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A big gain in Section 45(2) of Capital Gain

Ajay Agrawal 
on 28 March 2017

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All cases related to conversion of capital asset into stock in trade are dealt by Sec 45(2) of Income Tax Act, 1961 at any point of time. Whenever a capital asset whether short term or long term is converted into stock in trade by an assessee it is deemed as transfer of capital asset and attracts capital gain as per the provisions of the Act, in spite of the fact that the ownership of such capital asset doesn’t change by such conversion. Sec 2(47)(iv) deals with the transfer in relation to capital asset provides that it includes-"in a case where the asset is converted by the owner thereof into, or is treated by him as, stock-in-trade of a business carried on by him, such conversion or treatment"

Sec 45(2) states that conversion of the capital asset 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 purpose of Sec 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 and would determine capital gain or loss respectively.

For the removal of doubts, although conversion of a capital asset into stock in trade is treated as transfer in relation to a capital asset but section 45(2) provides that capital gain/loss shall be calculated on such converted asset in the year in which such asset is actually sold.

Illustration: A building has been acquired by the assessee on 01.05.1996 for Rs. 100,000. The assessee converts the building into stock in trade of his property dealing business on 01.01.2011 when the fair market value of the building is Rs. 800,000. The stock in trade is sold by the assessee on 01.05.16 for Rs. 2000,000.

Solution:

Assessment year 2017-18
PGBP = 2000,000-800,000 = 1200,000

Capital gains:
Period of holding: 01.05.1996 to 31.12.2010 (Long term)
Sales price as per Sec 45(2): 800,000
Less- Indexed COA: 100000*785/305
Long term capital gain: Rs. 542,623
Total Income: Rs. 1742,623

*Note: CII for AY 2018-19 would soon be announced with 2001 as the base year.

The illustration clearly explains us, though capital asset is deemed to be transferred in AY 2010-11 but the capital gain would be calculated in the year when the transferred asset is actually sold i.e. AY 2017-18. If stock in trade would have been sold partially then capital gain would be calculated proportionately in all such years.

I think you all have understood the process of computation of Capital gain and Total income. So, let us talk about the more important part; the application part. If you have noticed or observed the implications of the above discussed sections, there is a kind of hidden relief for the assessee. The assessee for whom the end result is capital gain would always be in the advantageous situation. Let us understand the advantage through the below explanation:

Situation A - When building was transferred from capital asset to stock in trade.

Total income of the assessee is Rs. 1742,623 (explained above)

Situation B - When building was a stock in trade since beginning.

Income of the assessee would be under PGBP only and total income would be Rs. 1900,000 (2000,000-100,000)

In this way, the total income of the assessee in Situation A is shown less than that of shown in Situation B by Rs. 157377 and that is only due to applicability of indexation in Situation A as the building was once a capital asset and later it was transferred to stock in trade.

The author can also be reached at ajayagrawal19191@gmail.com


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