Tax planning by conversion of stock in trade into capital asset.

[AMIT BAJAJ ADVOCATE]

When a capital asset is converted into stock in trade then capital gain u/s 45(2) of Income Tax Act arises in the year of sale and not in the year of conversion. But in vice versa situation i.e conversion of stock in trade into capital asset there does not arise any capital gain.

If an assessee is in the business of real estate and on closure of his business he retains the existing stock in trade of immovable properties of the business with him and holds it as investment then it will become his capital asset from the time of closure of his business. In such case if he later on sells the same capital asset  say after three years from the date of purchase of such asset then the gain arising there from will be a long term capital gain and  and the benefit of indexation and paying of tax @ 20% instead the normal rate can be planned.

Similar case can also happen in case of a business of trading in shares. Even during the continuation of the business the assessee may transfer some of his stock in trade into his capital asset by deciding to hold it as an investment and can sell the same at a later stage and can pay tax on the profit as capital gain instead of business profit.

It is here to be noted that long term capital gain from equity shares sold in stock exchange and on which Security Transaction Tax has been paid, is exempt u/s 10(38) of Income Tax Act. Thus in case of conversion of shares held as stock in trade into capital asset, the benefit of exemption u/s 10(38) will be available if such converted capital asset is sold later and long term capital gain arises from it. .

In such cases, there will not be any capital gain at the time of conversion and if the assessee sells such converted asset at a later date, the profit will certainly give rise to capital gain and in order to ascertain whether such profit is long-term capital gain, the period of holding would have to be reckoned from the date of acquisition of the asset as stock in trade and not from the date of conversion into capital asset, as section 2(42A) does not lay down that the holding of the asset for the required period has to be as capital asset.

Thus the assessee can go for tax planning and save the tax by treating as the long term capital gain which is taxable @ 20% instead of normal rate and benefit of indexation can also be taken.

 

Discussions to this article

[DEV KUMAR KOTHARI]

A good short article by Mr. Bajaj.

Tax saving should be natural outcome of planning  financials, business, investments etc.

I would like to add that in any financial or administrative decision the primary considerations are  or should be  business and financial necessities and expediencies  and changes should be due to changes in  facts and circumstances  and situations. A change in governments tax policy can also be a factor of such changes. Therefore. any decision to treat a capital asset or convert it into stock-in-trade or to convert stock-in-trade into capital asset should have factual aspects as primary consideration. The tax saving should be an natural outcome of planning of affairs and tax planning should not be primary consideration.The title of article can highlight changes in business realities resulting into tax saving. For example, with a view ot make provision for higher studies or other purposes one can also gift his stock-in-trade to children who can hold it as 'capital asset'. In that case the date of acquisition and cost of acquisition in hands of donor will be date and cost for donee and he can avail benefit of CII with reference to actual cost being cost of acquisition and date of actual acquisition by donor.

We should emphasise business planning, financial planning, retirement planing, planning for family welfare etc. instead of tax planning. 

[A.K. Batra]

Wheather discussion in second para is in accordance with the situation stated in the first paragraph of the article.

 

Manoj Garg