UNFOLDING THE INCOME FROM CAPITAL GAIN
CIT (ITAT), Ahmedabad
The issue of short term capital gains (STCG) vs long term capital gains (LTCG) is an ongoing issue. In many of the cases, it is also intertwined with treating such gains as business income. Further, in some of the cases where claims of LTCG have been made, the AOs have treated them as sham transactions and taxed them under Section 69 of the Act, particularly with respect to dealings in penny stocks. The focus of this concept paper has been kept on few critical issues covering over 90% of the cases handled by the AOs. Towards this end, the following principal issues have been discussed:
a. STCG vs LTCG vs business income in shares and securities
b. Conversion of capital asset into stock and vice-versa
c. Bogus LTCG in penny stocks
d. Claiming of deduction under Section 54F etc.
e. Sale of depreciable assets
f. Treatment of slump sale
g. Reference to DVO
h. Insertion of Section 50D
Besides, as the target audience is the Assessing Officers of the Department, the language and content has been oriented accordingly.
2. Basics in brief
Section 2(14) defines “capital asset”, and Section 2(47) defines “transfer” in relation to a capital asset. Section 2(42A) and Section 2(42B) define “short-term capital asset” and “shortterm capital gain” respectively, while Section 2(29A) and Section 2(29B) define “long-term capital asset” and “longterm capital gain”.
The period of holding determines as to whether a transaction is in the nature of STCG or LTCG. If the holding period is 36 months or more, the gains on transfer of such assets are taxed as LTCG. However, exception has been provided for shares in a company, any other security listed in a recognised Stock Exchange in India, Units of UTI/any Mutual Fund specified in Section 10 (23D), zero coupon bonds, in which case, the cut-off holding period is 12 months.
The distinction between STCG and LTCG is important, as LTCG is taxed at a concessional rate (Zero tax in case of certain share transactions), while STCG is taxed at normal rates (concessional tax in case of certain share transactions). Further, LTCG is entitled to indexation while STCG is not. The CBDT prescribes the cost inflation index for each year. Section 111A and Section 112 deal with taxation of capital gains. It is to be noted that deductions under Chapter VI-A are not available in respect of LTCG by virtue of Section 112(2). Similarly, long-term capital losses can be set-off only against long-term capital gains (unlike STCL on which no such restrictions apply), as per Section 70 (3) and Section 74 (1)(b) of the Act. Further ST capital loss cannot be set off against any other income.
Unlike business income where various expenditure is allowed, in respect of capital gains, only two deductions namely, (i) expenditure incurred wholly and exclusively in connection with such transfer and (ii) cost of acquisition and cost of improvement, if any, are allowed as deductions.
3. Capital Gains vs Business Income
In G Venkatswami Naidu and Co vs CIT, 35 ITR 594, the Hon’ble SC has held that even an isolated and single transaction may be of an adventure in nature of trade if some of essential features of trade are present in such a transaction. The Hon’ble Court further held that decision about character of a transaction as to whether it is in nature of trade cannot be based solely on application of any abstract rule, principle or test and must in every case depend upon all relevant facts and circumstances.
Thus, in all the cases involving such controversies, it is essential that the AO bring on record, full facts and particulars of the case.
3.1 Decisions of Hon’ble Gujarat High Court:
In the case of CIT vs Rewashanker A Kothari, 283 ITR 338 (DoJ: 16.12.2006), the Hon’ble Gujarat HC laid down the following tests:
“11. In the case of Pari Mangaldas Girdhardas v. CIT 1977 CTR (Guj.) 647, after analyzing various decisions of the Apex Court, this Court has formulated certain tests to determine as to whether an assessee can be said to be carrying on business.
(a) The first test is whether the initial acquisition of the subject-matter of transaction was with the intention of dealing in the item, or with a view to finding an investment. If the transaction, since the inception, appears to be impressed with the character of a commercial transaction entered into with a view to earn profit, it would furnish a valuable guideline.
(b) The second test that is often applied is as to why and how and for what purpose the sale was effected subsequently.
(c) The third test, which is frequently applied, is as to how the assessee dealt with the subject-matter of transaction during the time the asset was with the assessee. Has it been treated as stock-in-trade, or has it been shown in the books of account and balance sheet as an investment. This inquiry, though relevant, is not conclusive.
(d) The fourth test is as to how the assessee himself has returned the income from such activities and how the Department has dealt with the same in the course of preceding and succeeding assessments.
This factor, though not conclusive, can afford good and cogent evidence to judge the nature of transaction and would be a relevant circumstance to be considered in the absence of any satisfactory explanation.
(e) The fifth test, normally applied in cases of partnership firms and companies, is whether the deed of partnership or the memorandum of association, as the case may be, authorises such an activity.
(f) The last but not the least, rather the most important test, is as to the volume, frequency, continuity and regularity of transactions of purchase and sale of the goods concerned. In a case where there is repetition and continuity, coupled with the magnitude of the transaction, bearing reasonable proportion to the strength of holding, then an inference can readily be drawn that the activity is in the nature of business.”
3.2 In a very recent case of Vaibhav J Shah (HUF), Tax Appeal Nos. 77 of 2010 and 78 of 2010 (DoJ: 27.06.2012), the Hon’ble Gujarat HC has reiterated the tests laid down by it in the Rewashanker A Kothari case. Besides, the Hon’ble HC has held that “In view of the aforesaid decisions of the Apex Court as well as of this Court, it is clear that where number of transactions of sale and purchase of shares takes place, the most important test is the volume, frequency, continuity and regularity of transactions of purchase and sale of the shares. However, where there is repetition and continuity, coupled with magnitude of the transaction, bearing reasonable proportion to the strength of holding, then an inference can be drawn that activity is in the nature of business. Learned counsel for the revenue from the records could not demonstrate that there were large number of transactions which had frequency, volume, continuity and regularity and fell within the tests laid down by the Division Bench of this Court.”
3.3 Other Recent Decisions:
In the case of PVS Raju vs Addl CIT, 340 ITR 75 (DoJ: 27.07.2011), the Hon’ble AP High Court held as under:
The factors which weighed with the assessing authority, the CIT(A), and the ITAT in coming to the conclusion that the shares in question constituted “stock in trade”, and not “investment”, were that:-
(a) The frequency of buying and selling of shares by the appellants were high;
(b) the period of holding was less;
(c) the high turnover was on account of frequency of transactions, and not because of huge investment;
(d) the assessees had dealt in delivery trading purely with the intention of making quick profits on a huge turnover;
(e) the period of holding of a majority of the stock was between one to seven days;
(f) in most of the transactions, the assessees did not even hold on to at least some part of the huge purchases, and had engaged in the same scrips frequently;
(g) the intention of the assessees in buying shares was not to derive income by way of dividend on such shares, but to earn profits on the sale of the shares;
(h) the assessees had indulged in multiple transactions of large quantities with very high periodicity. These periodic transactions, selecting the time of entry and exit in each scrip, called for regular direction and management which would indicate that it was in the nature of trade;
(i) repeated transactions, coupled with the subsequent conduct of the assessees to re-enter the same scrip or some other scrip, in order to take advantage of market fluctuations lent the flavour of trade to such transactions;
(j) the assessees were purchasing and selling the same scrips repeatedly, and were switching from one scrip to another;
(k) the dominant impression left on the mind was that the assessees had not invested in shares;
(l) mere classification of these share transactions as investment in the assessee’s books of accounts was not conclusive;
(m) the intention of the assessees at the time of purchase was only to sell the shares immediately after purchase;
(n) frequency of purchase and sale of shares showed that the assessees never intended to keep these shares as investment; and
(o) it is only for the purpose of claiming benefit of lower rate of tax, under Section 111A of the Act, that they had claimed certain shares to be investment, though these transactions were only in the nature of trade.
While examining any case, the AOs should examine whether the transactions of the assessee fit within the above framework.
3.4 In the case of Sarnath Infrastructure (P.) Ltd. v. Asst. CIT  124 ITD 71 (Lucknow) ; 120 TTJ 216, the Lucknow Bench of the Income-tax Appellate Tribunal has laid various principles which may be applied to determine whether the transaction of purchase and sale of share is in the nature of trade or investment. The relevant findings of the Income-tax Appellate Tribunal read as under :
‘The following principles can be applied on the facts of a case to find out whether transaction(s) in question are in the nature of trade or are merely for investment purposes : (1) What is the intention of the assessee at the time of purchase of the shares. This can be found out from the treatment it gives to such purchase in its books of account-whether it is treated as stock-in trade or investment; whether shown in opening/closing stock or shown separately as investment or non-trading asset.
(2) Whether the assessee has borrowed money to purchase and paid interest thereon. Normally, money is borrowed to purchase goods for the purposes of trade and not for investing in an asset for retaining.
(3) What is the frequency of such purchases and disposal in that particular item ? If purchases and sales are frequent, or there are substantial transactions in that item, it would indicate trade. Habitual dealing in that particular item is indicative of intention of trade. Similarly, ratio between the purchases and sales and the holdings may show whether the assessee is trading or investing (high transactions and low holdings indicate trade whereas low transactions and high holdings indicate investment).
(4) Whether purchase and sale are for realising profit or purchases are made for retention and appreciation in its value? Former will indicate intention of trade and latter, an investment. In the case of shares whether intention was to enjoy dividend and not merely earn profit on sale and purchase of shares. A commercial motive is an essential ingredient of trade.
(5) How the value of the items has been taken in the balance sheet? If the items in question are valued at cost, it would indicate that they are investments or where they are valued at cost or market value or net realisable value (whichever is less), it will indicate that items in question are treated as stock-in-trade.
(6) How the company (assessee) is authorised in memorandum of association/articles of association ? Whether for trade or for investment ? If authorised only for trade, then whether there are separate resolutions of the board of directors to carry out investments in that commodity ? And vice versa.
(7) It is for the assessee to adduce evidence to show that his holding is for investment or for trading and what distinction he has kept to the records or otherwise, between two types of holdings : if the assessee is able to discharge the primary onus and could prima facie show that particular item is held as investment (or say, stock-in-trade) then onus would shift to the Revenue to prove that apparent is not real.
(8) The mere fact of credit of sale proceeds of shares (or for that matter any other item in question) in a particular account or much frequency of sale and purchase will alone will not be sufficient to say that the assessee was holding the shares (or the items in question) for investment.
(9) One has to find out what are the legal requisites for dealing as a trader in the items in question and whether the assessee is complying with them. Whether it is the argument of the assessee that it is violating those legal requirements, if it is claimed that it is dealing as a trader in that item ? Whether it had such an intention (to carry on illegal business in that item) since beginning or when purchases were made ?
(10) It is permissible as per the Central Board of Direct Taxes Circular No. 4 of 2007 of June 15, 2007 ( 291 ITR (ST.) 384) that an assessee can have both portfolios, one for trading and other for investment provided it is maintaining separate account for each type, there are distinctive features for both and there is no intermingling of holdings in the two portfolios.
(11) Not one or two factors out of the above alone will be sufficient to come to a definite conclusion but the cumulative effect of several factors has to be seen. The assessee-company was dealing in shares and it had dealt in shares both as stockin-trade as well as investment. It sold shares from the investment portfolio and claimed that the profit arising therefrom was capital gain. The Assessing Officer held that the main business of the assessee was purchase and sale in shares. It was neither a share dealer nor a share broker. The details for purchases and sales affected by the assessee company revealed that sales and purchases were quite substantial and would not be made by a person who invested in shares. Further, the assessee did not have sufficient funds to make such investments and the assessee was claiming to have made investment out of borrowed capital. He, therefore, held that the profit in question was assessable as business income. Held that the undisputed fact was that the assessee was dealing in shares both as business as well as investment. It had kept separate accounts in respect of two portfolios. No material was brought on record to show that demarcation line between business and investment was hazy or that the assessee had not maintained an investment portfolio and it was dealing in shares only like a trader. Thus, on appreciation of cumulative effect of several factors present it was to be held that the surplus was chargeable to capital gains only and the assessee was not to be treated as trader in respect of sale and purchase of shares in the investment portfolio.’
3.5 The following recent Tribunal decisions have been rendered in favour of Revenue:
a. Mafatlal Fabrics P Ltd vs DCIT, 49 SOT 303 (Mumbai ITAT), 02.11.2011
b. Swarnim Multiventures P Ltd vs DCIT, 54 SOT 347 (Hyderabad ITAT), 21.09.2012
c. ACIT vs Manoj Kumar Samdaria, 54 SOT 331 (Delhi ITAT), 25.10.2012
The decision of ITAT, Ahmedabad in the case of Sugham Chand Jain in which holding period was held to be decisive in treating transactions as business or capital gain is not very relevant now in view of Gujarat high court decisions mentioned earlier. Unless there is specific provision in the Act in the line of section 94(7), holding period cannot determine nature of transaction as business or capital gain.
Crucially, what is important is to examine the claim of the assessee in the light of the above decisions. Merely reproducing the citations will not suffice and AOs will need to bring out the factual aspects on each of the criteria in the order.
4. E nquiries by the AO
4.1 Records of previous years:
Go through the records of the earlier years and see if there is consistent pattern in trading and any other useful information.
4.2 Board Resolution and Minutes of Board meetings:
The AO can call for the Board Resolution and Minutes of Board Meetings in original. Section 193 of the Companies Act lays down the specific method of maintaining the minute’s book. The minutes are to be maintained in book form and pasting of individual sheets is not permitted. This can be an effective course of enquiry, even in cases where assessee claims that he holds two separate portfolios, namely trading and investment. In the case of Sathappa Textilers (P.) Ltd. v. CIT  126 Taxman 491, the Madras High Court considered a similar issue regarding validity of Minutes of Proceedings and rejected the loose sheets filed by the assessee.
When the originals are produced before the AO, they should also be examined from the viewpoint of whether they are appearing as brand new, freshly typed, and having the same ink etc.
The language used in the Board Resolution and Minutes are also very important. For instance, in one particular case, it was observed that the reasoning was given as “the strategy of making investments in the equity market is paying off and should over a period of time improve the financials of the company”. This can be interpreted that the activities of the assessee have been undertaken with an intention of making profits.
4.3 Memorandum of Association and Articles of Association:
If the investment in shares and debentures is mentioned in the objectives, the same should be brought out clearly.
In the case of Sarder Indra Singh & sons Ltd. Vs. CIT (1953) 24 ITR 415, the Supreme Court had considered the objects of Memorandum of Association, among others, which read as follows:
“To carry on and undertake any business, transaction, operation or work commonly carried on or undertaken by bankers, capitalists, promoters, financiers, concessionaires, contractors, merchants, managers, managing agents, secretaries and treasurers.
To purchase or otherwise acquire, and to sell......... stock, share ..... ...business concerns and undertakings. To invest and deal with the moneys of the company not immediately required for the company’s business upon such securities and in such manner as may from time to time be determined.”
After a careful consideration, the court ruled that the assessee was engaged in business activity of sale of shares and securities.
4.4 Notes to Accounts and Significant Accounting Policies:
The AO can check in these pages, as to whether any significant information is available regarding the intention of the assessee and how they are classified in the books. Also, if there is any change in the method of accounting during the year, it should be brought out.
4.5 Director’s Report:
Any claims made by the directors in this report placed before the shareholders can give a major clue towards the real intention of the assessee.
4.6 Separate Demat Accounts:
In all cases where the assessee claims that he has separate trading and investment account, it should be examined whether separate demat accounts are maintained for trading and investment portfolio.
If not, it is to be brought out that the assessee has not followed the FIFO method strictly in terms of Section 45(2A). More importantly, the usage of a singular demat account for multiple uses, could fairly indicate that the classification adopted by the assessee as capital gains / business income, is merely a postmortem exercise undertaken by the assessee to reduce the tax rates in his income.
4.7 Frequency of trading:
The factual aspects such as volume, frequency, continuity and regularity of transactions should be brought out in the assessment order. Besides, if the same scrip has been dealt with more than once, (say, purchase and sale in a repeated fashion of same scrip), the details should be brought out in the assessment order, which would prove the real intention of the assessee that he is a trader and not an investor.
4.8 Holding Period:
The holding period of few select securities can also be worked out and placed in the assessment order, particularly in cases where the holding period is a matter of few days only. Besides, the Ratio of turnover to average stock can be worked out. In one case, it was seen that the total sales during the year was Rs.189.20 crores while the average of opening and closing stock was Rs.22.78 crores. Thus, when an AO presented in his assessment order as “the sales of Rs.189.20 crores turnover has been achieved despite the average stock being only Rs.22.78 crores. This shows an average sales turnover ratio of 8.31 (189.20/22.78). This effectively means that the average period of all share holdings including the claims made by the assessee as long term capital gains is just 44 days.”, it makes for an impressive finding before the appellate authorities.
4.9 The time devoted to the activity and the extent to which it is the means of livelihood:
The P&L A/c can be analysed towards this end. Also, if the majority of Board meetings end up in reviewing the investments in shares and securities only, then a safe conclusion can be drawn that it is indeed the major activity. Needless to say, the factual aspects should be brought out in the assessment order.
4.10 Source of funds:
The AO can examine the sources of funds, whether they are from internal accrual or borrowings. Even in cases where the assessee is having own sufficient funds, the bank statements can be examined to find out the immediate source of such investment.
4.11 Investment Policy:
The assessee can be asked to produce its Investment Policy.
4.12 Investment Team:
The AO can also make enquiries regarding the investment team, reporting structure, decision making authority, etc. In one particular case, in the initial questionnaire, the AO had asked for “Details of employees (other than directors): Name, salary, area of work; whether employed fully during the year.” Subsequently, when the issue of taxing the income arose, the reply to this query could be used to prove that majority of employees were actually employed to take care of investments which constituted an organized business activity.
4.13 Internal Audit Report:
Where the assessee has been subjected to internal audit, the AO can call for copies of internal audit reports during the year. In one such case, it was seen that the Internal Audit Report for all the quarters contained reference only to trading activities without a single reference to the investment portfolio of the assessee. This can be crucial evidence.
5. CBDT Circulars
Circular No.768 dated 24.06.1998: Lays down the “date of transfer” and ‘period of holding of securities’ in respect of shares acquired in physical form and subsequently converted into demat. An example of application of FIFO as per Section 45(2A) is also given.
Instruction No.1827 dated 21.08.1989: Lays down the tests for distinction between shares held as stock-in-trade and shares held as investment. Has been subsequently supplemented with circular no.4 of 2007.
Circular No.4 dated 15.06.2007: Lays down the tests for distinction between shares held as stock-in-trade and shares held as investments. This circular also accepts the possibility that a person may have two portfolios under (i) investment and (ii) trading portfolio.
6. Conversion of Capital Asset into Stock
Section 45(2) of the Act lays down the taxability of a capital asset, which is converted into stock-in-trade. The effect of this provision is two-fold:
a. The fair market value on the date of conversion shall be treated as the full value of consideration, and taxed in the year in which the asset is actually sold.
b. The excess of the sales price over the full value of consideration shall be taxed as business income in the year in which sale takes place.
For the purposes of ascertaining the fair market value, the provisions of Section 55A apply, along with provisions of Rule 111AA. The provisions of Section 45(2) have been found to be misused in some cases. Examples are as follows:
a. In one case, it was seen that the assessee had sold listed equity shares acquired in January 2011 in February 2012. The said assets were claimed to have been converted into stock-in-trade on 01.04.2011. On verification of the details, the following was seen:
Cost / FMV
1 lac listed equity shares Purchased in investment portfolio for Rs.1.80 crores.
(as per stock exchange) Assessee claims to have converted these capital assets into stock-in-trade @ Rs.1.40 crores. Thus, capital loss of Rs.0.40 crore was claimed.
The shares were sold off and Rs.0.90 crore was claimed as business loss.
Had the capital assets not been converted into stock-in-trade, the assessee would have suffered long-term capital loss of Rs.1.30 crores, which could not have been claimed by virtue of provisions of Section 10(38). However, by adopting the above method, the assessee was cleverly claiming the losses in its return of income.
In the instant case, the AO has to examine the genuiness of conversion. The AO has to be innovative in calling the details, as he has to establish that such conversion was merely a sham and not genuine. Some of the details which can be examined by the AO are (i) Minutes of the Board, (ii) minutes of Investment Committee, (iii) copy of proposal mooted by the Investment Department, (iv) details of such conversion in the immediately preceding 4 years and succeeding years till date, (v) Minutes of original acquisition, (vi) remarks in Notes to Accounts, Auditor Report, Significant Accounting Policies. Other pointers could be the advance tax payments made by the assessee on quarterly basis (to know whether such conversion is an after-thought to reduce tax liability), quarterly financial statements submitted to banks / lenders (to know whether the change in classification was reflected therein). Also, if need be, the CEO / Chief Investment Officer can be summoned for recording the statement.
b. An assessee had acquired a plot of land and treated it as capital asset. However, it subsequently started sub-plotting the piece of land and selling it. Although the assessee stated the entire activity to be capital gains, the AO can examine when the significant activities of conversion of agricultural land into non-agricultural land took place, sub-plotting activities began.
Rajendra Kumar Dwivedi vs CIT, 349 ITR 432 (Allahabad HC) 24.08.2012: Where no agricultural operations were carried on and the land was sub-divided and sold in plots, even though the assets were acquired over 30 years ago, the HC has upheld the Department action in treating the asset having been converted into stock-in-trade when the sub-plotting activity commenced.
In the case of conversion, the date of conversion is important as the period of holding till that date will determine whether the transaction is one of STCG or LTCG.
7. Bogus LTCG/ STCG in penny stock
Certain share transactions, [in common parlance, known as ‘Penny stocks’] are fabricated with a view to launder the unaccounted money in the form of long-term capital gains at nil/concessional tax rates. The purchases are usually accompanied by a backdated contract Note showing the purchase of shares by the assessee at less than a rupee or just a few rupees per share, as they were quoted earlier (about a year or so). The purchase consideration could have been paid either in cash or by cheque. The shares are usually stated to have been purchased in physical format and then converted into electronic form. After a year or so, the assessee sells such dematerialized shares on secondary market at the prevalent price and receives the cheque payment thereby converting black money into white. Depending upon how far the contract note for purchase of such shares was backdated, the assessee launders the money by either paying zero or 15% capital gain tax (depending on the rates of taxation of capital gains for the relevant A.Y.)
The general modus operandi adopted by the assessees is as follows:-
1. With the collusion of broker, shares of an unknown company with dubious background are purchased for miniscule consideration. The broker usually issues a fake contract note.
2. The counterparty is/are usually not traceable or is related to the broker and the broker undertakes off-market transactions to accommodate the assessee.
3. After a year, the shares are sold back by the assessee through the same broker. In the meantime, the share prices are rigged by the concerned broker to an abnormally high level.
4. The shares are now sold by the assessee and sale consideration is received. The sale consideration is in fact first paid by the assessee in cash to a trusted confidante of the broker. This cash consideration which is introduced in a banking channel by routing through a number of accounts, finally reaches the accounts of the broker. With this amount, the broker pays the consideration to the assessee.
5. Thus the assessee’s own cash is introduced and comes back in the form of long term capital gain thereby claiming concessional tax rate.
6. For arranging these transactions, the broker typically charges commission. The typical characteristic of such transactions are as follows :-
a. The scrip invested is an obscure one in most cases. It is merely Shell Company with no activities whatsoever.
b. The assessee himself will be unaware of the financial performance of the company in which he is invested.
c. The shares are purchased at lower levels and sold at higher rates through the series of off-market transactions created by the broker with vested interest. The share prices are artificially rigged through the off-market transactions.
d. The assessee uses the services of the broker only for these particular transactions. Also, the assessee otherwise is passive investor or does not invest in other scrips.
e. The assessee has never met the broker and usually claims that the transactions are arranged through a different person. The assessee himself would have never met the broker.
7.1 Unfortunately, most of the assessment orders in respect of bogus LTCG have been knocked off at appellate stage. One such example is the case of Acchyalal Shaw vs ITO, 30 SOT 44 (Kol) (URO) dated 16.01.2009. Even if the transactions are found by the AO to have taken place on off-market basis, the appellate authorities have held that the assessee cannot be punished for the fault of the broker. The appellate authorities place reliance on the fact that the demat accounts show the delivery of shares and then rule in favour of the assessee.
7.2 To counter such tactics of the assessee, it is important to do further enquiries apart from conducting enquiries under Section 133(6) with the stock broker and the stock exchange.
a. First and foremost, the payment of purchase consideration has to be enquired from the bank account. Towards this end, the necessary information may be obtained from the bank as to who the ultimate beneficiary is, and in whose account the said funds were credited. If the funds are transferred to any other person other than the person from whom the shares are shown to have been purchased, this should be confronted with the assessee. Also, in many cases, substantial time lag is seen between the date of purchase and actual payment for purchase. In all such cases, the reasons for the same should be thoroughly investigated.
b. In many of the cases, it is seen that the receipt of shares in the demat account is much later, i.e. after 3-6 months of alleged purchases. In these cases, the assessee usually claims that the shares were received in physical form and then dematted. This claim of the assessee should be examined in greater detail. The assessee should be asked to furnish the relevant supporting evidences and then enquiry be made with the share transfer agent of the company as to the actual date of purchase and from whose account these shares were transferred. Such anenquiry is possible with the “folio number” of the shares. The seller of these shares to the assessee can be found out, and if possible, enquiries be made with the concerned AO as to whether such a seller has shown these transactions and the actual date of sale reflected by him. If the counterparty has shown a sale date much later than the alleged purchase date of the assessee, it has to be confronted and brought as an evidence.
c. While treating the transactions as sham, the entire receipt is added by the AO as income. Where the assessee is shown to have purchased the shares in an earlier year, one of the arguments frequently taken by the assessee is that the investment in shares in earlier year has been accepted by the Dept. The Tribunals, in such cases, give relief to the assessee. Hence, it is suggested that the case of the preceding year when investments are made, is reopened under the Act and necessary action be taken in respect of the investment claimed to be made in that year and outstanding as at year-end, particularly when the broker has not confirmed the purchase transactions and the records do not indicate receipt of shares either in demat or physical form before the year-end. The remedial action should invariably be adopted where the purchase consideration is stated to have been paid in cash.
d. In many of the cases, assessees rely on Board’s Circular No. 704, dated 28-4-1995, which reads as follows: “2. When the securities are transacted through stock exchanges, it is the established procedure that the brokers first enter into contracts for purchase/sale of securities and thereafter, follow it up with delivery of shares, accompanied by transfer deeds duly signed by the registered holders. The seller is entitled to receive the consideration agreed to as on the date of contract. The Board is of the opinion that it is the date of broker’s note that should be treated as the date of transfer in cases of sale transactions of securities provided such transactions are followed up by delivery of shares and also the transfer deeds. Similarly, in respect of the purchasers of the securities, the holding period shall be reckoned from the date of the broker’s note for purchase on behalf of the investors. In case the transactions take place directly between the parties and not through stock exchanges, the date of contract of sale as declared by the parties shall be treated as the date of transfer provided it is followed up by actual delivery of shares and the transfer deeds.”. The crucial words here are “In case the transactions take place directly”. So, the AO should examine the records of counterparty as stated above. It is also pertinent to note that SEBI had vide Circular No.SMDRP/POLICY/CIT-32/99 dated September 14, 1999 banned all negotiated deals including cross deals and all such deals are required to be executed only on the screens of the exchanges in the price and order matching mechanism of the exchange just like any other normal trade. Thus, off-market deals are not in confirmation with regulatory guidelines.
e. The assessee can be summoned, his statement recorded and various evidences gathered to fortify the circumstantial evidences. Some of such evidences could be:
a. Why did he decide to buy shares of this company?
b. Name and address of the person who recommended the purchase alongwith relationship with him/her.
c. Did assessee analyze the financial performance of M/s. Jay Kay Dee Industries Ltd., before purchase of the shares?
d. Did assessee know at what price multiples (P/E ratio) the shares purchased was trading
e. Was assessee keeping track of share price movement? If yes, how, and the source of information. Also, the frequency of getting such updation.
f. On what basis did assessee decide to sell the shares?
g. What business is the company invested in engaged in? What are the products they are dealing in?
h. Knowledge of assessee regarding the financial performance of the company invested in
i. Details of share transactions (other than impugned purchases) during last (say) 5 years:
j. How did assessee get introduced to broker?
Who introduced to this broker?
k. Did assessee fill the client introduction form / KYC forms? Copies thereof.
l. Have assessee ever been to the office of broker? If yes, whom did he meet?
m. How did assessee receive the contract notes from broker?
n. How did assessee place the purchase orders with broker? To whom did he speak/instruct for placing the orders?
o. How was the payment made/received to/from broker?
p. Did assessee know before-hand that share transactions were off-market transactions?
When did he know?
q. When was the demat account opened? How were the instructions given to demat participant for transfer of shares?
r. What is the status of that demat account now?
s. In most of the penny stock cases, it is seen that the purchase transactions are claimed to be made on off-market basis, after the enquiries are commenced by the AO. In such cases, where the scrip is received in the demat account with much delay; the AO can consider making an alternative addition by treating such transactions as STCG.
8. Claiming of deduction under Section 54F etc.
Section 54F provides for deduction to any assessee being an individual or HUF, who transfers any long-term capital asset other than a residential house. To avail the benefit, the new residential house has to be purchased within a period of 1 year before or 2 years after the date of transfer. Alternatively, the residential house has to be constructed within 3 years. The scheme also provides for deposit in Capital Gains Account Scheme, to be utilized in a specified manner and the manner of taxability if not fully utilized. Also, there are restrictions in terms of sale of such new asset within 3 years.
There are several Sections such as Sections 54, 54EC, 54F, etc., which are modeled on similar lines and the AO may go through the nature of asset and terms and conditions specified in each section. However, some of the issues are recurring in nature, and the case laws relating to such issues are given below:
8.1 Purchase of multiple houses:
As per Section 54 and Section 54F, a person the deduction is eligible only in respect of one residential house.
237 CTR 210, Pawan Arya vs CIT, (Punjab & Haryana HC), DoJ - 13.12.2010: The Hon’ble Court held that exemption under Section 54 is not admissible against acquisition of two houses.
107 ITD 327, ITO vs Ms Sushila M Jhaveri, ITAT Mumbai Special Bench, DoJ – 17.04.2007: In para 11, it has been held as follows: “it is held that exemption under Sections 54 and 54F of the Act would be allowable in respect of one residential house only. If the assessee has purchased more than one residential house, then the choice would be with assessee to avail the exemption in respect of either of the houses provided the other conditions are fulfilled.
However, where more than one unit are purchased which are adjacent to each other and are converted into one house for the purpose of residence by having common passage, common kitchen, etc., then, it would be a case of investment in one residential house and consequently, the assessee would be entitled to exemption”. Later decisions including (i) 45 SOT 111, Neville J Pereira vs ITO, ITAT Mumbai, DoJ – 20.10.2010; (ii) 53 SOT 236, Myrtle D’Souza vs ITO, ITAT Mumbai, DoJ – 20.06.2012, are on the same lines as the Special Bench decision in the case of Sushila M Jhaveri.
As per the ratio of the above judgments, it is imperative that the AO examine the factual aspects and bring them in the assessment order. Thus, a case where the assessee acquires 2 houses but converts them into 1, having a common kitchen, electricity meter etc. would be treated as 1 house only. Hence, it is important that the AO obtain the floor plans of the house(s) and critically examine as to whether they would qualify as one house only.
In the case of Krishnagopal Nagpal vs DCIT, DoJ: 07.03.2003, 82 TTJ 481, the ITAT Pune, had the occasion to examine the assessee’s claim of 7 row houses being “a residential house”. The ITAT held that “each row house is a separate and distinct residential house” (para 34).
8.2 Purchase in different name:
330 ITR 309, Vipin Malik HUF vs CIT, Delhi HC, DoJ – 07.08.2009: In this case, the Court upheld the contention that property has to be purchased in the name of seller only. Thus, where the asset sold belonged to the HUF of the assessee but the property was purchased in the name of the assessee and his mother, Section 54F was held to be not applicable.
8.3 Letter of Allotment:
In the case of Rasiklal M Parikh vs ACIT, 28 taxmann. com 195, ITAT Mumbai, DoJ - 31.10.2012: It was held that letter of allotment issued by builder could not be considered as investment in residential house for the purpose of Section 54F. In this case, the ITAT had also examined the deduction claimed in respect of multiple houses and held as under: “we fail to understand how the assessee can substantiate his claim that three flats which are adjacent to each other are nothing but one residential unit, when the construction is not completed even after a lapse of more than 7 years. By merely filing of the design in the form of an internal map, would not suffice. It is only by physical verification, the contention of the assessee could be established that three flats are one residential unit having one common passage, one electricity meter and one municipal corporation number.”.
8.4 Purchase of tenancy rights is not sufficient:
In Yogesh Sunderlal Shah vs ACIT, 139 ITD 214, DoJ – 21.09.2012, it was held that purchase of tenancy rights was not akin to purchase of a residential house, and the deduction under Section 54 was denied to the assessee.
8.5 House with no amenities and without approval is not qualified:
In Ashok Syal vs CIT, 209 Taxman 376, DoJ: 04.05.2012, the Punjab & Haryana HC has held that construction of a room on a plot with bricks and mud and absence of amenities like boundary wall, kitchen, toilet, electricity, water and sewerage connection, etc. could not be termed as “residential house”. The Court further noted that as per bye-laws, construction could not be made without getting map and drawings approved from competent authority, which had not been done.
8.6 Failure to construct residential house within stipulated period:
In the case of Anu Agarwal vs ITO, 28 taxmann.com 286, DoJ – 27.11.2012, the ITAT Chandigarh, has held that assessee was not entitled to Section 54F deduction where the assessee sold a property but failed to construct new residential house within specified period on plot purchased by her out of sale proceeds of that property.
8.7 Non-utlilization of sales consideration:
In 135 ITD 116, V Kumuda vs DCIT, DoJ: 06.01.2012, the Hyderabad ITAT held that assessee was not entitled to deduction under Section 54F where the sales proceeds were used for a different purpose and the new asset was acquired by way of bank loan and loans from family members. A similar decision has been rendered by the Kerala HC in the case of CIT vs VR Desai, 197 Taxman 52 (DoJ: 26.11.2009), where the sales proceeds had not been deposited in the Capital Gains Account Scheme. Similar is the case in Ranjit Narang vs CIT, 317 ITR 332, DoJ – 20.07.2009, wherein the Allahabad HC has upheld denial of deduction under Section 54F where the capital gains have not been utilized within 3 years.
It is imperative that the AO bring on record, all the facts related to the case, in the assessment order. It is quite possible that an assessee may not satisfy more than 1 condition laid down in the section. In all such cases, the AO has to reject the claim of the assessee on based on non-compliance of each condition, so that the order is self-sustaining.
It may be noted that in a recent decision of 340 ITR 1, DoJ: 11.10.2011, Suraj Lamp & Industries Ltd vs State of Haryana, the Apex Court has held that transactions of nature of General Power of Attorney Sales or Sale Agreement / General Power of Attorney / Will transfers do not convey title and do not amount to transfer, nor can they be recognized as valid mode of transfer of immovable property. This is a landmark decision which analyzes the provisions of Transfer of Property Act and implications of non-registration of property deed, and every AO is requested to go through this decision carefully.
In one live case which is presently being disputed before ITAT, Ahmedabad, the assessee claimed to have purchased houses from his own sons, and then claimed deduction under Section 54F on those houses. However, it was found that the agreement was not registered at all and was merely executed in a Rs.100 stamp paper. Hence, the case law of Suraj Lamp & Industries Ltd is being cited before the Tribunal. In the assessment order, the AO had also examined the returns of income of the sons and found that the capital gains in respect of the sales of houses to their father had not been offered in their respective returns. Thus, the AO had concluded that the so-called purchase was sham. It was also recorded by the AO on alternate ground that the houses were 3 separate houses and could not be termed as one house. Further, the CIT(A) had made exhaustive enquiries from the banks from whom the sons had originally availed bank loans to prove that the effective transfer of ownership had not taken place at all, and that the sons could not have transferred the property in view of the restrictive covenants in loan agreement. Thus, if the AO makes endeavor to gather additional facts and brings them on record, the order gets considerable strength for sustenance.
9. Sale of depreciable assets
Section 50 lays down that the capital gains arising on sale of depreciable assets shall be deemed to be short-term capital gains.
The case of CIT vs Sakthi Metal Depot, 333 ITR 492, DoJ: 06.01.2010 by Kerala HC is an important decision. It was held that for purpose of assessment of profit on sale of a depreciable asset, assessee need not have claimed depreciation continuously for entire period up to date of sale of asset. The assessee stopped claiming depreciation on flat 2 years prior to sale. However, since depreciation had been claimed in the past, by applying the provisions of Section 50A, the Court held that such gains were assessable as short term capital gains.
A similar view has been taken by the ITAT, Delhi Bench, in the case of Raj Woolen Industries vs ACIT, 54 SOT 117, DoJ – 14.05.2010.
10. Treatment of slump sale
Section 2(42C) defines slump sale, while Section 50B lays down the computation of capital gains in such a case.
In the case of Mahinda Engineering & Chemical Products Ltd., 51 SOT 496, (DoJ: 18.04.2012), the Mumbai ITAT has held that sales of trademarks, plant and machinery, technical know-how, copyrights, goodwill were part and parcel of same business and they were integral and indivisible components of a composite unit sold by assessee, actually being a part of single transaction, what was sold by assessee was business as a whole and not item wise sale of different assets. Hence, it was concluded that the transaction was a slump sale. The Tribunal had held that non-transferring of a plot of land was not deciding factor in such transaction. It is interesting to note that the Tribunal had examined various aspects including (i) noncompete agreement, (ii) Director’s Report to shareholders, (iii) Auditor’s Report etc. The ITAT has also reproduced several clauses of the agreement to arrive at this conclusion. Thus, it is very essential that the AO bring out all relevant portions of the agreement in the assessment order, to buttress his claim of slump sale. The Tribunal’s order is worth reading before passing any order regarding slump sale. A similar ratio has also been laid down by Kerala High Court in the case of Accelerated Freeze Drying Co. Ltd. 337 ITR 440, (DoJ: 06.10.2010).
In the case of SREI Infrastructure Finance Ltd., 251 CTR 129, DoJ: 30.03.2012, the assessee contended that scheme of arrangement was sanctioned by High Court under Sections 391 to 394 of Companies Act, 1956 and was statutory in nature and character and in such a case, provisions of section 50B would not apply. However, the Delhi High Court held that provisions of Section 50B are applicable and the scheme of sanction cannot be used as a ground to escape tax on transfer of capital asset.
In the case of DCIT vs Summit Securities Ltd, 135 ITD 99, DoJ: 07.03.2012, the ITAT Special Bench, Mumbai, held that negative figure of net worth cannot be ignored for working out capital gains in case of a slump sale under Section 50B. In this case, the assessee transferred its entire power transmission business to another company and the sale sonsideration of said business was Rs.143 crores. The assessee had negative ‘networth’ of Rs. 157 crores as per section 50B (i.e. value of liabilities or Rs.1517 crores was in excess of aggregate value of assets of Rs.1360 crores). In such a scenario, the ITAT Special Bench held that negative figure of net worth of Rs. 157 crore could not be ignored and the capital gain chargeable to tax in case of slump sale would be Rs. 300 crore (i.e., Rs. 143 crore plus Rs. 157 core) and not Rs. 143 crore as offered by the assessee.
11. Reference to DVO
In the case of 43 SOT 347, Thakorlal Harkishandas Intwala vs ITO, DoJ: 17.09.2010, the Ahmedabad Tribunal has upheld the rejection of valuation report as on 01.04.1981 filed by the assessee, in view of the exhaustive enquiries done by the AO regarding comparable instances of prevailing prices.
In cases in which the asset was acquired prior to 01.04.1981, the assessee has the option of taking the cost of acquisition as either the cost price or the fair market value as on 01.04.1981. If the fair market value is adopted, the assessee is required to file the valuation report of the registered valuer. Section 55A provides for reference to Valuation Officer by the AO, for ascertaining the fair market value of a capital asset.
Earlier sub-clause (a) of Section 55 was worded as “in a case where the value of the asset as claimed by the assessee is in accordance with the estimate made by a registered valuer, if the Assessing Officer is of opinion that the value so claimed is less than its fair market value”. Thus, this section was practically unusable as the objective of the AO is to refer such matters only when the fair market value adopted by the assessee is opined to be higher. Now, amendment has been brought in Section 55A w.e.f.01.07.2012. Thus, the relevant portion stands amended as “in a case where the value of the asset as claimed by the assessee is in accordance with the estimate made by a registered valuer, if the Assessing Officer is of opinion that the value so claimed is at variance with its fair market value”. Hence, in all cases where the AO is of the opinion that fair market value as on 01.04.1981 claimed by the assessee is on the higher side, the AO can make reference to the Valuation Officer.
Although section 55A does not talk of any reasons to be recorded in writing, considering the judicial interpretation in various other sections, it is recommended that the AO record his reasons in brief, before referring the valuation to the DVO.
12. Insertion of Section 50D
The Finance Bill, 2012 has inserted a new section 50D w.e.f. 01.04.2013, i.e. for AY 2013-14 onwards. The reasoning given is as under: “Capital gains are calculated on transfer of a capital asset, as sale consideration minus cost of acquisition. In some recent rulings, it has been held that where the consideration in respect of transfer of an asset is not determinable under the existing provisions of the Income-tax Act, then, as the machinery provision fails, the gains arising from the transfer of such assets is not taxable. It is, therefore, proposed that where in the case of a transfer, consideration for the transfer of a capital asset(s) is not attributable or determinable then for purpose of computing income chargeable to tax as gains, the fair market value of the asset shall be taken to be the full market value of consideration.”
13. Other Recent Decisions in favour of Revenue
Premier Synthetic Industries vs ITO, 208 Taxman 195 (Madras HC)(Mag), DoJ: 04.06.2012: Purchase and sale of shares causing losses in a short span of time without ostensible reasons and therefore capital loss claim could not be allowed.
ACIT vs Jaimal K Shah, 137 ITD 376 (Mumbai ITAT), DoJ: 30.05.2012: ‘Right of claim in flats’ and ‘flats’ are distinct. Period of holding is to be determined from date of possession of flats, and the agreement date is not relevant when the flats are taken possession of. Gains are short term capital gains.
GK Properties P Ltd vs ITO, 25 taxmann.com 197 (Hyderabad ITAT), DoJ: 31.08.2012: Purchase of agricultural land with sole motive to sell same for earning profit is taxable as business income and not capital gain.
ACIT vs Faiz Murtaza Ali, 52 SOT 358, (Delhi ITAT), DoJ: 31.05.2012: Without evidence of personal use of household items, furniture or collector items inherited or received in gift, those items could not be held to be personal effects within meaning of provisions of section 2(14), and were liable to be taxed as capital gains.