Capital gains when cost is reduced to nil due to forfeiture: A discussion about Tribunal judgment in case of Smt. Smita N.Saha on section 45 and 51 and some other related issues.

[CA DEV KUMAR KOTHARI]

Smt. Smita N. Shah. Versus Joint Commissioner Of Income-tax, Special Range 7 2004 (7) TMI 285 - ITAT BOMBAY-H  

Provisions considered by the Tribunal – section 45 and 51 of the Income-tax Act,1961.

Other provisions discussed by author on related issues section 48, 55 of the Income-tax Act,1961.

Facts in the case:

The assessee entered into an agreement for sale and had received advance payment from buyer for transfer of certain property.

For some reasons the sale could not be fructified and, resultantly, the assessee forfeited the advance money received due to failure on part of buyer.

On occasion of forfeiture The Assessing Officer (AO for short) computed the capital gains for excess of the forfeited amount above cost of acquisition.

When the capital asset was actually sold in subsequent deal, the AO again computed capital gains. For this occasion the AO  took the cost of acquisition at Nil and computed the capital gains. This action of the AO was confirmed by the Commissioner of Income-tax (Appeals) {CIT(A) for short. Hence assessee had to prefer second appeal before the Income Tax Appellate Tribunal (for short ITAT)

Order of ITAT:

Tribunal while considering provisions of section 45 of the Income Tax Act, 1961 (for short ITA) in relation to the said first occasion that is forfeiture of advance money held that there was no transfer of capital asset, therefore, section 45 was not attracted and capital gains could not be computed. Because in order to effect capital gain, transfer of asset is a sine qua non therefore, the amount forfeited could not be construed to be capital gains.

On consideration of section 51 of ITA, ITAT held that amount so forfeited will go to reduce the cost of acquisition of the asset or the fair market value as on 01.04.1981, if the assessee had exercised option to substitute such fair market value in place of cost of acquisition in terms of S. 55 and in case of depreciable asset from the written down value, as the case may be.

In this case the cost of acquisition was taken on the basis of the fair market value adopted by the DVO as on 1-4-1981 was considered as cost of acquisition by the AO amounting to Rs. 9,40,416.

The amount forfeited which is to be deducted as per the prescription of section 51, was Rs. 21,02,000.

Therefore, the calculation of cost of acquisition minus amount forfeited or retained resulted into a negative figure.

Application of cost inflation index (CII):

It was argued that should the retained money be ignored, the cost of acquisition would be indexed and would be worked out by applying relevant CII. But if it came in minus figure, it could not be worked out as per the cost inflation index. As such, section 51 should be interpreted with reference to the dictum:- ‘UT RES MAGIS VALEAT QUAM PEREAT’, i.e., such a meaning should be given to the statute so that it could carry out and effectuate to the fullest extent the intention of the Legislature.

If the language of the statute is plain, obvious meaning is to be applied. Rules of interpretation are applied only to resolve the ambiguities. The object and purpose of interpretation is to ascertain the MENS LEGIS, i.e., the intention of the law, as evinced in the statute. If the precise words used are plain and unambiguous, ITATl is bound to construe them in their ordinary sense of words which may be modified or varied where their import is doubtful or obscure.

section 51 takes care of the situation where any capital asset was negotiated for transfer on any previous occasion and as a result thereof assessee received and obtained advance money; in such eventuality, section prescribes that the cost of the asset is to be reduced to the extent of the advance money so received or retained in computing the cost of acquisition. No dispute was raised in respect of fair market value adopted by DVO.

The words ‘indexed cost of acquisition’ are nowhere mentioned in section 51. As such, it is beyond the competence of the Court to substitute the same.

The language of the statute is clear and explicit. The words of the statute speak the MENS LEGIS. As such, recourse cannot be had to the purposive theory of interpretation.

The Commissioner (Appeals) was correct in taking the cost of acquisition at ‘Nil’.

In the result appeal of the assessee was partly allowed.

Observations of author:

In this case the ITAT had rightly held that when section 51 is attracted and any advance money received on any previous occasion of agreement to sale, is forfeited or retained then the amount so forfeited or retained is to be reduced from the cost of acquisition of the asset. This is statutory implication. It appears that in this case the assessee had not raised the issue that when cost of acquisition is nil, capital gains cannot be determined. However, this aspect can be raised by assessee before the AO when he re compute income. This aspect is a consequential issue related with order of ITAT. The ITAT had held that the cost of acquisition is nil, the consequential result is that capital gains cannot be computed as per provisions and hence cannot be subjected to tax u/s 45 as per settled legal position.

In view of author, in absence of transfer of a capital asset the amount so received and retained is a capital receipt. Even in absence of provision like section 51 such amount cannot be called income.

On reduction of such amount, the cost of acquisition is to be reduced in accordance with provisions of S. 51. Had there been no such provision, it was not necessary to deduct the same from cost of acquisition. Therefore, for accounting purposes amount forfeited should be credited to capital or capital reserves and cost of capital asset should be carried at actual cost. When a large property was purchased at the same time and cost of acquisition is in relation to such large property, and a part of it was subject matter of negotiation, the amount forfeited on such negotiation should be credited to capital for accounting purposes. And for purposes of computation under ITA the amount should go to reduce the cost of entire property (large property for which cost of acquisition was incurred and not against the portion which was subject to previous negotiation which failed and resulted into forfeiture. This is because, the cost is to be computed with reference to the date of acquisition.

Adoption of fair market value as on 01.04.1981 is at option of assessee. The AO cannot force such an option. Therefore, depending on circumstances, it is for the assessee to adopt fair market value or not. In case fair market value was less than actual cost, then the assessee will not exercise such option. In the case before ITAT, it seems that the AO has applied the fair market value, however the assessee did not dispute the same.

In case the amount forfeited exceeds cost, then the cost of acquisition will have to be treated to be nil. It cannot be considered as a negative figure.

Whether the cost so adjusted be considered as nil or negative, the implication is that in such situation capital gains cannot be computed for the following reasons:

1. From consideration we need to deduct the cost of acquisition. When cost of acquisition is nil or negative, capital gains cannot be computed in terms of section 45 read with section 48. The capital gains must be less than the sale value or consideration accruing. It cannot be more than the consideration accruing. This rule apply to short-term capital asset as well as long-term capital asset.
2. When cost is nil (or negative) it cannot be increased by applying CII to compute long-term capital gains as per computation provisions. Therefore, computation provisions cannot be applied in case of long term capital asset due to failure of provision for computation of CII cost also.