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December 21, 2020

What had never accrued or was never received could not be computed as capital gains under section 48 – SC

by CA Shivam Jaiswal in Income Tax

What had never accrued or was never received could not be computed as capital gains under section 48 – SC

Capital gain is the profit one earns on the sale of an asset like stocks, bonds or real estate. It results in capital gain when the selling price of an asset exceeds its purchase price. It is the difference between the selling price (higher) and cost price (lower) of the asset. Capital loss arises when the cost price is higher than the selling price. The sale of capital assets may lead to capital gains and these gains may attract tax under the Income Tax Act.

Section 45 of Income Tax Act, 1961 provides that any profits or gains arising from the transfer of a capital asset effected in the previous year will be chargeable to income-tax under the head ‘Capital Gains’. Such capital gains will be deemed to be the income of the previous year in which the transfer took place. Section 52 was concerning Consideration for transfer in cases of understatement.

Let us refer to the case of K. P. Varghese v. ITO (1981), where the issue under consideration was whether understatement of consideration in a transfer of property was a necessary condition for attracting the applicability of section 52(2) or was is enough for the Revenue to show that the fair market value of the property as on the date of the transfer exceeded the full value of the consideration declared by the assessee in respect of the transfer by an amount of not less than 15% of the value so declared.

Facts of the Case:

  • Assessee who purchased a house situated in 1958 for Rs. 16,500, sold the same in AY 1966-1967 to his daughter in law and five of his children.
  • On this assessment was first completed in normal course accepting the case of assessee that no capital gains accrue on subject property sale transaction since the house was sold by the assessee at the same price at which it was purchased and no capital gains accrued to him as a result of the transfer.
  • Later on, AO issued notice under section 148 seeking to reopen the assessment of assessee for subject assessment year.
  • AO intimated to the assessee that he proposed to fix the fair market value of the house sold by the assessee at Rs. 65,000 as against the consideration of Rs. 16,500 for which the house was sold and assess the difference of Rs. 48,500 as capital gains in the hands of the assessee.
  • The assessee raised objections against the reassessment proposed to be made by the Income-tax officer but the objections were over-ruled and an order of reassessment was passed by the Income-tax officer including the sum of Rs. 48,500 as capital gains and bringing it to tax.
  • Though the sale of the house by the assessee was in favour of his daughter-in-law and five of his children who were persons directly connected with him, the AO could not invoke the aid of section 52(1) for bringing the sum of Rs. 48,500 to tax, because there was admittedly no under- statement of consideration in respect of the transfer of the house and it was not possible to say that the transfer was affected by the assessee with the object of avoidance or reduction of his liability under section 45.
  • The AO therefore rested his decision to assess the sum of Rs. 48,500 to tax on section 52(2) and taking the view that this sub-section did not require as a condition precedent that there should be under-statement of consideration in respect of the transfer and it was enough to attract the applicability of the sub-section if the fair market value of the property as on the date of the transfer exceeded the full value of the consideration declared by the assessee by an amount of not less than 15% of the value so declared, which was indisputably the position in the present case.
  • The AO assessed the sum of Rs. 48,500 to tax as capital gains.

Proceedings of High Court

  • Assessee filed writ petition before the High court.
  • The stand of assessee that under-statement of consideration in respect of the transfer was a necessary condition for attracting the applicability of section 52(2) and since in the present case there was admittedly no under-statement of consideration and it was a perfectly authentic transaction; section 52(2) had no application and the sum of Rs. 48,500 could not be brought to tax as capital gains under that provision was given imprimatur by the High court and re-assessment was resultantly quashed.
  • Revenue filed an intra court appeal against the order of Kerala high court in Division bench.
  • In full bench decision, the majority opinion of two judges favoured the revenue side as it held that in order to bring a case within section 52(2), it was not at all necessary that there should be under-statement of consideration in respect of the transfer and once it is found that the fair market value of the property as on the date of the transfer exceeded the full value of the consideration declared by the assessee in respect of the transfer by an amount of not less than 15% of the value so declared.
  • Section 52(2) was straightaway attracted and the fair market value of the property as on the date of the transfer was liable to be taken as the full value of the consideration for the transfer.
  • The writ petition was accordingly dismissed and the order of re-assessment sustained by the majority decision.
  • Aggrieved with the decision of the HC, assessee appealed before the Supreme Court (SC).

Observations of SC

  • SC held that it was a well settled rule of construction that where the plain literal interpretation of a statutory provision produced a manifestly absurd and unjust result which could never have been intended by the legislature, the court could modify the language used by the legislature or even ‘do some violence’ to it, so as to achieve the obvious intention of the legislature and produce a rational construction.
  • Having regard to this well recognised rule of interpretation, a fair and reasonable construction of section 52(2) would be to read into it a condition that it would apply only where the consideration for the transfer is under-stated or in other words, the assessee had actually received a larger consideration for the transfer than what is declared in the instrument of transfer and it would have no application in case of a bona fide transaction where the full value of the consideration for the transfer is correctly declared by the assessee.
  • There may be cases where the consideration for the transfer was shown at a lesser figure than that actually received by the assessee but the transferee was not a person directly or indirectly connected with the assessee or the object of under-statement of the consideration is unconnected with tax on capital gains.
  • Such cases would not be within the reach of sub section (1) and the assessee, though dishonest, would escape the rigour of the provision enacted in that sub-section.
  • Parliament therefore enacted sub-section (2) with a view to extending the coverage of the provision in sub-section (1) to other cases of under-statement of consideration.
  • This became clear if one gave regard to the object and purpose of the introduction of subsection (2).
  • It was a sound rule of construction of a statute that for the sure and true interpretation of all statutes in general, four things are to be considered:
    1. What was the common law before the making of the Act?
    2. What was the mischief and defect for which the common law did not provide?
    3. What remedy the Parliament hath resolved and appointed to cure the disease of the Commonwealth, and
    4. The true reason of the remedy, and then the office of all the Judges is always to make such construction as shall suppress the mischief, and advance the remedy
  • The speech made by the Mover of the Bill explaining the reason for the introduction of the Bill could be referred to for the purpose of ascertaining the mischief sought to be remedied by the legislation and the object and purpose for which the legislation is enacted.
  • Interpretation of a statute being an exercise in the ascertainment of meaning, everything which was logically relevant should be admissible.
  • The object and purpose of sub-section (2) was not to strike at honest and bona fide transactions where the consideration for the transfer was correctly disclosed by the assessee but to bring within the net of taxation those transactions where the consideration in respect of the transfer was shown at a lesser figure than that actually received by the assessee, so that they do not escape the charge of tax on capital gains by under-statement of the consideration.
  • This was the real object and purpose of the enactment of sub-section (2) and the interpretation of this sub-section must fall in line with the advancement of that object and purpose.
  • So, it was held that it accepted as the underlying assumption of subsection (2) that there is under-statement of consideration in respect of the transfer and sub-section (2) applied only where the actual consideration received by the assessee was not disclosed and the consideration declared in respect of the transfer was shown at a lesser figure than that actually received.
  • Section 52(2) was strongly supported by the marginal note to section 52 which read ‘Consideration for transfer in cases of under-statement’.
  • SC noted that it was undoubtedly true that the marginal note to a section could not be referred to for the purpose of construing the section but it could certainly be relied upon as indicating the drift of the section
  • SC held that the placement of subsection (2) in section 52 did indicate in some small measure that Parliament intended that sub-section to apply only to cases where the consideration in respect of the transfer was under-stated by the assessee.
  • As held by SC, it was not altogether without significance that the provision in sub- section (2) was enacted by Parliament not as a separate section, but as part of section 52 which, as it originally stood, dealt only with cases of under-statement of consideration.
  • It was further explained that, If Parliament intended sub-section (2) to cover all cases where the condition of 15% difference was satisfied, irrespective of whether there was understatement of consideration or not, it was reasonable to assume that Parliament would have enacted that provision as a separate section and not pitchforked it into section 52 with a total stranger under an inappropriate marginal note.
  • Moreover, there was inherent evidence in sub-section (2), which suggested that the thrust of that sub-section was directed against cases of under-statement of consideration.
  • SC held that, there were 2 distinct conditions which had to be satisfied before section 52(2) could be invoked by the Revenue and the burden of showing that these two conditions were satisfied rested on Revenue.
  • Revenue could not claim to have discharged this burden which lied upon it, by merely establishing that the fair market value of the capital asset as on the date of the transfer exceeded by 15% or more the full value of the consideration declared in respect of the transfer and the first condition was therefore satisfied.
  • SC held that Revenue must go further and prove that the second condition was also satisfied.
  • Merely by showing that the first condition was satisfied, the Revenue could not ask to presume that the second condition too was fulfilled, because even in a case where the first condition of 15% difference was satisfied, the transaction could be a perfectly honest and bona fide transaction and there could be no under-statement of the consideration.
  • It was clearly held that, the fulfilment of the 2nd condition had therefore to be established independently of the 1st condition and merely because the 1st condition was satisfied, no inference could necessarily follow that the 2nd condition was also fulfilled.
  • It was held that, to throw the burden of showing that there was no understatement of the consideration, on the assessee would be to cast an almost impossible burden upon him to establish the negative, namely, that he did not receive any consideration beyond that declared by him.
  • Also, section 52 was not a charging section but was a computation section.
  • It had to be read along with section 48 which provided the mode of computation and the starting point of computation was “the full value of the consideration received or accruing”.
  • What in fact never accrued or was never received could not be computed as capital gains under section 48.
  • Therefore sub- section (2) could not be construed as bringing within the computation of capital gains an amount which, by no stretch of imagination, could be said to have accrued to the assessee or been received by him and it must be confined to cases where the actual consideration received for the transfer is under-stated and since in such cases it is very difficult, if not impossible, to determine and prove the exact quantum of the suppressed consideration, sub-section (2) provided the statutory measure for determining the consideration actually received by the assessee and permits the Revenue to take the fair market value of the capital asset as the full value of the consideration received in respect of the transfer.
  • If sub-section (2) was literally construed as applying even to cases where the full value of the consideration in respect of the transfer was correctly declared by the assessee and there was no understatement of the consideration, it would result in an amount being taxed which has neither accrued to the assessee nor been received by him and which from no view point can be rationally considered as capital gains or any other type of income.
  • It was a well settled rule of interpretation that the Court should as for as possible avoid that construction which attributes irrationality to the legislature.

Finally accepting appeal of assessee it was concluded that, subsection (2) had no application to the present case and the Income-tax officer could have no reason to believe that any part of the income of the assessee had escaped assessment so as to justify the issue of a notice under section 148. SC allowed the appeal of assessee and quashed the reassessment order.

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