2005 (6) TMI 236 - AT - Income Tax

Summary

Issues Involved:
1. Conversion of capital asset into stock-in-trade under Section 45(2) of the Income Tax Act.
2. Determination of the nature of the transaction as an adventure in the nature of trade.
3. Calculation of long-term capital gain and business income.

Issue-Wise Detailed Analysis:

1. Conversion of Capital Asset into Stock-in-Trade under Section 45(2):
The core issue was whether the assessee's action of demolishing an existing structure and constructing a new commercial complex constituted a conversion of a capital asset into stock-in-trade under Section 45(2) of the Income Tax Act. The Assessing Officer (AO) argued that the demolition and subsequent construction signified a conversion of the capital asset into stock-in-trade, thereby necessitating the calculation of long-term capital gain based on the fair market value of the land in 1990 and treating the remaining difference as business income. The CIT(A) disagreed, stating that the burden of proof was on the Department, which failed to establish the conversion. The Tribunal, however, upheld the AO's view, emphasizing that the creation of a new commercial asset from the demolished structure indicated a conversion into stock-in-trade, making Section 45(2) applicable.

2. Determination of the Nature of the Transaction as an Adventure in the Nature of Trade:
The AO concluded that the entire transaction was an adventure in the nature of trade based on several factors: the commercial nature of the activity, the involvement of the assessee's wife, agreements with Kamal Construction Company, temporary vacation of the property by Kamal & Co., obtaining loans for construction, and incurring advertisement and brokerage expenses for selling the offices. The CIT(A) refuted this, stating that the assessee had no prior real estate business and thus Section 45(2) was inapplicable. The Tribunal reversed this decision, highlighting that the demolition and construction of a new commercial building, along with renting and selling parts of the building at different rates, indicated a business venture. The Tribunal noted that the entire transaction was systematic and profit-oriented, thus qualifying as an adventure in the nature of trade.

3. Calculation of Long-Term Capital Gain and Business Income:
The AO calculated the long-term capital gain by taking the fair market value of the land portion in 1990 and treated the remaining difference as business income. The CIT(A) directed a re-examination of the issue, suggesting the use of Section 55A if necessary, and concluded that the capital gain arising could not be considered business income. The Tribunal, however, upheld the AO's calculation, stating that the entire activity of demolishing the old structure and constructing a new commercial complex was a business activity. Consequently, the long-term capital gain was to be calculated at the time of conversion, and the subsequent sale or renting of the newly constructed commercial building was to be treated as business income.

Conclusion:
The Tribunal concluded that the actions of the assessee and his wife amounted to converting a capital asset into stock-in-trade, thereby invoking Section 45(2). The nature of the transaction was deemed an adventure in the nature of trade, and the calculation of long-term capital gain and business income by the AO was upheld. The decision of the CIT(A) was reversed, and the appeal of the Revenue was allowed.