Conversion of shares from stock in trade to investment

Dear Rakesh,

As per Section 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."

So to summarize :

The on conversion of capital asset to stock in trade the following will be the tax treatment:

1. The F.M.V as on the conversion will be used to calculate the capital gain on conversion.

2. Indexation only upto the year of conversion can be applied if it is as long term asset.

3. But capital gain will be taxable only in the year of sale of the stock in trade.

4. So in the year of sale you will have to pay the tax on both business income generated from the sale of stock in trade as well as the capital gain on the conversion of asset to stock in trade.

I hope this helped you.

Sorry for the above reply, I got the question wrong:

Please find an apt response to you question which I found on the internet:

While incorporating sub-section  2 to section 45, the legislature has not visualized the situation in other way round, where stock-in-trade is to be converted into the investment and later on the investment is sold on profit. In the absence of a specific provision to deal with this type of situation, a rational formula should be worked out to deal with this type of situation, two formulas can be evolved to work out the profits and gains on transfer of assets. One Formula which had been adopted by the assessing officer, i.e., difference between the book value of the shares and the market value of the shares on the date of conversion, be taken as a business income and the difference between the sale price of the shares and the market value of the shares on the date of conversion, be taken as capital gain. The other formula which was adopted by the assessee, i.e., the difference between the sale price of the shares and the cost of acquisition of share, which was the book value on the date of conversion with indexation from the date of conversion, should be computed as a capital gain. In the absence of a specific provision, out of these two formulas, the formula which was favorable to the assessee, should be accepted. Therefore, the Commissioner (Appeals) had properly examined this issue in the present situation and directed the Assessing officer to accept the capital gain offered by assessee. Hence, the order passed by the Commissioner (Appeals) deserved to be upheld [ACIT v Brisght Star Investment (P.) Ltd. (2008) 24 SOT 288 (Mum)]