2009 (10) TMI 824 - AT - Income Tax

Summary

Issues Involved:
1. Classification of capital gains from the sale of deep discount bonds as long-term or short-term.
2. Eligibility for deduction under Section 54EC of the Income Tax Act.
3. Treatment of notional accrued interest on Optionally Fully Convertible Premium Notes (OFCPNs).

Issue-wise Detailed Analysis:

1. Classification of Capital Gains:
The primary issue was whether the capital gains derived from the sale of deep discount bonds by the assessee should be classified as long-term or short-term capital gains. The assessee argued that the bonds were acquired on 23-09-2000, the date on which the letter of allotment was issued, and thus, the gains should be treated as long-term since the bonds were held for more than 12 months. The Assessing Officer (AO) and the Commissioner of Income Tax (Appeals) [CIT(A)] contended that the period of holding should be reckoned from the date of issuance of the debenture certificates (10-05-2001) or the date of listing in the National Stock Exchange (NSE) (20-09-2001), making the gains short-term.

The Tribunal held that the assessee became the owner of the bonds on the date of the letter of allotment (23-09-2000). The letter of allotment evidenced the assessee's title to the bonds, and the relationship of debtor-creditor was established on that date. The subsequent issuance of debenture certificates did not alter this relationship. Therefore, the capital gains arising from the sale of the bonds were long-term, as the bonds were held for more than 12 months from the date of the letter of allotment.

2. Eligibility for Deduction under Section 54EC:
The eligibility for deduction under Section 54EC of the Income Tax Act was contingent on the classification of the capital gains as long-term. Since the Tribunal concluded that the capital gains were long-term, the assessee was entitled to the deduction under Section 54EC. The Tribunal allowed the assessee's claim for exemption under Section 54EC, holding that the investment in Rural Electrification Corporation bonds qualified for the deduction.

3. Treatment of Notional Accrued Interest on OFCPNs:
The assessee raised an additional ground concerning the addition of Rs. 2,11,535/- as notional accrued interest on Optionally Fully Convertible Premium Notes (OFCPNs). The assessee followed the cash system of accounting and contended that the interest should be assessed only in the year of encashment. The AO, however, assessed the interest on an accrual basis, relying on Circular No. 2 of 2002 issued by the CBDT.

The Tribunal referred to the order of the Ahmedabad Bench of the Tribunal in the case of Kisan Discretionary Family Trust vs. ACIT, which held that Circular No. 2 of 2002 is applicable only to deep discount bonds purchased after 15-02-2002. Since the assessee followed the cash system of accounting, the interest could not be assessed on an accrual basis. The Tribunal allowed the additional ground raised by the assessee, holding that the interest of Rs. 2,11,535/- could not be assessed in the year under appeal.

Conclusion:
The Tribunal concluded that the capital gains from the sale of deep discount bonds were long-term, entitling the assessee to the deduction under Section 54EC. Additionally, the notional accrued interest on OFCPNs could not be assessed on an accrual basis due to the assessee's cash system of accounting. The appeal was partly allowed in favor of the assessee.