Capital gains: Donor’s date of acquisition is relevant for inflating cost of acquisition and cost of improvement with cost of inflation index (CII) for computing capital gains on sale by donee- authors views find support from Bombay and Delhi High Courts.

[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.

S.47 transactions not regarded as transfer for purpose of S.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.

Arun Shungloo Trust vs. CIT before Delhi High Court,       tmi   

CIT v. Manjula J. Shah    Bombay High Court                    tmi

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

CIT vs. Laxmi Machine Works, 2007 -TMI - 6557 - SUPREME Court

K.P. Varghese vs. ITO 1981 -TMI - 5862 – (SUPREME Court)

C.W.S. (India) Ltd. Vs. CIT, 1994 -TMI - 5449 – (SUPREME Court)

of K.P. Varghese vs. ITO 1981 -TMI - 5862 – (SUPREME Court)

CIT vs. G. Narasimhan And Others, 1998 -TMI - 5706 – (SUPREME Court)

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

Mrs. Pushpa Sofat vs. ITO 2001 -TMI - 60959 – (ITAT CHANDIGARH)

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

Earlier queries and articles:

In Discussion Forum of the  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?

At that time the author had placed his views on 28.10.2009 as follows:    

 In case of gifts, there is no transfer vide S. 49(1) (ii), as per S. 2(42A)- Explanation 1 (c) in case capital asset is acquired by way of any manner laid down in S. 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 S. 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.

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.

The judgments of Bombay and Delhi High Court:

On departmental appeal the Bombay High Court has  affirmed the decision of the Special Bench in case of Manjula Shah  and dismissed the appeal of the revenue.

In this case the assessee’s daughter purchased a flat on 29.1.1993 at a cost of Rs.50.48 lakhs. She gifted the flat to the assessee on 1.2.2003. The assessee sold the flat on 30.6.2003 for Rs. 1.10 crores. In computing LTCG, the assessee took the indexed cost of acquisition under Explanation (iii) to s. 48 on the basis that she “held” the flat since 29.1.1993. The AO held that as the assessee had “held” the flat from 1.2.2003, the cost inflation index for 2002-03 would be applicable. The CIT (A) and the Special Bench of the Tribunal upheld the claim of the assessee. On appeal by the department, HELD dismissing the appeal:

Under Explanation 1(i)(b) to s. 2(42A), in determining the period for which any asset is held by an assessee under a gift, the period for which the said asset was held by the previous owner has to be included. Accordingly, though the assessee acquired the capital asset on 30.6.2003, she was deemed to hve “held” the asset from 29.1.1993 onwards. This fiction will apply to clause (iii) of the Explanation to s. 48 as well for determining the “indexed cost of acquisition”. The object of the legislature is to tax the gains arising on transfer of a capital acquired under a gift or will by including the period for which the said asset was held by the previous owner. This object cannot be defeated by excluding the period for which the said asset was held by the previous owner while determining the indexed cost of acquisition of that asset to the assessee.

Similar issue came in Arun Shungloo Trust vs. CIT before Delhi High Court, The Delhi High Court also decided the issue in favor of assessee.

In this case a person (whi is also the settlor  of assessee) acquired property before 1.4.1981 and he settled the same  on trust on 5.1.1996.

 The assessee-trust sold the property and computed the indexed cost of acquisition on the basis that it “held” the property from the time the settlor had held it. The AO accepted that the settlor’s cost of acquisition had to be treated as the assessee’s cost of acquisition but held that the settlor’s period of holding could not be treated as the assessee’s period of holding. This was upheld by the Tribunal.

Therefore, assessee preferred an appeal and the High Court, decided the issue in favor of assessee. The High Court reasoned and held on the following lines:

1. The department’s contention that in a case where s. 49 applies the holding of the predecessor has to be accounted for the purpose of computing the cost of acquisition, cost of improvement and indexed cost of improvement but not for the indexed cost of acquisition will result in absurdities.
2. It leads to a disconnect and contradiction between “indexed cost of acquisition” and “indexed cost of improvement”.
3. This cannot be the intention behind the enactment of s. 49 and the Explanation to s. 48.
4. There is no reason why the legislature would want to deny or deprive an assessee the benefit of the previous holding for computing “indexed cost of acquisition” while allowing the said benefit for computing “indexed cost of improvement”.  The benefit of indexed cost of inflation is given to ensure that the taxpayer pays capital gain tax on the “real” or actual “gain” and not on the increase in the capital value of the property due to inflation.
5.  The expression “held by the assessee” used in Explanation (iii) to s. 48 has to be understood in the context and harmoniously with other Sections and as the cost of acquisition stipulated in s. 49 means the cost for which the previous owner had acquired the property, the term “held by the assessee” should be interpreted to include the period during which the property was held by the previous owner CIT v. Manjula J. Shah  supra. followed.

Some more aspects:

As discussed by the author in previous articles and discussion forum some  relevant aspects which seems were not argued are also relevant as briefed below:

When the law provides that in case of gift, inheritance etc. there is no transfer, it is clear that for the purpose of computing capital gains, the holding is considered as continued and  it is deemed that there is no break in holding period.

When cost of acquisition of previous owner is considered as cost of acquisition of present owner (donee), it is deemed that the present owner hold the property at the cost at which the previous owner held. Therefore, for computing the capital gains the holding is deemed as continued holding for this reason also.

When at the time of transfer  by way of gift, etc. it is deemed that there is no transfer, that clearly means that for the purpose of computing capital gains the holding period is not broken. On consideration of provisions of section 2(42A) and particularly the Explanation under that clause which provide the circumstances of holding of period, it is clear that the period of holding of previous owner in case of gift etc. should be considered as included. It can be said that the circumstances staeted in the Explanation are just illustrative and not exhaustive. This is also clear from the clause (ii) to the Explanation, which provide that in cases other than those mentioned in clause (i), the period for which any capital assets is held by assessee shall be determined subject to any rules which may be made by the Board in this behalf.

Sub-clause (b) of Clause (i) of  Explanation provide that in such cases the period of holding of previous owner shall be included. When the period of previous owners holding is included for determining character  of capital asset as short term or long-term capital asset, there is no reason not to include the period of holding of previous owner for allowing benefit of CII, particularly when cost of acquisition in hands of previous owner is treated as cost of acquisition of present owner (assessee).

 Therefore, to make it clear it is desirable that the Board should have laid down rules in this regard.