2011 (10) TMI 406 - HC - Income Tax

Interpretation of statutes - Taxability of the gains arising on transfer of the capital assets - Asset transferred as Gift - Period of Holding - cost of acquisition - deeming fiction in Explanation 1(i)(b) to Section 2(42A). HELD THAT - When the legislature by introducing the deeming fiction seeks to tax the gains arising on transfer of a capital asset acquired under a gift or will and the capital gains under Section 48 of the Act has to be computed by applying the deemed fiction it is not possible to accept the contention of revenue that the fiction contained in Explanation 1(i)(b) to Section 2(42A) of the Act cannot be applied in determining the indexed cost of acquisition under Section 48 of the Act. To accept the contention of the revenue that the words used in clause (iii) of the Explanation to Section 48 of the Act has to be read by ignoring the provisions contained in Section 2 of the Act runs counter to the entire scheme of the Act. Section 2 of the Act expressly provides that unless the context otherwise requires the provisions of the Act have to be construed as provided under Section 2 of the Act. In Section 48 of the Act the expression asset held by the assessee is not defined and therefore in the absence of any intention to the contrary the expression asset held by the assessee in clause (iii) of the Explanation to Section 48 of the Act has to be construed in consonance with the meaning given in Section 2(42A) of the Act. If the meaning given in Section 2(42A) is not adopted in construing the words used in Section 48 of the Act then the gains arising on transfer of a capital asset acquired under a gift or will be outside the purview of the capital gains tax which is not intended by the legislature. Therefore the argument of the revenue which runs counter to the legislative intent cannot be accepted. The question of deducting the cost of improvement incurred by the previous owner in the case of an assessee covered under Section 49(1) of the Act would arise only if the period for which the asset was held by the previous owner is included in determining the period for which the asset was held by the assessee. Therefore it is reasonable to hold that in the case of an assessee covered under Section 49(1) of the Act the capital gains liability has to be computed by considering that the assessee held the said asset from the date it was held by the previous owner and the same analogy has also to be applied in determining the indexed cost of acquisition. If indexation is linked to the period of holding the asset and in the case of an assessee covered under Section 49(1) of the Act the period of holding the asset has to be determined by including the period for which the said asset was held by the previous owner then obviously in arriving at the indexation the first year in which the said asset was held by the previous owner would be the first year for which the said asset was held by the assessee. Since the assessee in the present case is held liable for long term capital gains tax by treating the period for which the capital asset in question was held by the previous owner as the period for which the said asset was held by the assessee the indexed cost of acquisition has also to be determined on the very same basis. In the result we hold that the ITAT was justified in holding that while computing the capital gains arising on transfer of a capital asset acquired by the assessee under a gift the indexed cost of acquisition has to be computed with reference to the year in which the previous owner first held the asset and not the year in which the assessee became the owner of the asset. Accordingly we dispose off the appeal by answering the question in the affirmative i.e. in favour of the assessee and against the revenue.

1. ISSUES PRESENTED and CONSIDERED

The core legal issue considered in this judgment is whether, while computing the capital gains arising from the transfer of a capital asset acquired by the assessee under a gift, the indexed cost of acquisition should be calculated with reference to the year in which the previous owner first held the asset or the year in which the assessee became the owner of the asset.

2. ISSUE-WISE DETAILED ANALYSIS

Relevant legal framework and precedents:

The primary legal provisions involved are Section 48, Section 49, and Section 2(42A) of the Income Tax Act, 1961. Section 48 deals with the mode of computation of capital gains, Section 49 addresses the cost of acquisition in certain cases, and Section 2(42A) defines short-term and long-term capital assets. Explanation 1(i)(b) to Section 2(42A) and Explanation (iii) to Section 48 are particularly relevant in determining the period for which an asset is held and the indexed cost of acquisition, respectively.

Court's interpretation and reasoning:

The Court interpreted that the phrase "held by the assessee" in Explanation (iii) to Section 48 should be understood in conjunction with Explanation 1(i)(b) to Section 2(42A), which includes the period for which the asset was held by the previous owner when determining the period for which the asset is held by the assessee. The Court reasoned that the object of the statute is to tax gains arising from the transfer of a capital asset acquired under a gift or will, and this object would be defeated if the period held by the previous owner was not considered in determining the indexed cost of acquisition.

Key evidence and findings:

The Court found that the assessee acquired the asset under a gift deed dated 1/2/2003, and the previous owner had purchased the asset on 29/1/1993. The assessee sold the asset on 30/6/2003. The assessing officer initially determined the indexed cost of acquisition based on the year the assessee acquired the asset (2002-03), but the CIT(A) and ITAT determined it based on the year the previous owner acquired the asset (1993-94).

Application of law to facts:

The Court applied the legal provisions to conclude that the indexed cost of acquisition should be calculated from the year the previous owner first held the asset. This was based on the interpretation that the period for which the asset was held by the previous owner should be included in determining the indexed cost of acquisition, as per the deeming provision in Explanation 1(i)(b) to Section 2(42A).

Treatment of competing arguments:

The revenue argued that the indexed cost of acquisition should be determined based on the year the assessee first held the asset, citing the literal interpretation of Explanation (iii) to Section 48. The Court rejected this argument, emphasizing that the legislative intent and the object of the statute required considering the period held by the previous owner. The Court also referenced the decision in Dy. CIT v. Kishore Kanungo and the principle of literal versus purposive interpretation as discussed in CIT v. Anjum M.H. Ghaswala.

Conclusions:

The Court concluded that the indexed cost of acquisition must be computed with reference to the year in which the previous owner first held the asset, aligning with the legislative intent to tax long-term capital gains appropriately.

3. SIGNIFICANT HOLDINGS

The Court held that while computing the capital gains arising on the transfer of a capital asset acquired by the assessee under a gift, the indexed cost of acquisition must be computed with reference to the year in which the previous owner first held the asset. This decision was in favor of the assessee and against the revenue.

Preserve verbatim quotes of crucial legal reasoning:

"In construing the words 'asset was held by the assessee' in clause (iii) of Explanation to Section 48 of the Act, one has to see the object with which the said words are used in the statute. If one reads Explanation 1(i)(b) to Section 2(42A) together with Section 48 and 49 of the Act, it becomes absolutely clear that the object of the statute is not merely to tax the capital gains arising on transfer of a capital asset acquired by an assessee by incurring the cost of acquisition, but also to tax the gains arising on transfer of a capital asset inter alia acquired by an assessee under a gift or will as provided under Section 49 of the Act where the assessee is deemed to have incurred the cost of acquisition."

Core principles established:

The judgment establishes that the period for which the asset was held by the previous owner must be included in determining the indexed cost of acquisition for assets acquired under a gift, aligning with the legislative intent to tax the gains arising from such transfers effectively.

Final determinations on each issue:

The Court determined that the ITAT was justified in its decision, and the appeal was disposed of in favor of the assessee, affirming that the indexed cost of acquisition should be computed with reference to the year the previous owner first held the asset.

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