Option of substituting fair market value on prescribed date is not available for capital asset in respect of which depreciation has been obtained
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.
Let us refer to the case of Commonwealth Trust Ltd. v. CIT (1997), where the issue under consideration was whether an assessee who had acquired capital asset before 01.01.1954 otherwise than by any of the modes mentioned in section 49 and sold it after 01.01.1954, on which it had already claimed and allowed depreciation, was also entitled to have the quantum of taxable capital gains computed in the manner provided by section 55(2)(i)?
Facts of the Case:
- The assessee, a limited company, was possessed of considerable properties at Calicut and Mangalore. It owned these properties right from 1920 onwards.
- The assessee had claimed depreciation for its factory buildings which had been allowed in the previous years.
- The assessee sold some of these properties on which it had already claimed depreciation.
- The Calicut Weaving Factory was sold for Rs. 20,000, its original value being Rs. 10,000.
- The assessee had incurred an additional expenditure of Rs. 979 on this property.
- In computing the capital gains the assessee showed a capital loss of Rs. 78 on the sale of this property. This the assessee did on revaluing the property.
- The assessee sold its Mangalore buildings for Rs. 2,25,000. Its original cost as adjusted came to Rs. 76,680.
- In respect of these buildings also depreciation was claimed and allowed in the previous years.
- Here again the assessee revalued the buildings as on 1st January, 1954 and on that basis showed the capital gains at Rs. 44,713.
- The stand taken by the assessee was that it had the option under section 55(2)(i) either to adopt the written down value of the building or the value of the building as on 01.01.1954 and it had chosen the latter.
- The Income tax Officer (ITO), however, took the view that the assessee did not have the right to substitute the value because the assets were depreciable assets to which section 50(1) applied which was a special provision in respect of depreciable assets and the provision as contained in section 55(2)(i) allowing option which was a general provision was not applicable in the case of depreciable assets.
- The ITO, therefore, substituted the original value and arrived at a capital gain of Rs. 9021 in the case of Calicut property and Rs. 1,46,320 in the case of Mangalore buildings.
What are the provisions of Section 49?
According to Section 55, Cost of Acquisition (COA) means any capital expense at the time of acquiring capital asset under transfer, i.e., to include the purchase price, expenses incurred up to acquiring date in the form of registration, storage etc. expenses incurred on completing transfer.
Section 49 pertains to Cost of Acquisition with Reference to Certain Modes of Acquisition. According to Section 49(1), where the capital asset became the property of the assessee:
- on any distribution of assets on the total or partial partition of a Hindu undivided family;
- under a gift or will;
- by succession, inheritance or devolution;
- on any distribution of assets on the dissolution of a firm, body of individuals, or other association of persons, where such dissolution had taken place at any time before 1.04.1987;
- on any distribution of assets on the liquidation of a company;
- under a transfer to a revocable or an irrevocable trust;
- by transfer from its holding company or subsidiary company;
- by transfer in a scheme of amalgamation;
- by an individual member of a Hindu Undivided Family giving his separate property to the assessee HUF any time after 31.12.1969,
In all above cases, the cost of acquisition of the asset shall be the cost for which the previous owner of the property acquired it, as increased by the cost of any improvement of the asset incurred or borne by the previous owner or the assessee, as the case may be, till the date of acquisition of the asset by the assessee.
What are the provisions of Section 50?
Section 50 pertains to special provision for computation of capital gains in case of depreciable assets. Where the capital asset is an asset forming part of a block of assets in respect of which depreciation has been allowed, the provisions of sections 48 and 49 shall be subject to the following modifications:
- where the full value of the consideration received or accruing as a result of the transfer of the asset together with the full value of such consideration received or accruing as a result of the transfer of any other capital asset falling within the block of the assets during the previous year, exceeds the aggregate of the following amounts, namely:
- expenditure incurred wholly and exclusively in connection with such transfer or transfers
- the written down value of the block of assets at the beginning of the previous year; and
- the actual cost of any asset falling within the block of assets acquired during the previous year, such excess shall be deemed to be the capital gains arising from the transfer of short- term capital assets;
- where any block of assets ceases to exist as such, for the reason
Order of Appellate Authorities and High Court
- On appeal filed by the assessee, the Appellate Assistant Commissioner (AAC) agreed with the ITO.
- He was also of the view that the assessee did not have the right to substitute the value as on 01.01.1954 in respect of depreciable assets.
- The assessee then went to the Tribunal and the Tribunal dismissed the appeal but at the instance of the assessee referred the aforesaid second question for the decision of the High Court.
- The High Court agreed with the view of the Tribunal and decided the question in the affirmative, in favour of the Revenue and against the assessee.
- Against the order of the High Court (HC), assessee appealed before the Supreme Court (SC)
Observations of Supreme Court (SC)
- Dismissing the assessee’s appeal, SC held that, Section 55(2) would be applicable to all assets depreciable or non-depreciable for the purposes of arriving at the cost of acquisition under sections 48 and 49 but section 50 carves out a category of those capital assets which had been subjected to grant of depreciation allowance and this section 50 therefore provides a special method for determining the cost of acquisition in such cases.
- Further it noted that, for sections 48 and 49 the provision of section 55(2) would apply as modified by those of section 50.
- It further held that, for the purposes of applying section 55(2), sections 48 and 49 would have to be applied as modified by section 50.
- SC inferred after analysing and studying the anatomy of these provisions that, where the capital asset purchased by the assessee is a depreciable or non-depreciable asset, the assessee will have the option for substituting for its actual cost of acquisition its fair market value as on 01.01.1954 but where it is a depreciable asset and the assessee has enjoyed depreciation allowance, his cost of acquisition shall have to be determined as provided in section 50.
- Section 50 was in absolute terms specially providing for fixing the cost of acquisition in the case of depreciable asset only.
- Ergo, it was summed up that section 50(1) had no dependence on the provisions of section 55(2).
- There is no mention of “fair market value” in section 50(1) and besides that the adjustments stated there are with reference to the written down value only which has nothing to do with the fair market value.
So, the court held that, where the capital asset was depreciable and the assessee had availed deduction on account of depreciation, the cost of acquisition shall have to be determined in terms of the provisions of Section 50 read with section 48.
In simple words, Capital asset in respect of which depreciation has been obtained, option of substituting fair market value on prescribed date is not available to such a person. Assessee has enjoyed depreciation allowance, therefore his cost of acquisition shall have to be determined as provided in section 50
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