Date of improvement will not affect ‘date of acquisition of a capital asset’ .- Discussion in view of judgment of Allahabad High Court in case of Ram Rani Kalia.

[CA DEV KUMAR KOTHARI]

Section 2(29B), read with section 45,

Commissioner of Income-tax, Allahabad  v. Smt. Rama Rani Kalia [2013 (9) TMI 962 - ALLAHABAD HIGH COURT]

General discussion:

In context of ‘capital gains’ under the Income-tax Act, 1961 the date of acquisition and cost of acquisition; date or dates of improvement and cost of improvements to capital asset; period of holding of capital asset, are very important for determination of chargeability of tax under the head as well as for computation of capital gains after deduction of allowable cost of acquisition and cost of improvement with benefit of Cost inflation index in case of most  of capital assets which are held for longer duration of more than one year or three years as may be applicable.

Separate cost inflation index are applicable for cost of

acquisition and cost of improvement from time to time:

For computation of  allowable cost for determination of  ‘capital gains’, cost inflation index applicable for the year of acquisition and different cost inflation index for different years in which improvement  took place are to be applied. For example suppose a plot of land was purchased in the year 1982, and construction took place during 1985, 1999, and 2013 then cost of  acquisition will be inflated with reference to cost inflation index of year of acquisition and the cost of improvement will be inflated with reference to the four years in which improvement took place.

When the period of holding since acquisition till the date of transfer makes the capital asset a long-term capital asset, the cost inflation index is to be applied to cost of acquisition and cost of improvement both. Even if cost of improvement was incurred with a period of three years, the cost inflation index will be applicable in case the year of improvement and year of transfer are different. In other words the capital asset is transferred in a year after the year of improvement, and then cost inflation index benefit will be applicable.

Therefore, it is clear from the scheme of provisions that  the year of acquisition does not change when an improvement takes place in a subsequent year.

Conversion of lease hold rights into ownership is improvement of capital asset:

Under a lease agreement the lessee gets possession of property and right to use as a lessee. Such rights are capital asset. During lease period the lessee is ‘owner’ as a lessee.

When a lease expires, or is terminated, then the capital asset in form of lease comes to an end.

However, if the lessor converts leasehold rights of the lessee into ownership rights, or such conversion takes place due to any legal action or as a consequence of any terms and conditions, then the property just get imp[roved and a leasehold property is converted into a free hold property.

In case of such conversion, there may be a cost of improvement or there may not be any cost of improvement. In case there is cost of improvement incurred by lessee to make the property free hold, than such cost of improvement will also be allowable. If the leasehold property is a long –term capital asset, then the cost of improvement will also be eligible for inflation with cost inflation index, wherever applicable.

Improvement will not change period of holding:

There can be several type of improvement in capital assets. For example, an agricultural land may be converted into industrial land or residential land. A village area may be brought under municipal area. A small township may become a big city due to improvement in infrastructure.

A low land can be improved by filling material to make it a high land.

When an agricultural land is converted into industrial land, there is no change in period of holding. The date of acquisition of agricultural land which is now industrial land will remain to be date of acquisition.  

Some improvements require intervention of owner and incurring of expenses. Some improvements may be without any cost of improvement or even efforts made by the owner. For example improvement due to extension of municipal limits to village area, or improvement by conversion of land from agricultural land to residential land or an agricultural land to urban land may not involve any cost of improvement to be incurred by the owner. Such improvements can be regarded as accumulation of capital.     

Leasehold right into freehold right makes only improvement of capital asset:

Conversion of rights of lessee in property from leasehold right into freehold right makes only improvement of capital asset. There is qualitative change in capital asset but there is no change in date of acquisition of capital asset.

However, in case before such conversion, lease is terminated and then capital asset is transferred, then the matter will be different.

Case of Smt. Rama Rani Kalia:

The assessee had long-term capital asset in form of lease hold shop. While holding leasehold rights and possession of the shop ,the lease hold shop was converted into free hold shop on payment of certain amount. The assessee transferred the shop within a short period after conversion into freehold shop. The revenue contended that the period of holding must be reckoned from date of acquiring ownership rights as free hold owner. The assessee contended that the period is to be reckoned from the date when leasehold rights were acquired. The CIT(A) allowed claim of assessee.

The relevant paragraphs of the order of the CIT (A) are quoted as under (with highlights added by author):—

"5.2 So far as, the sole ground of appeal is concerned, which relates to the fact of the matter that the sale made, to be considered as Long Term Capital Gain and not as Short Term Capital Gain, as stated earlier also, I am of the view and as also the appeals decided by me in the cases of—

(1)		Usha Mehta, (A.No.45/ITO/R-I(4)Alld/2010-11 dated 28.9.2010).
(2)		Malini Malviya, (A.No.47/ITO/R-I(2)Alld/2010-11 dated 28.9.2010)
(3)		Vinodini Mehta (A.No.46/ITO/R-I(4)Alld/2010-11 dated 28.9.2010)
(4)		Tribeni Prasad Mehta, (A.No.47/ITO/R-I(4)Alld/2010-11 dated 28.9.2010)
(5)		Seema Segal, (A.No.67/ACIT/R-I/Alld/08-09 dated 12.11.2010) On the same issue and in particular after considering the orders of the Hon'ble ITAT, Allahabad in Dhiraj Shyamji Chauhan, Allahabad Vs. CIT Allahabad in ITA No. 134(Alld)/2007- Asst. Year 1999-2000 dated Nov 22, 2007, wherein it was held that the conversion of the property from leasehold to freehold is nothing but the improvement of the title of the property, but the fact remains that assessee was the owner even prior to the said conversion, the plea of the appellant is acceptable. As also submitted by the appellant, in the cases of Sri D.N. Chadha & T.N. Chadha [ITA No. 38 & 45 (Alld)/2008 dated February 28, 2008, the Hon'ble ITAT, Allahabad has reiterated the same point of view. In the case of CIT v. Sujatha Jewellers 2006 (3) TMI 115 - MADRAS High Court  also, the assessee took an immovable property in lease and sub leased the same to another company. The AO held that the transfer of lease by the assessee would amount to transfer of capital asset viz. Lease rights. It was held that the assessee had acquired interest in the property by having a lease in its favour and by sub leasing the property, it had transferred, the interest in property in favour of a third party which is liable to be taxed under the head 'Capital Gains'. By sub leasing of property, the interest of the transferor i.e. lessor is extinguished and this extinguishment of right is covered u/s 2(47) of the Act. Therefore, it was held that the transaction of sub-lease constitutes transfer and the gains arising there from were assessable as Capital Gains. While deciding this case, the decisions rendered in A.R. Krishnamurty & A.R. Raja Goptal v. 1980 (12) TMI 33 - MADRAS High Court and R.K. Palshikar (HUF) v. CIT1988 (5) TMI 3 - SUPREME Court  were followed by the Hon'ble Court. Even before the insertion of clause (v) to section 2(47) of the I.T. Act, by the Finance Act, 1987, w.e.f. 01.04.1988, it was held in the case of A.R. Krishnamurthy and A.R. Raja Gopal v. CIT 1980 (12) TMI 33 - MADRAS High Court  that the word 'transfer' u/s 2(47) gave a restricted meaning and it includes grant of lease rights. It was held by the Hon'ble Apex Court regards Section 2(47) that this clause contains an 'inclusive' definition of transfer. Therefore, other modes of 'transfer' are also liable to Capital Gain subject to fulfilment of other conditions regarding taxability under the head 'Capital Gain' (C.I.T. v. Narang Dairy Products 1996 (2) TMI 6 - SUPREME Court)  As also decided by Hon'ble ITAT, Allahabad, in the case of Dhiraj Shyamji Chauhan v. CIT Allahabad that it was evident that the assessee was holding the property since 1922 on lease basis. Thus, the assessee was having right may be restricted, on the property. The right of the holder of the lease hold property is almost actually as the owner of the property, that for example entire DDA property is sold on lease hold basis. The assessee got the conversion of the property into freehold property, that may be considered as improvement in the title, but the fact remains that the assessee was the owner since 1922 on lease basis."

The CIT (A) relied on the definition of 'long term capital gain' which contains an 'inclusive' definition of transfer, and does not rule out other mode of transfer subject to fulfillment of conditions regarding taxability under the head 'Capital Gain' vide C.I.T. v. Narang Dairy Products 1996 (2) TMI 6 - SUPREME Court

CIT v. Dr. V.V. Modi [1995 (10) TMI 30 - KARNATAKA High Court]

CIT(A) also relied on CIT v. Dr. V.V. Modi 1995 (10) TMI 30 - KARNATAKA High Court . In that case  the assessee was allotted a site by the Bangalore Development Authority in 1972.  Assessee secured a conveyance on payment of entire sale consideration at the end of 10th year, and a sale deed was executed in his favour by the Development Authority registered on 13.5.1982.

On 27.11.1982, the assessee sold the site to a third person. In the said case, the Tribunal found that in such case 50 % should be considered as short-term gain and 50 % as long term capital gain.

On a reference it was held by the Karnataka High Court that from the date of sale in favour of the assessee, the assessee had only one capacity of being the absolute owner of the site in question, and it was in that capacity alone, the assessee transferred his title over the site in question in favour of the purchaser.

In case of Rama Rani Kalia, Income Tax Appellate Tribunal held that it was a case of long term capital gain, as the assessee was owner of the property, even prior to conversion 9(from leasehold to free hold) 

The difference between the 'short-term capital' asset and 'long-term capital asset' is the period over which the property has been held by the assessee and not the nature of title over the property. The lessee of the property has rights as owner of the property subject to covenants of the lease, for all purposes. He may, subject to covenants of the lease deed, transfer the lease hold rights of the property with the consent of the lessor. The conversion of the rights of the lessee in the property from having lease hold right into free hold is only by way of improvement of her rights over the property, which she enjoyed. It would not have any effect on the taxability of gain from such property, which is related to the period over which the property is held. If the period is less than 36 months, the gain arising from such transfer would be of short-term capital gain.

In the present case, the property was held by the assessee as a lessee since 1984, and the same was transferred on 31.03.2004, after the lease hold rights were converted into free hold rights on the same property which was in her possession, in her favour on 29.03.2004. The conversion was by way of improvement of title, which would not have any effect on the taxability of profits as short term capital gain.

The honorable High Court thus held that  “There is no error of law in the order of the Tribunal. The question Nos. 1 and 2, framed in the appeal, are thus decided in favour of the assessee and against the department.”

The Income Tax Appeal filed by revenue was thus  dismissed.

Observations o f author:

As discussed in general discussions about capital gains there is statutory recognition of concepts of ‘acquisition’ and ‘improvement’. The date of acquisition is fixed at the time when an asset or property of any kind is acquired. This date cannot be changed on happening of some events like improvement or detoriating of capital asset. The expressions are used with the article ‘the’. That means that the date of acquisition is fixed for each capital asset. The provision that cost of improvement will be inflated with reference of cost inflation index in which improvement cost was incurred, also clearly shows that the legislative intent is to keep the date of acquisition as fixed one and cost of improvements according to the year of improvement. Therefore, in this case the revenue must accept the judgment of honorable Allahabad High Court and should not challenge it before the Supreme Court.