FB 2018 - Capital gains in case of item of inventory converted into capital asset.

[CA DEV KUMAR KOTHARI]

Related provisions:

S.2, 28, 45, 49, 50 of the Income-tax Act, 1961

Related article:

FB 2018 - S.28 - CONVERSION OF STOCK INTO CAPITAL ASSET - AND RELATED PROVISIONS – a provision which is not required at all – must be dropped- dated 03.02.2018.

At the time of conversion of treatment of any item of inventory (stock-in-trade) as capital asset, the fair market value (FMV) on date of such conversion or treatment will be treated as business income. Such FMV and date of conversion of treatment shall be considered the cost of acquisition and date of acquisition as per proposed amendments in S. 2.24, 28 and 49 of the Income-tax Act,1961.

As per proposed amendment business income will be computed on the basis of date of conversion or treatment and the fair market value on that day.

Taxing such income is not at all justified because in fact any income is not realized. If such income is taxed, it will mean that the assessee has made profit out of his book entry. However, taxing income at the time of actual sale as business income , and  capital gains both, asper computation shall be justified.

In case such capital assets (after conversion or treatment as such) is used as an items of depreciable assets of business, the assessee shall be eligible for depreciation at prescribed rates and manner.

Capital gains will be taxable only when such capital asset ( after conversion) is actually sold or transferred. In case such assets form part of block of assets on which depreciation has been allowed, then capital gains shall be computed according to concept of block of assets.

 From THE FINANCE BILL, 2018 (with highlights added for related proposals)

3. Amendment of section 2.

In section 2 of the Income-tax Act,––

 (b) with effect from the 1st day of April, 2019,––

(i) in clause (24),––

(A) after sub-clause (xii), the following sub-clause shall be inserted, namely:––

“(xiia) the fair market value of inventory referred to in clause (via) of section 28;”;

(ii) in clause (42A), in Explanation 1, in clause (i), after sub-clause (b), the following sub-clause shall be inserted, namely:––

“(ba) in the case of a capital asset referred to in clause (via) of section 28, the period shall be reckoned from the date of its conversion or treatment;”

9. Amendment of section 28

In section 28 of the Income-tax Act, with effect from the 1st day of April, 2019,––

 (II) after clause (vi), the following clause shall be inserted, namely:––

“(via) the fair market value of inventory as on the date on which it is converted into, or treated as, a capital asset determined in the prescribed manner;”.

18. Amendment of section 49.

In section 49 of the Income-tax Act, after sub-section (8), the following sub-section shall be inserted with effect from the 1st day of April, 2019, namely:––

“(9) Where the capital gain arises from the transfer of a capital asset referred to in clause (via) of section 28, the cost of acquisition of such asset shall be deemed to be the fair market value which has been taken into account for the purposes of the said clause.”. 

 

Rationalisation of provision relating to conversion of stock-in-trade into Capital Asset

Section 45 of the Act, inter alia, provides that capital gains arising from a conversion of capital asset into stock-in-trade shall be chargeable to tax. However, in cases where the stock in trade is converted into, or treated as, capital asset, the existing law does not provide for its taxability.

In order to provide symmetrical treatment and discourage the practice of deferring the tax payment by converting the inventory into capital asset, it is proposed to amend the provisions of -

(i) section 28 so as to provide that any profit or gains arising from conversion of inventory into capital asset or its treatment as capital asset shall be charged to tax as business income. It is also proposed to provide that the fair market value of the inventory on the date of conversion or treatment determined in the prescribed manner, shall be deemed to be the full value of the consideration received or accruing as a result of such conversion or treatment;

(ii) clause (24) of section 2 so as to include such fair market value in the definition of income;

(iii) section 49 so as to provide that for the purposes of computation of capital gains arising on transfer of such capital assets, the fair market value on the date of conversion shall be the cost of acquisition;

(iv) clause (42A) of section 2 so as to provide that the period of holding of such capital asset shall be reckoned from the date of conversion or treatment.

These amendments will take effect, from 1st April, 2019 and will, accordingly, apply in relation to the assessment year 2019-20 and subsequent assessment years.

[Clause 3, 9 & 18]