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

[CA DEV KUMAR KOTHARI]

Amendment of S.2 (24) relating  definition of income is proposed inter alia to include cases of business stock-in-trade /inventory being treated or converted into capital asset.

 It is proposed to include fair market value of such stock (inventory) converted into capital asset to be considered as business income of the previous year in which such conversion or treatment takes place.

 In the definition clause an amendment related to computation of capital gains on transfer of  such assets which is converted or treated as ‘capital assets’ is also made so as to specify that the date on which such conversion or treatment is made will be considered as date of acquisition of such assets as capital asset. Therefore, period of holding before such date shall not be included while deciding the nature of capital asset as short-term capital asset or long-term capital asset.

The treatment of fair market value as on date of conversion or treatment as business income is not justified because it will amount to including notional income into taxable income.

An item of stock-in-trade is converted or treated as ‘capital asset’ when it has lost character and quality of stock-in-trade and assumed an asset to be held as capital asset for long duration. 

For example, stock-in- trade of property may be converted into fixed assets for purpose of business, a dealer of vehicles may convert some vehicles as his fixed assets for business purposes like demo vehicle, vehicle for transportation of stores and spares, staff bus etc. In such cases stock –in-trade is transferred to investment or fixed assets but ownership remain with the same person.

Therefore, including fair market value in business income is not at all justified. 

In related provision, as exist about conversion or treatment of ‘capital asset’ as stock-in-trade, vide S.45 (2)  it is provided that such conversion or treatment will be treated as transfer and  fair market value as on date of such conversion or treatment shall be considered as consideration accruing on such transfer.

However, it is provided that the income chargeable to tax on actual transfer of such asset (stock-in-trade) shall be taxable under head capital gains and business only when actually such stock-in-trade is sold or transferred by assesse.

That is only in case of actual sale for consideration of stock-in-trade computation shall take place.

The same principal should be applied for profit on sale or transfer of any stock-in-trade converted or treated as capital asset.

However as per proposed amendment, just on date of transfer ( by book entry) of stock –in-trade into capital asset, the fair market value shall be considered as business income.

This seems not justified.

There is no need for this amendment. This is because, when a stock- in- trade is transferred to ‘capital asset’, at cost or book value, there is no accrual of any income. There is in fact no transfer of ownership. The asset remain with the owner. There is no sale or actual transfer.

However, provision can be made that in case such converted capital asset is sold at the time of sale, income derived shall be computed under head business, based on cost or book value of converted stock and fair market value on date of conversion into capital assets.

For computation of capital gains, provision already exist in S.45.

THE FINANCE BILL, 2018

 (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;”.

Explanatory memorandum: 

Clause (24) of the said section defines the expression “income”.

It is proposed to insert a new sub-clause (xiia) in the said clause (24) so as to include the fair market value of inventory referred to in Clause (via) of section 28, also within the definition of income.

Clause (42A) of the said section, inter alia, provides for determination of period for which the capital asset is held by the assessee.

It is proposed to insert a new sub-clause (ba) in clause (i) of Explanation 1 of the said clause (42A) so as to provide that in case inventory is converted into or treated as a capital asset under the proposed new clause (via) of section 28, the period shall be reckoned from the date of its conversion or the treatment.

These amendments will take effect from 1st April, 2019 and will, accordingly, apply in relation to the assessment year 2019- 2020 and subsequent years.

Clause 9 of the Bill seeks to amend section 28 of the Income-tax Act relating to profits and gains of business or profession.

The said section, inter alia, provides that certain types of compensation receipts as set out in sub-clauses (a) to (d) of clause (ii) of the said section are taxable under the head "Profits and gains of business or profession".

It is proposed to insert a new sub-clause (e) in the said clause (ii) so as to provide that any compensation due or received by any person, by whatever name called, at or in connection with the termination or the modification of the terms and conditions, as the case may be, of any contract relating to his business shall be chargeable to tax under the head "Profits and gains of business or profession".

It is further proposed to amend the said section so as to provide that the fair market value determined in the prescribed manner of the inventory as on the date of its conversion or treatment as capital assets shall be chargeable to tax under the head “Profit and gains of business and profession”.

These amendments will take effect from 1st April, 2019 and will, accordingly, apply in relation to the assessment year 2019-2020 and subsequent years.