2015 (5) TMI 1114 - AT - Income Tax

Capital gain on conversion of land as stock in trade - business income treatment - Held that - The land was to be treated as capital asset upto conversion of it into stock in trade and the assessee is liable for capital gain on conversion of it as stock in trade and provisions of section 45(2) is applicable and after this when the land was actually sold, the income arising from sale to be considered as Business Income which is to be assessed in this assessment year. As the Assessing Officer computed the entire sale consideration under the head business income , he did not apply the provisions of sec.45(2) of the Act, which is not proper. In view of this, we direct the AO to compute the capital gains upto the date of conversion into stock in trade by applying provisions of section 45(2) of act and thereafter, on actual sale of the land i.e. difference between the value of sale and stock in trade to be considered as business income and to be assessed in this assessment year, accordingly. Appeal of the assessee is partly allowed.

Summary

Issues Involved:
1. Treatment of land holding as investment versus stock in trade.
2. Application of Section 45(2) of the Income Tax Act regarding capital gains on conversion of land.
3. Assessment of income from the sale of land as business profit versus capital gains.
4. Validity of reconversion of stock in trade to investment.
5. Tax implications of demerger and subsequent sale of land.

Detailed Analysis:

1. Treatment of Land Holding as Investment versus Stock in Trade:
The assessee argued that the land holding should be treated as an investment, and thus the entire sale consideration should be considered as capital gains. The Commissioner of Income Tax (Appeals) did not accept this, treating the land as stock in trade, leading to the assessment of the entire sale consideration as business profit.

2. Application of Section 45(2) of the Income Tax Act:
The assessee contended that the land was converted into stock in trade by Essorpee Mills Limited (EML) on 01.04.2007, and under Section 45(2), the capital gains should be assessed at the time of actual transfer of land. The Tribunal upheld this view, directing the Assessing Officer to compute capital gains up to the date of conversion into stock in trade and treat the subsequent gains from the actual sale as business income.

3. Assessment of Income from Sale of Land as Business Profit versus Capital Gains:
The Assessing Officer initially assessed the entire sale consideration as business profit. However, the Tribunal noted that the land was originally treated as a capital asset and converted into stock in trade. Thus, the gains up to the date of conversion should be assessed as capital gains, and the gains from the actual sale should be treated as business income.

4. Validity of Reconversion of Stock in Trade to Investment:
The assessee claimed that after the demerger, they converted the land back into investments from stock in trade. The Tribunal did not find merit in this argument, noting that the conversion was done without legality and with the intention to avoid taxes. The Tribunal emphasized that the accounting treatment given by EML cannot affect the applicability of Section 45(2) to the sale of land by the assessee.

5. Tax Implications of Demerger and Subsequent Sale of Land:
The Tribunal considered the demerger approved by the High Court, which transferred the real estate division of EML to the assessee. The Tribunal referred to a previous order where the sale of 5.075 acres of the same property was treated as business income, with the capital gains assessed as per Section 45(2). The Tribunal directed the Assessing Officer to apply the same principles to the current case, treating the land as a capital asset up to its conversion into stock in trade and assessing the subsequent gains from the actual sale as business income.

Conclusion:
The Tribunal concluded that the land should be treated as a capital asset up to its conversion into stock in trade, and the gains from this conversion should be assessed as capital gains under Section 45(2). The income from the actual sale of the land should be treated as business income. The appeal of the assessee was partly allowed, with directions to the Assessing Officer to compute the capital gains and business income accordingly.