2017 (6) TMI 1157 - HC - Income Tax

Treatment to sale considerations - capital gain or business income - Held that - Decision of the Hon ble Supreme Court in the case of Commissioner of Income Tax vs. Groz-Beckert Saboo Ltd. (1978 (11) TMI 2 - SUPREME Court) wherein an assessee converts his capital assets into stock-in-trade and starts dealing in them, the taxable profit on the sale must be determined by deducting from the sale proceeds the market value at the date of their conversion into stock-in-trade and not the original cost of the assessee. As in the case of M/s. Essorpe Mills Ltd. and M/s. Essorpe Holdings Pvt. Ltd Versus DCIT 2013 (7) TMI 996 - ITAT CHENNAI wherein the revenue has accepted the sale of 50% of the same property by the Essorpe Holdings Pvt. Ltd., to an extent of 5.075 acres of land for the assessment year 2009-10, directing the Assessing Officer to apply the provisions of Section 45(2) of the Act and compute the capital gains upto to the date of conversion into stock in trade, and thereafter on actual sale of the land i.e. the difference between the value of sale and stock in trade to be considered as business income.

Issues Involved:
1. Treatment of land as stock-in-trade or capital asset.
2. Applicability of Section 45(2) of the Income Tax Act.
3. Computation of capital gains versus business income.
4. Validity of Board's resolution altering the character of the land.
5. Impact of demerger on tax liability.

Issue-wise Detailed Analysis:

1. Treatment of Land as Stock-in-Trade or Capital Asset:
The respondent company, Essorpe Holdings Pvt. Ltd. (EHPL), and Essorpe Mills Ltd. (EML) had entered into a demerger, transferring the real estate division of EML to EHPL. The land in question was originally treated as an investment and later converted into stock-in-trade by EML on 01.04.2007. The conversion was accepted by the Revenue, and the legal consequences of such conversion were governed by Section 45(2) of the Income Tax Act. The Tribunal observed that the land was to be treated as a capital asset up to the date of conversion into stock-in-trade and that the profit on the sale of such asset should be assessed under 'Profits and gains of business' and not 'capital gains.'

2. Applicability of Section 45(2) of the Income Tax Act:
Section 45(2) states that the profits or gains arising from the conversion of a capital asset into stock-in-trade shall be chargeable to income-tax as the income of the previous year in which such stock-in-trade is sold. The Tribunal directed the Assessing Officer to compute the capital gains up to the date of conversion into stock-in-trade and thereafter, on the actual sale of the land, the difference between the value of sale and stock-in-trade should be considered as 'business income.' The Tribunal's decision was based on the precedent set by the co-ordinate Bench in the case of M/s. Essorpe Mills Ltd. for the assessment year 2009-10.

3. Computation of Capital Gains versus Business Income:
The Assessing Officer initially computed the entire sale consideration under the head 'business income' without applying the provisions of Section 45(2). The Tribunal, however, upheld that the gain on transfer of property up to the date of conversion into stock-in-trade should be assessed under 'capital gains,' and the gain post-conversion should be assessed as 'business income.' The Tribunal's direction was to compute the business income in respect of stock-in-trade of the property, taking into consideration the provisions of Section 45(2).

4. Validity of Board's Resolution Altering the Character of the Land:
The Revenue contended that the Board's resolution dated 01.04.2010, which altered the character of the land from stock-in-trade to investment, had no legal sanctity. The Tribunal did not accept the Board's resolution, and the Assessing Officer treated the entire sale consideration of the land as business income. The Tribunal's decision was based on the principle that once an asset is converted into stock-in-trade, it continues to be treated as such, and the application of Section 45(2) does not reconvert it back into an investment.

5. Impact of Demerger on Tax Liability:
The demerger of EML into EHPL was not considered a transfer under Section 47(vi)(b) of the Income Tax Act, which states that any transfer in a demerger of a capital asset by the demerged company to the resulting company is not regarded as a transfer. Therefore, the capital gains on the conversion of the land into stock-in-trade were to be charged at the time of the actual sale by EHPL. The Tribunal held that the provisions of Section 45(2) were applicable to the case of the assessee, and the capital gains accrued on conversion were to be levied at the time of the sale.

Conclusion:
The Tribunal's decision to apply the provisions of Section 45(2) and compute the capital gains up to the date of conversion into stock-in-trade, and thereafter assess the difference as business income, was upheld. The substantial questions of law framed under Section 260A of the Income Tax Act were answered against the Revenue, and the appeal was dismissed. The Deputy Commissioner of Income Tax, Corporate Circle-2, Coimbatore, subsequently passed an order modifying the total income of the assessee, applying the provisions of Section 45(2).

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