(vi) a local authority, and

(vii) every artificial juridical person, not falling within any of the preceding sub-clauses.

Explanation.—For the purposes of this clause, an association of persons or a body of individuals or a local authority or an artificial juridical person shall be deemed to be a person, whether or not such person or body or authority or juridical person was formed or established or incorporated with the object of deriving income, profits or gains.

From the aforesaid provisions of Section 2(31), it may be seen that a Joint Venture would be covered under clause (v) of Section 2(31), as an association of persons or AOP, for short.

2. Meaning of the term ‘Association of persons’

We have now to understand the meaning of the term ‘Association of persons’ or ‘AOP’. As per the Law Lexicon by P.R. Aiyer p.158, the term “AOP” has been defined as follows:-

(i) An association of persons must be one in which two or more persons join in a common purpose or common action, and as the words occur in a Section which imposes tax on income, the association must be one the object of which is to produce income, profits or gains-C.I.T. Vs. Smt. Indira Balakrishnan, [1960] 39 ITR 546,551 (S.C.)

When the business of the import and distribution of cloth was done by a group on a joint basis, when the sales and the profits were ascertained on a joint basis and then distributed according to the capital contributed by each member of the group, the fact that the Deputy Commissioner of the District had appointed the members constituting of the group to import and distribute the cloth in the District does not make any difference in finding this group as the “association of persons”-C.I.T. Vs. Buldana District Main Cloth Importers Group, [1961] 42 ITR 172(S.C.).

(ii) Association of persons can be formed only when two or more individuals voluntarily combine together for a certain purpose. Murugesan & Brothers Vs. C.I.T. [1973] 88 ITR 432(S.C.)

(iii) The term ‘association of persons’, means an association in which two or more persons join in a common purpose or common action, and as the words occur in a Section which imposes a tax on income, the association be one, the object of which is to produce income, profits or gains. .V. Shanmugam & Co. Vs. C.I.T. [1971] 81 ITR 310 (S.C.).

The term “AOP” has also been dealt with in a number of judgements under Income-tax Act. An ‘AOP’ must be one in which two or more persons join in a common purpose or common action, and as the words occur in a Section which imposes tax on income , the association must be one, the object of which is to produce income, profits or gains – CIT Vs. Indira Balakrishnan [1960] 39 ITR 546, 551 (SC)

Some of the other cases laying down tests or providing criteria of association of persons, are as follows-

(i) Murugesan & Bros. Vs. C.I.T.[1973] 88 ITR 432 (SC)

It was held in this case that to constitute an AOP two or more individuals voluntarily combine together for a certain purpose.

(ii) Ag. I.T. Vs. Raja Ratan Gopal [1966]59 ITR 728 (SC) and Mohamed Noorullah Vs. C.I.T. [1961] 42 ITR 115(SC)

It was held in these cases that to constitute and AOP two or more persons should have joined in the promotion of a joint enterprise with the object of producing income, profits or gains.

(iii) I.T. Vs. N.V. Shanmugham & Co. [1966] 62 ITR 701 (Mad.)

It was held in this case that the association need not necessarily be on the basis of a contract; consent and understanding may be presumed.

(iv) I.T. Vs. C. Karunakaran [1988] 170 ITR 426, 429-430 (Ker.)

It was held in this case that wherever individuals employ their assets in a joint enterprise with a view to make profit, though not as partners, they constitute an association of persons by reason of their common purpose or common action. In such an enterprise, the distinction between a firm and an association of persons may often be thin and sometimes very obscure.

(v) N. Sunanda Vs. C.I.T [1988] 174 ITR 664, 666 (Karn)

It was held in this case that to constitute and AOP there must be a joining together in a common venture, the object of which is to produce income, profits or gains.

(vi) I.T. Vs. Chandmal Rajgarhia, [1995] 213 ITR 789, 793 (Pat)

It was held in this case that the essential criterian that attracts the label of ‘association of persons’ in the Income-tax Department is the unity of the income-making purpose rather than the unity of title in the income yielding asset.

(vii) Sardar Harvinder Singh Sehgal Vs. Asst. CIT[1997] 227 ITR 512,531 (Gauh)

It was held in this case that in order to constitute an association of persons, they must join in a common purpose or common action and the object of the association must be to produce income.

From the aforesaid discussion, it may be seen that an ‘association of persons’ means an association in which two or more persons join in a common purpose or common action. The word ‘person’ herein is very significant, as ‘person’ may mean any entity as defined in Section 2(31) of the Income-tax Act. In other words, individuals, HUFs, companies or firms, etc. may be members of such A.O.P.

3. An important judgement – Birla Tyres Vs. JCIT [2003] 80 TTJ 915 (Cal.-T) (T.M.)

Recently, the issue relating to the status of an AOP came up for consideration in the case of Birla Tyres Vs. JCIT [2003] 80 TTJ 915 (Cal.-T) (TM). The main issue involved in the aforesaid case was whether loss in the case of an AOP could be carried forward and adjusted against the income of the following years.

It was held in this case that conjoint reading of Section 67A and other relevant provisions of the Act, indicates that an AOP is an independent assessable entity, different and distinct from its members. In this case, the AOP was constituted by four members which were companies viz. (i) M/s Century Textiles Inds. Ltd. (ii) M/s Kesoram Inds. Ltd. (iii) M/s Jayashree Tea & Inds. Ltd. (iv) M/s Bharat General & Textiles Inds. Ltd. The aforesaid AOP has been treated as an independent taxable entity distinct from its members. It may be seen in this case that the AOP in question, was constituted by four companies.

In the aforesaid context, it was held by the Tribunal that as an AOP is an independent assessable entity, different and distinct from its members, its loss can be set off only against its own profits and not against the profits of its members. It was further held that there is nothing in the Act for dis-qualification of AOP from taking the benefit of the provisions of Sections 71,72 etc., in its own assessment.

The aforesaid judgement of the ITAT fully supports the view that an AOP is an independent taxable entity quite different and distinct from its members, which could be individuals, HUFs, firms, companies or even other AOPs, etc.

4. Meaning of the term ‘Joint Venture’

As per Concise Oxford Dictionary, ninth edition, ‘adventure’ means an enterprise, a commercial speculation whereas ‘venture’ means risky enterprise, commercial speculation. Thus, for our purpose, there would be no difference between the terms ‘adventure’ and ‘venture’. In other words, the terms ‘joint adventure’ and ‘joint venture’ will have the same or similar meaning in the given context. The term ‘joint adventure’ has been defined on pp.1002 of the Law Lexicon by P.R. Aiyer.

(i) Joint adventure

A joint adventure is a limited partnership; not limited in a statutory sense as to liability, but as to its scope and duration.

A joint adventure is an enterprise undertaken by several persons jointly (Cyclopedic L.Dict).

“A commercial enterprise by several persons jointly” (English L. Dict.) “A commercial or maritime enterprise undertaken by several persons jointly.” (Black’s Law Dictionary)

(ii) Joint adventure & partnership

The subject of joint adventures is of comparatively modern origin. It was unknown at common law, being regarded as within the principles governing partnerships. One distinction lies in the fact that while a partnership is ordinarily formed for the transaction of a general business of a particular kind, a joint adventure relates to a single transaction, although the latter may comprehend a business to be continued for a period of years. Another distinction is that a corporation incapable of becoming a partner may bind itself by a contract for a joint adventure, the purposes of which are within those of the corporation.

From the aforesaid definition of joint adventure it may be seen that joint adventure is a limited partnership but not exactly a partnership. In a joint venture the liability of the members/partners is unlimited as in the case of a firm but its scope and duration are limited.

5. The incentive deduction will be available to such Joint Venture

As already explained, such Joint Venture business will be assessable in the status of an AOP.

In this context, it will be necessary to look at the definition of the term ‘assessee’, as defined under Section 2(7) of the Income-Tax Act, 1961. As per Section 2(7) ‘assessee’ means a person by whom any tax or any other sum of money is payable under the Income-Tax Act. As per Section 2(31) of the Income-Tax Act, the word ‘person’, includes an AOP.

The deductions under Section 80-IA and Section 80-IB are available to an assessee, subject to certain conditions. Thus, it is clear that a Joint Venture assessable in the status of an AOP, will be entitled to the deductions under Section 80-IA (4) (iii) and Section 80-IB (10) etc. of the Income-Tax Act, 1961.

6. Whether share of a member in the income of a Joint Venture business, taxed in the status of an AOP, will again be taxed in the hands of the members.

In order to answer this query, a number of the provisions of the Income-Tax Act, falling under different Chapters thereof, will have to be examined. These provisions may be listed as follows:-

(i) Section 66, with the heading “Total income”, falling under Chapter – VI.

(ii) Section 67A, with the heading “ Method of computing a member’s share in income of associ­ation of persons (AOP) or body of individuals (BOI)”, falling under Chapter – VI.

(iii) Section 86, with the heading “Share of member of an association of persons or body of indi­viduals in the income of the association or body”, falling under Chapter – VII.

(iv) Section 110, with the heading, “Determination of tax where total income includes income on which no tax is payable”, falling under Chapter – XII.

(v) Section 167B, with the heading, “Charge of tax where shares of members in association of persons or body of individuals unknown, etc”, falling under Chapter – XV.

It may be seen from the heading of Section 67A that it deals with the computation of a member’s share in the income of the association of persons (AOP) or Body of individuals (BOI)

First proviso (a) to Section 86

The heading of Section 86 is – “share of a member of an ‘Association of persons’ or ‘Body of individuals’ in the income of the association or body.” As the heading of Section 86 suggests, it deals with the charge of income-tax on the share of a member of an AOP / BOI, in the income of such AOP/BOI. For our purpose, proviso (a) to Section 86 is relevant. As per the aforesaid proviso (a), where the AOP/BOI is chargeable to tax on its total income at the maximum marginal rate or any higher rate under any of the provisions of the Act, the share of a member computed as aforesaid, shall not be included in its total income.

Second proviso to Section 86

In this context, the second proviso to Section 86 is also very relevant. As per the aforesaid proviso where no income-tax is chargeable on the total income of AOP/BOI, the share of a member computed as aforesaid shall be chargeable to tax as part of his total income. In this context, the meaning of the expression ‘where no income-tax is chargeable on the total income of the AOP/BOI’, is relevant. The aforesaid expression means, incomes which do not form part of the total income. In this connection, it may be stated that a deduction or relief under Section 80-IA, Section 80-IB, Section 80-I and Section 80-J, cannot be said to be income, profits and gains, not includible in the total income. In support of this proposition, reliance may be placed on the judgement in the case of Second ITO Vs. Stumpp, Schuele & Somappa P. Ltd. [1997] 106 ITR 399 (Karn.).

The aforesaid judgement of the Karnataka High Court was affirmed by the Apex Court in the case of Second ITO Vs. Stumpp Schuele & Somappa P. Ltd. [1991] 187 ITR 108 (S.C.)

Thus, the deductions available under Sections 80-IA and 80-IB do not pose any problem in this respect. Otherwise also, if the total income of an AOP is entitled to deduction under Section 80-IA or Section 80-IB, then the question of any tax-liability on the share of a member in the income of the AOP, will not arise, as the income of the AOP or BOI would be Nil.

Tax-implications of the provisions of Section167B -‘charge of tax where shares of members in AOP or BOI are known, etc.’

From the provisions of Section 167B, it may be seen that Section 167B(1) deals with charge of tax, where the individual shares of the members of an AOP / BOI, in the whole or any part of income of such AOP /. BOI, are in-determinate or unknown. In such a case, income-tax is charged on the total income of the AOP/BOI at the maximum marginal rate.

Section 167B(2), however, deals with cases, which do not fall under aforesaid Section 167B(1). In other words, Section 167B(2) deals with cases where the shares of the members of the AOP / BOI are determinate or known. As per Section 167B(2)(i), where the total income of any member of an AOP / BOI, for the previous year, excluding the share from such AOP / BOI, exceeds the maximum amount which is not chargeable to tax, in the case of that member, tax shall be charged on the total income of the AOP / BOI, at the maximum marginal rate.

The term “maximum marginal rate” is defined under Section 2(29C) of the Act, and it means the rate of income-tax (including surcharge on income-tax, if any) applicable in relation to the highest slab of income in the case of an individ­ual , AOP or BOI, as specified in the Finance Act of the relevant year. It may be clarified here that when maximum marginal rate is charged on an income, no basic exemption is allowed in respect of the income and the benefit of lower rate of taxation on the lower slabs of income, is also not available in such a case.

It may be reiterated here that where the AOP / BOI, is chargeable to tax on its total income at the maximum marginal rate or any higher rate under any of the provisions of the Act, then as per clause(a) of the first proviso to Section 86, the share of a member of such AOP / BOI, shall not be included in its / his total income.

7. Conclusion

In the light of the aforesaid discussion, it may be concluded that-

(a) Income of a Joint Venture project, may be assessed in the status of an ‘Association of persons’ under the Income-Tax Act.

(b) The deductions under Section 80-IA or Section 80-IB, etc., will be available to such a Joint Venture assessable in the status of an AOP.

(c) No share of income of such AOP, fully deductible under Section 80-IA or 80-IB, would be liable to tax again in the hands of the members thereof.

see more at http://taxguru.in/income-tax/taxation-joint-venture-business.html 

Export of material/equipment under bond, without payment of Central Excise duty, for Kholongchhu Hydro-Electric Project (KHEP) in Bhutan allowed

Seeks to amend Notification No. 45/2001 – CE (NT) dated 26th June, 2001, as amended, to allow export of material/equipment under bond, without payment of Central Excise duty, for Kholongchhu Hydro-Electric Project (KHEP) in Bhutan

Government of India

Ministry of Finance

(Department of Revenue)

Notification No. 3/2016-Central Excise (N.T.)

New Delhi the 3^rd February, 2016

G.S.R. (E).- In exercise of the powers conferred by sub-rules (1) and (3) of rule 19 of the Central Excise Rules, 2002, the Central Board of Excise and Customs hereby makes the following further amendment in the notification of the Government of India, in the Ministry of Finance, Department of Revenue, No. 45/2001-Central Excise (N.T.), dated the 26^th June, 2001 published in the Gazette of India, Extraordinary vide number G.S.R. 474(E), dated the 26^th June, 2001,namely:-

In the said notification, paragraph 1, in sub-paragraph (5),-

(i)  For the marginal heading, the following marginal heading shall be substituted, namely:-

“Export of all excisable goods without payment of duty to Kurichu Hydro Electric Project, Tala Hydro Electric Project, Punatsangchhu- I Hydro  Electric Project,  Punatsangchhu-II Hydro Electric Project,  Mangdechhu Hydro Electric Project and Kholongchhu Hydro Electric Project in Bhutan”;

(ii)  for the words “Kurichu Hydro Electric Project, Tala Hydro Electric Project, Punatsangchhu-I Hydro Electric Project, Punatsangchhu-II Hydro Electric Project and Mangdechhu Hydro Electric Project ” the words “Kurichu Hydro Electric Project, Tala Hydro Electric Project, Punatsangechhu-I Hydro Electric Project, Punatsangchhu-II Hydro-Electric Project, Mangdechhu Hydro-Electric Project and Kholongchhu Hydro Electric Project” shall be substituted.

[F.No.116/31/2015-CX.3]

(Shankar Prasad Sarma)

Under Secretary to the Government of India 

Note:– The principal notification No. 45/2001-Central Excise (N.T.), dated the 26th June, 2001 was published vide G.S.R. 474(E), dated the 26th June, 2001 and was last amended vide notification No. 08/2008-Central Excise (N.T.) dated 11th February, 2008 G.S.R. 81(E), dated the 11th February, 2008.

Sale of a capital asset converted into stock-in-trade

In business there are occasions when a capital asset is converted into stock-in-trade and stock-in-trade is converted into capital asset. There may also be occasions when an asset ceases to be a stock-in-trade. In this context, section 45(2) of the Income-Tax Act, 1961 (the Act) is relevant. For the sake of ready reference, section 45(2) is reproduced as follows :

“Capital gains.

45 (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.”

From the aforesaid provisions of section 45(2), it may be seen that 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, is to be charged to tax under the heading “Capital gains” in the previous year in which such stock-in-trade is sold or otherwise transferred by him. It has been further provided that, for the purposes of computing the capital gains in such case, the fair market value of the capital asset on the date on which it was converted or traded as stock-in-trade, is to be deemed to be the full value of consideration received or accruing as a result of the transfer of the capital asset.

In the present context, it will be appropriate to deal with the following aspects :

(i) Relevance of legal precedents laid down by the Supreme Court before the insertion of section 45(2) of the Act.

(ii) Detailed discussion about the provisions of section 45(2) of the Act.

(iii) The relevant legal precedents.

(iv) Conclusion

The same are discussed as follows :

I. Relevance of legal precedents laid down by the Supreme Court before the insertion of section 45(2) of the Act.

In this regard, it may be appropriate to consider the relevant legal development before the insertion of the present sub-section (2) in section 45 of the Act, vide the Taxation Laws (Amendment) Act, 1984, with effect from 1.4.1985. In this context there are two landmark judgements delivered by the Apex Court. One in the case of Sir Kikabhai Premchand and the other in the case of Bai Shirinbai K.Kooka. Both the aforesaid judgements of the Supreme Court are discussed as follows :

1. CIT Vs Sir Kikabhai Premchand [1953] 24 ITR 506 (SC).

In this case, the assessee was a dealer in silver and shares and he was the sole owner of the business. The assessee maintained his accounts according to the mercantile system and valued his stock at cost price both at the beginning and at the end of the year. During the relevant year of account, the assessee withdrew some silver bars and shares from the business and settled them on certain trusts in which he was the managing trustee. In his books, the assessee credited the business with the cost price of the bars and shares so withdrawn. The Income-tax authorities held that the assessee derived income from the stock-in-trade, thus, transferred and assessed him on a certain sum being the difference between the cost price of the silver bars and shares and their market value on the date of their withdrawal from the business. The appellate Tribunal and the High Court upheld the action of the IT authorities.

On appeal to the Supreme Court, it was held that the assessee might have stored up a future advantage for himself, but as the transactions were not business transactions and as he derived no immediate pecuniary gain, the State could not tax them, for under the Income-Tax Act, the State has no power to tax a potential future advantage. It was further held that in revenue cases, regard must be held to the substance of the transaction rather than to its mere form.

2. CIT Vs Bai Shirinbai K.Kooka [1962] 46 ITR 86 (SC).

Thereafter, the Supreme Court delivered another landmark judgement on the issue, in the case of CIT Vs Bai Shirinbai K.Kooka [1962] 46 ITR 86 (SC). In this case, the assessee who held by way of investment several shares in companies, commenced a business in shares, converting the shares into stock-in-trade of the business and subsequently, sold these shares at a profit. In this case, a Bench of seven judges decided by six to one, held that the assessee was entitled to record the market price as cost of his investment in his business books. In this case, where the assessee brought his shares held as investments into stock-in-trade, the earlier decision of the Supreme Court in Sir Kikabhai Premchand’s case was sought to be relied upon by the Revenue, which required cost to be adopted consistent with the principle decided in that case. The Supreme Court, however, distinguished Sir Kikabhai Premchand’s case on the following ground. The important observations of the Hon. Supreme Court, on page 92 of the Report are as follows :

“From what has been stated above it would at once appear that Kikabhai’s case was the converse of the present case. In Kikabhai’s case a part of the stock-in- trade was withdrawn from business; there was no sale nor any actual profit. The ratio of the decision was simply this. Under the Income-Tax Act the State has no power to tax a potential future advantage and all it can tax is income, profits and gains made in the relevant accounting year. In the case under our consideration the admitted position is that there has been a sale of the shares in pursuance of a trading or business activity and actual profits have resulted from the sale. The question in the present case is not whether the State has a power to tax potential future advantage, but the question is how should actual profits be computed when admittedly there has been a sale in the business sense and actual profits have resulted therefrom. We agree with the High Court that in this respect there is a vital difference between the problem presented by Kikabhai’s case and the problem in the present case. We further agree with the view expressed by the High Court that the ratio in Kikabhai’s case need not necessarily be extended to the very different problem presented in the present case, not only because the facts are different, but because there is an appreciable difference in principle. The difference lies in this : in one case there is no question of any business sale or actual profits and in the other admittedly there are profits liable to tax, but the question is how the profits should be computed. We must, therefore, overrule the first two arguments of the learned Additional Solicitor General that the distinction drawn by the High Court between Kikabhai’s case and the present case is not warranted on principle and that the ratio of the decision in Kikabhai’s case must necessarily apply to the present case also.”

It was, thus, held that the assessee’s assessable profits on the sale of the shares was the difference between the sale price of the shares and the market price of the shares prevailing on the date when the shares were converted into stock-in-trade of the business in shares and not the difference between the sale price and the price at which the shares were originally purchased by the assessee. The principle in Kikabhai’s case is not applicable to a case like this, as there was no sale in Kikabhai’s case and the ratio of the decision was that under the Income-Tax Act, the State had no power to tax a mere potential advantage.

Thus, while holding that the market value should be adopted when investment is converted into stock-in-trade, it also held that there was no inconsistency when cost is adopted on conversion to stock-in-trade to investment.

II. Discussion about the provisions of section 45(2) of the Act.

On the basis of the discussion in the preceding paragraph (I), it may be seen that section 45(2) of the Act, does not make a departure from the principle laid down by the Supreme Court. Since market value is adopted on conversion of investment into stock-in-trade, it is considered only fair that after introduction of tax on capital gains on sale of investment, the assessee should pay tax on such capital gains, with reference to the market value adopted for computing the business income arising to the assessee from investments or personal assets converted to stocks. The provision is also fair in that the tax on such capital gains will be payable only on realization of such converted stock in the year of sale thereof, though the capital gain is determined on the date of conversion.

It is, thus, quite clear that on conversion of a capital asset into stock-in-trade, and thereafter, sale of the stock-in-trade, the tax-treatment in respect thereof, will be as follows :

(i) There will be capital gains liability in respect of the conversion of capital asset into stock-in-trade, at market value thereof. Thus, the capital gains will be computed as a difference between the cost of capital asset to the assessee and the market value of such capital asset on the date of its conversion into stock-in-trade.

However, the capital gains tax will be required to be paid only at the time of sale of the stock-in-trade.

(ii) As regards the sale of the stock-in-trade, the profit realized will be liable to tax as business income and such profit would accrue at the time of sale of the stock-in-trade.

The business income will be computed as a difference between the sale price of the stock-in-trade and market value of the capital asset on the date of its conversion into stock-in-trade.

In the present context, it must be appreciated that while framing the provisions of section 45(2), a practical view has been adopted in respect thereof, in as much as even capital gains liability would arise not on the date of conversion of the capital asset into stock-in-trade, but on the date of sale of such stock-in-trade.

In this regard, it will be appropriate to refer to Circular No.791, dt.2.6.2000, issued by the CBDT. This Circular relates to the issue whether the date of transfer, as referred to in section 54E of the Act, is the date of conversion of the capital asset into stock-in-trade or the date on which the stock-in-trade is sold or otherwise transferred by the assessee. In this regard, paragraph (4) of the aforesaid Circular is relevant, which is reproduced as follows :

“4. Sections 54EA, 54EB and 54EC also provide deduction from long-term capital gain if the sale proceeds/long-term capital gain is invested in specified assets within a period of 6 months from the date of transfer. It is not possible for an assessee to make the required investment under the aforesaid sections at the point of conversion of capital asset into stock-in-trade because the right to collect sales consideration in such cases arises only at the point of sale or transfer otherwise of stock-in-trade. The board has considered the matter afresh in consultation with the Ministry of Law and has decided that the period of 6 months for making investments in specified assets for the purpose of sections 54EA, 54EB and 54EC should be taken from the date such stock-in-trade is sold or otherwise transferred, in terms of section 45(2) of the Act.”

It is, thus, clear that for investment of long-term capital gains, it is not possible for an assessee to make the required investment under the provisions of sections 54EA, 54EB and 54EC, at the point of conversion of capital asset into stock-in-trade, because the right to collect the sale consideration in such cases arises only at the point of sale or transfer of stock-in-trade. Therefore, the period of six months for making investments in specified assets for the purpose of sections 54EA, 54EB and 54EC, is to be reckoned from the date such stock-in-trade is sold or otherwise transferred, in terms of section 45(2).

III. The relevant legal precedents :

In the present context, it will also be necessary to deal with some of the relevant legal precedents in relation to the correct understanding of the provisions of section 45(2) of the Act. These legal precedents are discussed as follows :

1. CIT Vs Saffire Hotels P.Ltd [2015] 116 DTR 385 (Bom)

In this case, the assessee was engaged in the business of developing property and declared income of Rs.35.59 lakhs for the AY 2003-04. The Respondent assessee claimed to be following project completion method and no premises had been sold during the relevant AY. During the assessment proceedings, the contention of the assessee that no premises had been sold was found to be incorrect. Thus, by an order, dt.23.1.2006, the AO enhanced the income to Rs.2.61 crores, being the undisclosed income.

In appeal before the CIT(A), the assessee took up an alternative stand, viz. that even if the AO is correct in determining that the property had been sold during the year, yet a portion of the undisclosed income is assessable as capital gains, in as much as the land originally was a capital asset of the assessee company, which had been formed to run a hotel. Therefore, the provisions of section 45(2) of the Act, were attracted when the land (capital asset) was converted into stock-in-trade. It is at that time that the same is brought to tax, although payable when stock-in-trade was sold . The CIT(A) did not accept the aforesaid submission of the assessee and upheld the order of the AO.

On further appeal, the Tribunal on the basis of facts found that during the course of assessment proceedings before the lower authorities, evidence was brought on record which indicated that the assessee was incorporated in 1970. Its main object was to carry on its business of running a hotel and for which purpose the land, in question, was acquired as a capital asset. It was only later that the land, in question, was utilized as part of its stock-in-trade for the purpose of carrying on its business of construction. The aforesaid conclusion was reached by placing reliance on the permission of the Government of India, Tourism Department, dt.21.8.1971, evidencing approval for the proposed construction of a hotel building. Further evidence was laid before the Tribunal in the form of commencement certificate issued in 1972 by the Pune Municipal Corporation for undertaking the basic initial construction work for the hotel project. Thus, the Tribunal held that the provisions of section 45(2) of the Act, would be applicable in the present case.

Further, on the issue as to the date on which capital asset was converted into stock-in-trade, the assessee contended that 1993 be treated as the year, while Revenue contended that 1989 be treated as the year of conversion into stock-in-trade. The impugned order of the Tribunal restored the issue of date of conversion into stock-in-trade to the AO to decide, on the basis of evidence produced before it.

On appeal by the Revenue before the High Court, it was held that on the basis of evidence before the lower authorities, even if ignoring the fresh evidence which was in the form of commencement certificate, dt.15.6.1972, issued by the Pune Municipal Corporation during the course of hearing before the Tribunal, it is clear that the land was originally a capital asset, which was later on converted into stock-in-trade. Therefore, section 45(2) is applicable. Accordingly, the Tribunal was correct in setting aside the case to the file of the AO to decide the year of conversion or treatment of land into stock-in-trade, since tax is payable only in the year in which the assessee ultimately sells such stock-in-trade.

2. CIT Vs Najoo Dara Deboo [2013] 218 Taxman 473 (All)

In this case, the assessee, owner of a premises, entered into an agreement in 1994 with the builder for construction of a multi-storeyed building. The builder, accordingly, developed the land and constructed a complex thereon. As per the agreement, the builder was to give 35 per cent of the built-up area to the assessee and was to get 65 per cent of built-up area along with undivided 65 per cent interest in the land. The AO held that since the assessee had handed over possession of the plot to the builder in pursuance of an agreement for transfer and thus, transfer took place during the relevant previous year, in view of the provision of section 2(47) of the Act. The AO, therefore, made addition on account of long-term capital gains. On appeal, the CIT(A) and the Tribunal deleted the addition.

On further appeal by the Department, it was held by the High Court that the assessee paid capital gains tax in the assessment years 1998-99 to 2000-01, when flats / built-up areas were sold and sale consideration was reeceived. Therefore, no capital gains tax would be charged in the assessment year, in question, when the agreement was signed. In the present context, paragraph 9 of the order of the High Court, on page 477 of the Report is relevant, which is reproduced as follows :

“9. It may be mentioned that the capital gain can be charged only on receipt of the sale consideration and not otherwise. How can a person pay the capital gain if he has not received any amount. In the instant case, the assessee has honestly disclosed the capital gain for the assessment years 1998-99 to 2000-01, when the flats/areas were sold and consideration was received. During the year under consideration, only an agreement was signed. No money was received. So, there is no question to pay the capital gain. When it is so, then we find no reason to interfere with impugned orders passed by the Tribunal. The same are hereby sustained along with reasons mentioned therein.”

3. CIT Vs Rajesh Bahadur and Others (AOP) [2007] 294 ITR 297 (Del)

In this case, the assessee was an association of persons (AOP) which by an agreement, dt.1.6.1981, joined together with the common object of re-developing certain property and to build flats on the plot. A return of income was filed by the AOP for the AY 1982-83, showing Nil income. In respect of the year ending 31.3.1988, the assessee submitted a return of income showing a loss of Rs.16,49,310, in which interest payment of Rs.15,86,219, for the period from 30.6.1980 to 31.3.1988, on amounts given to the AOP by its members, was claimed as deduction. One of the issues in this case was with regard to the deletion of addition of Rs.30 lakhs made by the AO on account of value of land adopted by the assessee in the Profit and Loss Account at market value instead of cost price. The assessee had claimed deduction in respect of this amount being the market value of property which was converted into stock-in-trade in June, 1988. The AO had taken the view that the assessee should have taken only the cost price as the value of the opening stock, since the closing stock had been valued at cost and there was no provision in the Act for valuing the stock at market price and as such, he rejected the claim of the assessee.

It was held by the High Court that it is sell-settled that when the capital assets are converted into stock-in-trade, the assessee is entitled to adopt the market value of the asset as on the date of conversion and this principle has been approved by the Apex Court, in the case of CIT Vs Bai Shirinbai K.Kooka [1962] 46 ITR 86 (SC). In view of the decision of the Apex Court, the High Court agreed that the reasoning given by the Tribunal that there was no question of valuing the closing stock as on 31.3.1988, because there was no closing stock left on that date and thus, the claim of the assessee was fully justified and allowable.

4. CIT Vs Subodhchandra S.Patel [2004] 265 ITR 445 (Guj) : 138 Taxman 185 (Guj)

In this case, the assessee was holding certain shares as capital assets in its books of account. The said shares were converted into stock-in-trade and contributed by the assessee to a partnership firm as its capital. The AO held that the conversion of capital assets into stock-in-trade was not genuine and only capital assets were transferred to the partnership and not stock-in-trade, as claimed by the assessee. Accordingly, the AO taxed the difference in cost of shares and market value of the shares as capital gains in the hands of the assessee. The order of the AO was also confirmed by the CIT(A). On further appeal, the Tribunal, upholding the order of the CIT(A), held that the transaction would amount to transfer, within the meaning of section 2(47), in the light of the decision of the Apex Court, in the case of Sunil Siddharthbhai Vs CIT [1985] 156 ITR 509 (SC). Thereafter, the assessee filed a Miscellaneous Application contending that the Tribunal failed to apply second proposition of the said decision of the Supreme Court. The Miscellaneous Application was allowed by the Tribunal.

On a reference, it was held by the High Court that the Revenue admitted in no uncertain terms that the capital assets were transferred within the meaning of section 2(47) from the assessee to the partnership firm, by way of capital contribution and once that was so, it was not possible for the Revenue to contend that the firm was not genuine. The moment the Revenue took that stand, there could be no transfer of the assets and there could be no movement of assets from the assessee to the other entity, which would result in a transfer amenable to capital gains tax. In the circumstances, once it was held that there was a transfer of the assets from the assessee to the partnership firm, it was clear that the same was without consideration and in such circumstances, no tax on capital gains could be levied, as the computation machinery failed.

In other words, it was held by the High Court that the Tribunal having failed to record a finding in relation to the second proposition of law enunciated by the Supreme Court, in the case of Sunil Siddharthbhai Vs CIT [1985] 156 ITR 509 (SC) that a transfer of capital asset by a partner to a firm falls outside the scope of capital gains tax.

5. Ramesh Abaji Walavalkar Vs Addl.CIT [2012] 80 DTR (Trib) 319 (Mum)

It was held in this case that on the facts of the case, there was a conversion of land by the assessee into stock-in-trade on 15.5.2002, within the meaning of section 45(2) and therefore, the profits or gains arising from the transfer by way of such conversion were chargeable to tax as the income of the assessee under the heading “Capital gains” in the AY 2005-06, in which the stock-in-trade was sold by the assessee.

It was further held that in case of land allotted to the assessee in lieu of acquisition of agricultural land, which was, later on, converted into stock-in-trade and sold by the assessee, the cost of acquisition of the land for the purpose of computing capital gain shall be the market value of the said land on the date of allotment.

IV. Conclusion

In the light of the discussion in the preceding paragraphs, it may be seen that if a person desires to develop or exploit in any other manner, a capital asset held by him, he may take full advantage of the provisions of section 45(2) of the Act. Such a person or the assessee may convert the capital asset into stock-in-trade and thereafter, he may either develop it or exploit it in any other manner.

Such a course of action will be very useful in the case of a person who desires to develop a plot of land, which he is holding as a capital asset. He may convert such a plot of land into stock-in-trade and thereafter, by way of development of the plot of land, he may construct residential or commercial building units on the same. Such a course of action will provide an advantage to such a person, because he will not be required to pay capital gains tax immediately on the date of conversion of the capital asset into stock-in-trade. He may, in view of the provisions of section 45(2) make payment of the capital gains tax at the time of sale of such capital asset, after its conversion into stock-in-trade.

Besides, such an assessee will have another advantage by way of reduction of his tax liability in respect of the gains realized by him, by way of difference between the market value of the capital asset on the date of its conversion into stock-in-trade and the cost of such capital asset.

In other words, he will be required to pay capital gains tax in respect of such gains in place of normal tax, which is definitely higher than the capital gains tax.

Thus, the tax liability of the assessee in such a case will be two-fold, as follows :

1. He will be required to pay capital gains tax on the amount of difference between the market of the capital asset on the date of its conversion into stock-in-trade and cost of such capital asset.

He will have an additional advantage as such capital gains tax will be required to be paid only at the time of sale of such stock-in-trade.

2. The assessee will be required to pay tax on the business income by way of profit realized by him, as a difference between the sale price of the stock-in-trade and market value of the capital asset on the date of its conversion into stock-in-trade.

The concerned tax-payers may derive lot of tax benefit by following the aforesaid guidelines, in view of the provisions of section 45(2) of the Act.

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