Determining of cost of acquisition and taxability in the case of self generating assets - Applicability of clause (a) of sub-section (2) of section 55. - Income Tax - 1964/1999

INSTRUCTION NO. 1964/1999 Dated: March 17, 1999 Subject: Determining of cost of acquisition and taxability in the case of self generating assets - Applicability of clause (a) of sub-section (2) of section 55 - Regarding. Under the provisions of Income-tax Act, any profits or gains arising from the transfer from a capital assets is chargeable to tax as capital gains u/s. 45. the term 'Capital Asst' has been defined under the Act as Property of any kind held by the assessee whether or not connected with his business or profession. The term 'Transfer' has been defined to include extinguishment of any right in relation to a capital asset. The scheme of taxing the profit arising from a transfer of a capital asset is contained in section 45 to 55A of the Income-tax Act, 1961. 2. In this connection, it is pointed out that with effect from 1.4.99, the Finance (No. 2) act, 1998 has been enlarged the definition of block of assets by including intangible assts such as know how, patents, copyrights, trade-marks, licenses, franchises or any other business or commercial rights of similar nature which are eligible for depreciation. 3. Disputes have arisen from time to time on the question of determination of capital gains in the case of self generating assets. In this connection, the decision of the Supreme Court in the case of B.C. Srinivasa Shetty (128 ITR 294) is relevant. In this decision, the Supreme Court had occasion to discuss the nature and scope of goodwill of a business. In the wake of this decision, in order to provide for a mechanism to determine the cost of acquisition in the case of self generating assets, clause (a) to sub-section (2) of section 55 was amended. Accordingly from assessment year 1988-89, "a capital asset being goodwill of a business, tenancy rights, stage carriage permits or loom hours" was included in this section thereby providing a means to determine the cost of acquisition. Further from assessment year 1998-99 as an alternative to goodwill of a business, "a right to manufacture, produce or process an article or thing" has also been included in the clause (a) of sub-section (2) of section 55. 4. Recently, the Board has received references where clarifications have been sought on the taxability of compensation received for agreed absence of competition or under agreements containing certain restrictive covenants. In this connection, it may be clarified that the taxability of such compensation under the Income-tax Act depends upon the nature and circumstances of each case with reference to the agreement in question. The first issue that may have to be decided in such cases is whether the capital asset in question is goodwill of a business or a right to manufacture, produce or process any article or thing. This is because the amendment made by the Finance Act, 1997 in section 55(2) enlarging the scope of a capital asset is structured in such a manner that it is either "goodwill" or "right to manufacture, produce or process an article or thing" - (i) Where the capital asset transferred is in the nature of goodwill of a business, recourse to section 55(2) can be made only from assessment year 1988-89 and subsequent assessment years. (ii) Where the capital asset transferred is in the nature of a right to manufacture, produce or process an article or thing, recourse to section 55(2) can be made only from assessment year 1998-99 in respect of any consideration received for the transfer thereof which includes extinguishment or curtailment of such right. In this connection, attention is invited to Clause 19 of the Memorandum explaining the provisions of the Finance Bill, 1997, wherein it has been pointed out that consideration received on extinguishment of such a right is in the nature of capital receipt and is not liable to tax under the head 'capital gains' upto assessment year 1997-98. it is clarified that even where such transfer, extinguishment or curtailment of such a right is complete or in part, the taxability of the consideration will remain unaffected i.e., the same will not be taxable under the head capital gains only up to assessment year 1997-98 and will become taxable from the assessment year 1998-99 and subsequent assessment years. (iii) Where the capital assets are intangible assets(like trade marks etc. listed in para 2 above) not being in the nature of goodwill of a business, the issue to be decided depends upon one vital factor whether such asset sought to be transferred was initially acquired at a cost or whether it was self generated. In the event, such asset was acquired at a consideration, capital gains will have to be calculated in accordance with law in this behalf. However, where such asset in question is a self generating asset, no capital gains will be levied up to assessment year 1997-97, after which date capital gains will become leviable. It may be clarified that mere payment of some amount for registration of such intangible asset like trade mark etc. may not constitute the cist of acquisition for the purpose of computation of capital gains. 5. The above may be brought to the notice of all officers in your region. F. No. 225/83/99-ITA-II (MALATHI R. SRIDHARAN) Under Secretary to the Govt. of India.