Capital gains: Donor's date of acquisition is relevant for increasing cost of acquisition with cost of inflation index (CII) when done sells the property received in gift- decides Special Bench of ITAT.

[C.A. DEV KUMAR KOTHARI]

Relevant links:

Sections of Income-tax Act, 1961:

2(14) - capital asset.

2(29A) - long-term capital asset.

2(29B) - long-term capital gain.

2(42A) - Short-term capital asset.

2(42B) - short-term capital gain.

2(47) - transfer.

S.45 - Capital gains.

Section 47 transactions not regarded as transfer for purpose of Section 45.

S. 48- mode of computation of capital gains.

S.49- cost with reference to certain modes of acquisition.

S.55- meaning of  'adjusted', 'cost of acquisition' and  cost of improvement.

DCIT Vs MANJULA J SHAH 2009-TIOL-698-ITAT-MUM-SB

CIT vs. Laxmi Machine Works, 2008 -TMI - 6557 - SUPREME Court

K.P. Varghese vs. ITO 2008 -TMI - 5862 - SUPREME Court

C.W.S. (India) Ltd. Vs. CIT, 2008 -TMI - 5449 - SUPREME Court

 K.P. Varghese vs. ITO 2008 -TMI - 5862 - SUPREME Court

CIT vs. G. Narasimhan And Others, 236 ITR 227 (SC)

Smt. Meena Devgan vs. ITO, 117 TTJ 121 (Cal)

Mrs. Pushpa Sofat vs. ITO 81 ITD 1

CBDT Cir. No. 636 dt. 31.8.1992 198 ITR 1(St.)

Query on www.taxmanagementindia.com

Vide issue no. 1554 posted on 22.10.2009 by Shri Kaladhara Saralaya the following query was placed:

 In case of gifted property, what should be the Cost Inflation Index (CII) rate we have to apply to arrive at the cost for the purpose of calculating capital gains? Is it CII of the year in which the original owner (Donor) became the owner of the property or of the year on which the donee receives the gift?

The author had placed his views on 28.10.2009 as follows:

In case of gifts, there is no transfer vide Section 49(1) (ii), as per Section 2(42A)- Explanation 1 (c) in case capital asset is acquired by way of any manner laid down in Section 49, then the holding period of previous owner is included in holding period of assessee who received capital asset by way of gift etc. The assessee , in such case can exercise option to take FMV as on 01.04.1981 in case previous owner held the property prior to that. In other words, as there was no taxable transfer at the time of gift, the continuous holding is deemed since the property was held by previous owner. Therefore, CII of the year of acquisition by previous owner or 1981-82 (if held prior to 01.04.81 by previous owner) will be applicable. This is also as per purpose of CII that is to remove the element of cost inflation while computing capital gains on transfer of long term assets. This is also result of reading meaning of indexed cost of acquisition and indexed cost of improvement as given in the last proviso to Section 48 vide clauses (iii) and (iv) respectively. It cannot be that FMV is taken as on 01.04.1981 ,CII for improvement is taken for 1989 and 1999 when previous owner effected improvement and CII for cost of acquisition is taken for 2008 when present owner/ assessee got gift. That will lead to anomalous situation. On reading of these two meanings, it can be said that CII of the year in which cost or cost of improvement were incurred are relevant. On the basis of CII for the year in which previous owner acquired property , computation can be made and there should not be difficulty though litigation may take place that one have to be ready to face because there seems defect of drafting of meaning of indexed cost of acquisition. Generally it has been accepted. In case of one of my client involving conversion of debenture into shares, CIT(A) allowed date of acquisition of debenture for LTC gain and CII and department accepted the order of CIT(A) though the revenue effect was substantial.

At that time there were some judgments of Tribunals taking contrary views. Bombay ITAT has taken view that year of receiving gift is relevant to apply CII for year of acquisition. Calcutta ITAT has taken view in favor of assessee and held that year of acquisition by previous owner (donor) is relevant for applying relevant CII. However, author has placed his views without being influenced by the two set of judgments. At that time the decision of ITAT Special Bench, dated 16.10.2009 was not available.

Recently a judgment of Special Bench of ITAT has been released. The bench has held that the CII of the year in which the donor acquired the gifted assets is relevant. After this judgment the author has placed further views on the discussion forum on 11.11.2009 which read as follows:

The views expressed by me in my earlier reply found acceptance In DCIT12(2), Vs.MANJULA J SHAH, 2009-TIOL-698-ITAT-MUM-SB decided by Special Bench of ITAT on October 16, 2009. As per Special Bench, the date of acquisition by the previous owner in case of gift, is relevant for the purpose of indexing the cost of acquisition in hands of donee / assessee who subsequently sold the property received in gift from the previous owner. The bench applied purposive approach, avoidance of anomalies, and some decisions of the Supreme Court on interpretation. I feel that one more aspect that when two or more provisions in the I.T. Act, are contradictory and pitted against each other, that is effect to one will defeat effect to another provisions, then the provision which is/ are beneficial to the assessee should be applied. In case of gift etc. the provisions to take date and cost of acquisition of previous owner and also allowing present owner to take FMV as on 01.04.1981, if property was acquired by previous owner before that date (though gift may be afterwards), treating long-term nature by including period of holding of previous owner, allowing cost of improvement to be indexed according to the year in which even previous owner incurred it, are in favor of assessee/ present owner, whereas only wordings in relation to CII of cost of acquisition is against the assessee. In such circumstances, provisions which are beneficial to assessee need to be given weightage besides some drafting mistakes causing contradictions in drafting can be considered as drafting error. In such situations language or words used can be modified to reach to purpose seeking approach and to avoid anomaly.

A Brief analysis of decision of ITAT:

Provisions considered:

Sections 2(42A), Section 45, Section 47, Explanation (iii) and (iv) to section 48.

Facts of the case:

Assessee sold on 30.06.2003 a flat for Rs. Rs. 1,10,00,000/-

The flat so sold was actually received by the assessee as gift from her daughter Mrs. Shilpa J. Shah under a gift deed dated 1.02.2003. The donor purchased the flat on 29.1.93 for a total consideration of Rs. 50,48,350/-

Assessee claimed indexed cost of acquisition of Rs. 1,04,81,552/- by considering cost  in hands of donor  and also the  year of acquisition by the donor as base year for applying cost inflation index (CII) for FY 1992-93 that is 223 and CII of 463 applicable to the year of sale that is FY 2003-04.

Assessee also claimed stamp duty of Rs. 1,01,010/-

Thus assessee declared long-term capital gains at Rs. 4,17,338/- on sale of the flat.

The A.O. considered that the said flat was received by the assessee as gift only on 1.2.2003. So assessee held the flat for the first time in F.Y. 2002-03 and therefore he applied CII of 447  instead of 223 claimed by assessee.

The claim and various  contentions raised by the assessee were rejected by the A.O. he gave emphasis to caluse (iii) in Explanation to Section 48. He held that other provisions could not be extended or applied for the purpose of working out indexed cost of acquisition and in view of the clear provisions of Explanation (iii) to Section 48, the indexed cost of acquisition was liable to be worked out by taking the cost inflation index of 447 applicable to F.Y. 02-03 being the first year in which the asset was held by the assessee.

The AO worked out the indexed cost of acquisition at Rs. 52,29,052/- (i.e. Rs. 50,48,350 x 463/447) and the long term capital gain was computed by him at Rs. 56,69,838/- as against Rs.4,17,388/- declared by the assessee.

Before CIT(A) and ITAT- matters for consideration:

Gift- assessee receives a flat from his daughter under gift deed.

After few years assessee sells off the flat.

Assessee works out allowable inflated cost of acquisition of flat by applying cost inflation index in relation to the year in which the previous owner had first held the asset (acquired the asset)

AO works out the allowable inflated cost of acquisition by applying the cost inflation index for the year in which the gift deed was registered.

 CIT(A) allows the claim of assessee while deciding first appeal.

Special bench of ITAT

Due to conflicting decisions by Tribunals  issue was  referred to the Special Bench.

Tribunal considered that there is no capital gain chargeable to tax as a result of transfer of a capital asset under gift since the transaction involving a gift of capital asset is not regarded as transfer for the purpose of Section 45. However, if such capital asset becoming the property of the assessee under gift is subsequently transferred  by done then as per Section 45, the capital gain arising from such transfer is made chargeable to tax and the date and cost of acquisition of the previous owner are adopted as a cost and date of acquisition of the assessee for the purpose of computation of income from such capital gains including for determination of character of 'capital asset'- short-term or long-term.

Second stage of transfer: as a result of gift not regarded as transfer resulting into taxable capital gain vide the provisions of section 47 there was no tax imposed at first stage of transfer by gift. Therefore, transfer is made chargeable to tax at the second stage when the capital asset becoming the property of the assessee under gift is transferred by him.

The relevant provisions which treat the cost and date of acquisition of the previous owner as the cost and date of acquisition of the assessee shows the scheme of the Act for taxation of capital gains.

 The importance is assigned to the period of holding of the capital asset in as much as Explanation (iii) to section 48 refers to the first year in which the asset was held by the assessee whereas Explanation 1(b) to section 2(42A) provides for inclusion of the period for which the asset was held by the previous owner in determining the period for which any capital asset is held by the assessee.

The legislative intention is very clear to treat the date as well as cost of acquisition of capital asset of the previous owner to be the date and cost of acquisition of the assessee for the purpose of computing capital gain in terms of Section 48.

When the meaning of indexed cost of improvement provide that cost of improvement incurred by previous owner ( in case of gift) shall be inflated with reference to CII of the year of improvement, there cannot be any reason that the cost of acquisition should be inflated with reference to the year in which assessee received gift.

 In view of CIT vs. Laxmi Machine Works, 2008 -TMI - 6557 - SUPREME Court, Schematic interpretation of the relevant provisions needs to be adopted to serve the legislative intention behind enacting the relevant provisions.

The fiction vide Explanation 1(b) to section 2 (42A)  has to be carried to its logical conclusion as held following CIT vs. G. Narasimhan And Others, 236 ITR 227 (SC).

The purpose of indexation has to be kept in mind in this context and when cost was admittedly incurred by the previous owner in the earlier years, the only logical conclusion is that the benefit of indexation should be given for the corresponding period.

Interpretation sought to be given by the D.R. be applied then  nobody would get the benefit of indexation for the period of holding of the capital asset by the previous owner which is certainly not acceptable in logical terms.

 Literal interpretation would result in absurdity and unjust result which has to be avoided following K.P. Varghese vs. ITO 2008 -TMI - 5862 - SUPREME Court

Decision rendered by the Mumbai Bench of ITAT in the case of DCIT vs. Kishore Kaungo , taking a  literal interpretation  is leading to absurdity and unjust result. Therefore the view taken by the Division Bench of the Tribunal adopting such literal interpretation needs to be reviewed by this Special Bench.

The decision rendered by Calcutta bench of ITAT in the case of Smt. Meena Devgan vs. ITO, 117 TTJ 121, taking a view in favour of the assessee on this issue, on the other hand, is a well discussed and well considered one.

ITAT Chandigarh SMC Bench in the case of Mrs. Pushpa Sofat vs. ITO 81 ITD 1 has also taken view in  favour of the assessee in similar circumstances.

 The Circular No. 636 reported at 198 ITR 1(St.) at page No. 24 issued by the CBDT explaining the purpose of indexation while computing the long term capital gain also support the view in favor of assessee.

Example considered

Tribunal considered an example where capital asset has become a property of the assesee under a gift prior to the cut off date of 1.4.1981 but the same is transferred by him only after 1.4.1981; say in Financial Year 1987-88, the year to be adopted for indexation as per the contention of the learned D.R., would be Financial Year 1987-88. However, the cost of acquisition of capital asset in such case would be taken as Fair Market Value of 1.4.1981 being the cut off date embedded in the indexation scheme as agreed even by the learned D.R.

The situation, will thus arise where the cost of acquisition of capital asset would be taken as of 1.4.1981 whereas the cost inflation index for the year 1987-88 would be applied to the said cost to work out the indexed cost of acquisition. Such a working will not stand to any reasonability or logic and will certainly defeat the very purpose of indexation scheme as explained in the aforesaid Circular No. 636 dated 31.8.90.

Decision of Tribunal:

In view of the reasons discussed by Tribunal it was  held that  for the purpose of computing long term capital gain arising from the transfer of a capital asset which had become property of the assessee under gift, the first year in which the capital asset was held by the assessee has to be determined to work out the indexed cost of acquisition as envisaged in Explanation (iii) to section 48 after taking into account the period for which the said capital asset was held by the previous owner. In that view of the matter, Tribunal held that the indexed cost of acquisition of such capital asset has to be computed with reference to the year in which the previous owner first held the asset.

 Accordingly, The Special bench answered the question referred to it  in favour of the assessee and upheld the order of the learned CIT(A) and held that the CII of the year  in which previous owner purchased the property shall be considered and  the appeal of the revenue was dismissed.

Conclusion:

In case a capital asset is acquired by way of gift or other modes in which transfer from previous owner to the present owner is not regarded as transfer, then it can be said that the period of continuous holding is considered for the purpose of considering holding period, applying CII for ascertaining allowable inflated cost of acquisition and inflated cost of improvement based on the year, in which the previous owner incurred the cost or cost of improvement, as the case may be.

From here need not be printed.