Capital gains : Holding period will determines nature of assets even when computation is made under section 50 - loss on transfer of other long term capital asset is eligible for set off against deemed short-term capital gains under section 50 on transfer of long-term depreciable assets.

[CA DEV KUMAR KOTHARI]

Judgments under consideration of present article about set off of loss:

Manali Investments Versus Asstt. CIT 2011 (4) TMI 116 - ITAT MUMBAI

Commissioner of Income-tax-19, Mumbai v. Manali Investment 2013 (12) TMI 333 - BOMBAY HIGH COURT

Relevant provisions and references:

From Income-tax Act, 1961:

Meaning of “short-term capital asset” vide S. 2 (42A).

Meaning o “short-term capital gain” vide S. 2 (42B).

Meaning o “long-term capital asset” vides s. 2 (29A).

Meaning of “long-term capital gain” vide s. 2 (29B).

Special provisions for computation of capital gains in case of depreciable assets – S. 50.

Special provision about WDV deemed as cost of acquisition – S. 50A

Special provisions in case of slump sale of undertaking – S. 50B.

Section 74 relating to set off and carry forward of loss on transfer of capital assets.

Special rates of tax in case of transfer of long-term capital assets vide S. 112.

Commissioner of Income-tax Versus Rajiv Shukla 2011 (4) TMI 173 - Delhi High Court

CIT v. Assam Petroleum Industries P. Ltd. 2003 (6) TMI 23 - GAUHATI High Court 

Commissioner of Income-Tax Versus Ace Builders (P.) Ltd. 2005 (3) TMI 36 - BOMBAY High Court

CIT v. Delite Tin Industries in I. T. A. 1118 of 2008 dated September 26, 2008 2008 (9) TMI 593 - BOMBAY HIGH COURT.  

CIT v. Delite Tin Industries - special leave petition of revenue has been dismissed by Supreme Court on August 21, 2009 (2009 (8) TMI 1076 - SUPREME COURT)  

CIT Vs. Amarchand N Shroff1962 (10) TMI 51 - SUPREME COURT

CIT Vs. Mother India Refrigeration Industries P. Ltd. 1985 (8) TMI 2 - SUPREME Court

Earlier articles :

Benefit of concessions related with long-term capital assets is available for long-term depreciable assets also when income is computed under section 50 by CA Dev Kumar Kothari

Difference tax treatment for long-term and short term capital assets:

In context of tax on income by way of capital gains there is significant difference between short term assets and long term assets. In case of short term assets generally normal rate of tax is applicable (except few cases when short term capital asset has suffered security transaction tax (STT) whereas in case of long-term capital assets rate of tax is lower, benefit of cost inflation index is allowed, some long term capital gains are exempt.

In case of set off of loss and carry forward of loss under head capital gains also there is difference between short term capital loss and long term capital loss.

Period of holding:

In case of provisions relating to capital gains, at many places the expression showing relevance of ‘period of holding’ are used. Thus when a tax treatment is to be with reference to period of holding, the period of holding becomes relevant, even if for some purposes the gains are considered as short term capital gain or short term capital loss.  

Certain important Meanings:

For the purpose of this study, it is sufficient to say that an asset which is held for more than specified period (generally 36 months) is a long-term capital asset and an asset which is held for less than specified period (generally 36 months or less) is a short-term capital asset. Before going through intricacies of the provisions, the relevant part of meaning with highlights is reproduced below:-

“short-term capital asset” means a capital asset held by an assessee for not more than thirty-six months immediately preceding the date of its transfer; S. 2 (42A)

“short-term capital gain” means capital gain arising from the transfer of a short-term capital asset; S. 2 (42B)

“long-term capital asset” means a capital asset which is not a short term capital asset;  s. 2 (29A).

“long-term capital gain” means capital gain arising from the transfer of a long-term capital asset; s. 2 (29B).

On reading of the above provisions , it can be said that capital gains arising on sale of a capital asset forming block of assets, would be long-term capital gain if the capital asset was held for more than thirty six months before it was sold.

Words used in some beneficial provisions:

In relation to aspect of re-investment of long-term capital gains, we find in various provision words used are gains arising from transfer of long-term capital assets.

Words used in provisions of section 74 about set off and carry forward:

In section 74 we find expression used to indicate nature of loss are as follows:

(a)     ‘in so far such loss relates to a short-term capital asset…’

(b)    ‘in so far such loss relates to a long-term capital asset…’

(c)     In respect of any other asset not being a short-term capital asset….

Thus we find that the provisions of section 74 recognize the aspect of holding period and not capital gains / loss being short term capital gain / loss   or long-term capital gain / loss for set off within the year and set off after carry forward. As per provisions loss on sale of short-term capital asset can be set off against any income falling under the head “capital gains”, that means gain on transfer of any capital asset irrespective of period of holding however, in case loss relates to a long-term capital asset, then such loss can be set off only against gains on transfer of any long-term capital asset.

Therefore in relation to depreciable assets we find following features:

Section 50 deems such gains as short-term capital gains for the purpose of computation. We need to compute capital gains based on block of asset. The gains, if any are deemed as short-term capital asset for the purpose of computation under method of ‘block of asset’.

For the purpose of set off , carry forward and set off we need to work out capital gains based on period of holding. If a depreciable asset is long-term its loss will be allowed to be set off only against any other gain on transfer of long-term capital asset.

If a depreciable asset is short-term, loss on its transfer will be allowed to be set off against any other capital gain on transfer of short-term capital asset as well as long-term capital asset.

Gain on transfer of depreciable assets which are long-term can be set off against loss on transfer of long-term capital asset as well as short-term capital asset.

Gain on transfer of depreciable assets which are short-term can be set off against loss on transfer of short-term capital asset only.

Case of Manali Investment:

In the case of Manali Investment in appeal by the Revenue the following re-framed question of law was under consideration of Bombay High court:

"Whether on the facts and in the circumstances of the case and in law, the Tribunal was correct in holding that the assessee is entitled to set-off under Section 74 in respect of capital gain arising on transfer of capital assets on which depreciation has been allowed in the first year itself and which is deemed as short term capital gain under Section 50 of the Income Tax Act relying upon the judgment of this Court in the case of CIT V/s. Ace Builders (P.) Limited (281 ITR 210) even though the said decision was rendered in the context of eligibility of deduction under Section 54E ?"

Analysis of facts and ruling:

Assessee had sold its meters and transformers on which it had claimed full depreciation in first year itself ( per author- this means WDV of sold assets, item wise was nil)

Assessee claimed gains as long term capital gains on transfer meters and transformers.

Assessee had brought forward loss on transfer of long term capital assets.

Assessee claimed set off of such brought forward loss against gains on transfer meters and transformers, in terms of Section 74 of IT Act because meters and transformers were long-term capital assets as per holding period.

The AO took view that in view of computation made under Section 50 of the Act, the gain is in the nature of short-term capital gain, therefore, he disallowed the claim for set off of loss on transfer of other long-term capital assets.

On appeal the Commissioner of Income Tax (A) upheld the order of the assessing officer.

Therefore, assessee preferred appeal before the Tribunal.

The Tribunal allowed the claim of the assessee to set-off its long term losses in terms of Section 74 of the Act against the long term capital gains on sale of transformers and meters.

Tribunal followed the decision in case of CIT v. Ace Builders (P.) Ltd 2005 (3) TMI 36 - BOMBAY High Court in which it was held that by virtue of Section 50 of the Act only the capital gains is to be computed in terms thereof and be deemed to be short-term capital gains. However, this deeming fiction is restricted only for the purposes of Section 50 of the Act and the benefit under Section 54E of the Act which is available only to long term capital gains was extended.

The Tribunal held that the position is similar and the benefit of set-off against long term capital loss under Section 74 of the Act is to be allowed.

The court noted that an identical issue with regard to set off against long term capital loss arose in an appeal filed by the Revenue in the matter of CIT v. Hathway Investments (P.) Ltd, being Income Tax Appeal (L) No. 405 of 2012. And the court by its order dated 31^st January 2013refused to entertain the appeal filed by the Revenue.

The Revenue has not been able to point out any distinguishing features in the present case warranting a departure from the principles laid down in the matter of Ace Builders (P.) Ltd. (supra) and the order dated 31^st January, 2013 in case of Hathway (supra.)

Therefore, in view of the above facts court held that “ we see no reason to entertain the proposed re-framed question of law. Accordingly, the appeal is dismissed with no order as to costs.”

From order of Tribunal:

Some salient observations and decision found in order of Tribunal are analyzed below:

Section 50 has marginal note : “Special provision for computation of capital gains in case of depreciable assets”

Section 50 begins with the non-obstante clause excluding the operation of section 2(42A) and provides that where the capital asset is an asset forming part of a block of assets in respect of which depreciation has been allowed under this Act or under the Indian Income-tax Act, 1922, the provisions of section 48 and 49 shall be subject to modifications set out in clauses (1) and (2) of this section.

In this case meters and transformers, the block of assets under which these were placed, ceased to exist.

Clause (2) of section 50 provides that where any block of assets ceases to exist as such, for the reasons that all the assets in that block are transferred during the previous year, the cost of acquisition of the block of assets shall be the written down value of the block of assets at the beginning of the previous year, as increased by the actual cost of any asset falling within that block of assets, acquired by the assessee during the previous year and the income received or accruing as a result of such transfer or transfers shall be deemed to be the capital gains arising from the transfer of short term capital assets.

The sum and substance of this provision is that when all the assets in a particular block of assets are transferred and such the block of assets ceases to exist, then the excess of sale price over the opening written down value together with the cost of assets purchased during the year, shall be deemed to be the capital gains arising from the transfer of short term capital assets.

In the opening part of section 50, the provisions of section 2(42A) have been made non-operative by means of the non obstante clause.

As per section 2(42A), to the applicable extent a capital asset held by an assessee for not more than 36 months immediately preceding the date of its transfer is considered as short-term capital asset.

The effect of section 50 is that once depreciation has been allowed under this Act on a capital asset which forms part of a block of asset then capital gain on the transfer of such assets shall not be computed in accordance with the provisions of section 48 and 49, but the income so resulting shall be deemed to be the capital gains arising from the transfer of short term capital assets in the manner provided in the latter section.

Section 50 contains a special provision for “computation of capital gains” in case of depreciable assets.

It is a deeming provision and only by legal fiction income from the transfer of otherwise long term capital assets ( held for a period of more than 36 months) is treated as capital gains arising from the transfer of short term capital assets.

A deeming provisions is one, the mandate of which does not exist but for such provision. An imaginary state of affairs is taken as actuality notwithstanding the fact that it is at variance with the otherwise legal position.

It is trite that a deeming provision cannot be extended beyond the purpose for which it is enacted. The Hon’ble Supreme Court in CIT Vs. Amarchand N Shroff 1962 (10) TMI 51 - SUPREME COURT dealt with the scope of a deeming provision and laid down that the fiction cannot be extended beyond the object for which it is enacted.

The same view has been reiterated by the Hon’ble Apex Court in CIT Vs. Mother India Refrigeration Industries P. Ltd. 1985 (8) TMI 2 - SUPREME Court holding that : “legal fictions are created only for some definite purpose and this must be limited to that purpose and should not be extended beyond their legitimate field”. The enunciation of law by the highest Court of land in the above case divulges that the operation of a deeming provision cannot be extended beyond the purpose for which it is enacted.

Thus we have to restrict deeming provision of section 50 only up to the point which has been covered within the purview of section 50.

The prescription of section 50 is to be extended only up to the computation of capital gains.

Once the amount of capital gain is determined in case of depreciable assets as per this section, ignoring the mandate of sections 48 and 49 which otherwise deal with the mode of computation of capital gains, the function of this provision shall come to an end and the capital gain so determined shall be dealt with as per the other provisions of the Act.  

The dispute is about setting off of brought forward loss from long term capital assets against the income computed under section 50, on transfer of meters and transformers.

The assessee is contending that the amount in question be considered as eligible for set off against the brought forward loss from long term capital assets as per section 74.The Revenue has held against this claim.

When we closely read the meanings of short-term capital asset, long-term capital asset and short-term capital gains and long-term capital gains, it becomes apparent that the transfer of a long term capital asset resulting into gain leads to “long term capital gain” and the profit on the transfer of a short term capital asset results into `short term capital gain’. It, therefore, emerges that if any capital asset of the nature, not covered in proviso to sec. 2(42A), is sold by the assessee after holding for a period of 36 months or more, the capital gain arising there from shall be characterized as “long term capital gain”.  

The assessee claimed the benefit of set off of the brought forward loss from the long term capital assets against the income from the transfer of Meters and transformers, which were admittedly held for a period more than 36 months.

Section 74(1) provides that where in respect of any assessment year, the net result of the computation under the head `Capital gains’ is a loss to the assessee, the whole loss shall, subject to the other provisions of this chapter, be carried forward to the following assessment years and further clause (b) provides that insofar as such loss relates to a long term capital asset, it shall be set off against income, if any, under the head “Capitalgains” assessable for that assessment year in respect of any other capital asset not being a short term capital asset. The effect of this provision is that the brought forward loss from long term capital assets can be set off only against long term capital gain within the period prescribed in sub-section (2) of section 74. Consequently it becomes manifest that there is no provision for allowing set off of such brought forward loss against the short term capital gain in the following years.

The core of controversy is about the determination of the character of Rs.145.99 lakhs for the purpose of section 74, as to whether it is a short term capital gain or long term capital gain.

Tribunal viewed that the position in case of S. 74 is similar to that in relation to section 54E before Bombay High Court in case of ACE Builders (supra). Capital gain has resulted from the transfer of an asset which was held for a period of more than three years and no long term capital gain has entered into the computation of total income of the assessee on this transaction. This amount would also retain the character of long term capital gain for all other provisions and consequently qualify for set off against the brought forward loss from the long term capital assets. In our considered opinion, the facts of the instant case are fully covered by the judgment of the Hon’ble jurisdictional High Court in ACE Builders (supra), which is binding on all the authorities acting under its jurisdiction. We, therefore, overturn the impugned order on this score and hold that the assessee is entitled to such set off in terms of section 74.

Conclusion:

The period of holding of a capital asset will determine its character as a long-term capital asset or a short-term capital asset. In case of general cases of long-term capital assets that is section 48 there is provision to allow benefit of inflating cost of acquisition with cost inflation index (CII). This benefit is not available in case where section 50 is applied. In case of section 50, the gains are computed with reference to written down value of block of assets brought forwarded, actual cost of new assets acquired and sale value of assets sold during the previous year. If there remain any WDV of the block after adjustments for additions and transfers, there will be no capital gains. If there is some surplus by way of excess of sale value over ( WDV B/f + additions) , then such excess is computed as short-term capital gains means benefit of CII is not allowed. In case any block ceases to exist, then also short-term capital gains are computed.

However, this computation does not change the period of holding and character of capital asset. When any other provision is applicable based on period of holding, the section 50 shall not be extended to deem a capital asset which is held for more than 36 months before transfer, as an asset not held for more than 36 months. Capital reinvestment provisions, provisions of set off and carry forward, and special rate of tax are based on period of holding therefore, benefit of such provisions will be allowable.

Loss to assessee due to such interpretation:

It is not a case that assessee is winner in all matters due to above interpretation. As noted earlier, in case any asset forming block of asset was held for more than 36 months and there is loss on its transfer, then loss on transfer of such asset shall be loss on transfer of a long-term capital asset, and such loss shall be eligible only for set off against gains on transfer of any long term capital asset, although computation is made u/s 50 without allowing benefits of application of cost inflation index on cost of acquisition and cost of improvement.