No cost of acquisition means No capital gain Tax

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No cost of acquisition means No capital gain Tax

In case of Capital Gain computation, Hon’ble supreme court in a number of cases have enumerated the view that the charging section i.e., s. 45 and the computation provisions are inextricably linked and constitute an integrated code.

Where the computation provisions cannot apply, such a case is not intended to fall within the charging section. Therefore, it is not possible to compute capital gains and it is not taxable under s. 45. Sec. 55(2) is not applicable as the cost of acquisition is not ascertainable. This was the principle laid down in

accessible at –  https://thetaxtalk.com/2018/08/02/no-cost-no-capital-gain/

 

Here is one more judgment on the similar lines:

PNB FINANCE LTD. vs. COMMISSIONER OF INCOME TAX

SUPREME COURT OF INDIA

S.H. Kapadia & B. Sudershan Reddy, JJ.

Civil Appeal No. 3721 of 2002

6th November, 2008

(2008) 76 CCH 1238 ISCC

(2008) 220 CTR 0110 : (2008) 15 DTR 0047 : (2008) 307 ITR 0075 : (2008) 175 TAXMAN 0242

Legislation Referred to

Section 41(2), 45, 48, 55(2)(i),

Case pertains to

Asst. Year 1970-71,

Decision in favour of:

Assessee

JUDGMENT

S.H. KAPADIA, J.

This civil appeal is directed against the judgment of Delhi High Court in income-tax reference under s. 256(1) of the IT Act, 1961 (“1961 Act”) for the asst. yr. 1970-71.

  1. The issue which arises for determination in this civil appeal is whether transfer of banking undertaking on the facts and circumstances of this case gave rise to taxable capital gains under s. 45 of the 1961 Act.
  2. Punjab National Bank Ltd. was set up in 1895 in an area which now falls in Pakistan. It was nationalized as Punjab National Bank (PNB) by Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970.

On 19th July, 1969 PNB Ltd. on nationalization vested in Punjab National Bank. PNB Finance Ltd. is the appellant herein. On nationalization it received compensation of Rs. 10.20 crore This compensation was calculated on the basis of capitalization of last 5 years profits. The said compensation was received during the accounting year ending 31st Dec., 1969 corresponding to the asst. yr. 1970-71.

  1. During the asst. yr. 1970-71, appellant had to compute capital gains under s. 48 by deducting from the sale consideration the cost of acquisition as increased by the cost of improvement and expenses incurred in connection with the transfer. Under the law then prevailing, assessee could index the cost of acquisition by applying cost inflation index which became indexed cost of acquisition.
  2. Incidentally, it may be noted that by an amendment to s. 50B inserted by the Finance Act, 1999 w.e.f. 1st April, 2000, cost of acquisition is now notionally fixed in case of “slump” sale. Under the said arrangement, assessee is required to draw up his balance sheet as on the date of transfer for its undertaking and net worth of that date is now required to be taken into account. Under the said amendment, net worth consists of written down value (WDV) of depreciable assets and the book value of the current assets minus liabilities taken over. Therefore, after 1st April, 2000 cost of acquisition is notionally fixed in case of slump sale. However, no such formula existed during asst. yr. 1970-71. At that time, assessee had to deduct either cost of acquisition or fair market value as on 1st Jan., 1954 from the sale price (compensation) of Rs. 10.20 crores [see s. 55(2)(i)]. This option was conferred on the assessee solely for its benefit. However, s. 55(2) only triggered if there existed the figures of “cost of acquisition” and “fair market value” as on 1st Jan., 1954 so that the choice could be exercised. At that time, it was open to the assessee to contend that he would exercise the option only after both the figures of original cost and fair market value of the asset as on 1st Jan., 1954 was available. In short, it is only after 1st April, 2000 that computation machinery came to be inserted in s. 48 which deals with mode of computation.
  3. Any surplus on transfer of capital asset is chargeable to tax under s. 45 in the previous year in which the transfer took place (i.e. in this case on 18th July, 1969). This is the mandate of s. 45. The full value of consideration received by the assessee in this case was Rs. 10.20 crores
  4. A return was filed in this case by the assessee showing an income of Rs. 2,03,364. In the covering letter with which the return of income was filed by the assessee it was noticed by the AO that the assessee had opted for having the value ascertained of the banking undertaking as on 1st Jan., 1954. The letter was dt. 30th Sept., 1970. In para 5 of that letter, the assessee stated as follows :

“Assuming, while denying, that the provisions of s. 45 are applicable, the company exercises its option for substitution of the fair market value of such undertaking as on 1st Jan., 1954 in accordance with ss. 49 and 50 of the IT Act, 1961.”

  1. It was argued by the assessee before the AO that the option under s. 55(2)(i) was to be exercised only if it was advantageous to the assessee. The assessee submitted that he had an option under s. 55(2)(i) of having the value of the undertaking ascertained either on the basis of historical cost of acquisition of the capital asset (banking undertaking) or having its value ascertained as on 1st Jan., 1954, whichever is higher but could not exercise it as the cost of acquisition in this case was not computable. In the alternative, appellant assessee herein submitted fair market value of the undertaking as on 1st Jan., 1954. By letter dt. 30th Sept., 1970, assessee claimed a capital loss. The AO held that since the assessee had submitted its own computation of the fair market value of the undertaking as on 1st Jan., 1954 the only question he was required to consider was the correctness of the figure of capital loss submitted by the assessee vide its covering letter dt. 30th Sept., 1970. In this connection, it may be noted that compensation of Rs. 10.20 crores was paid to the assessee from which assessee claimed deduction of Rs. 17,22,73,246 (market value of the undertaking as on 1st Jan., 1954 fixed at Rs. 10,41,51,625 plus cost of improvement fixed at Rs. 6,81,21,621). This is how the assessee contended that it had in the above transaction suffered a capital loss of Rs. 7.02 crores This calculation was not accepted by the AO who proceeded to hold on the basis of capitalization of last 5 years profits the capital gains of Rs. 1,65,34,709 (see p. 42 of the paper book).
  2. Aggrieved by the decision of the AO, the matter was carried in appeal by the assessee to the AAC who by his order dt. 16th Oct., 1974 came to the conclusion that, in this case, it was not possible to allocate the full value of the consideration received (compensation) amounting to Rs. 10.20 crore between various assets of the undertaking and, consequently, it was not possible to determine the cost of acquisition and cost of improvement under the provisions of s. 48 of the 1961 Act and since computation was inextricably linked with the charging provisions under s. 45 of the said Act it was not possible to tax the surplus, if any, under s. 45 of the 1961 Act.
  3. Aggrieved by the decision of the AAC, the Department went by way of reference (sic) to the Tribunal which took the view that, in this case, since the assessee had exercised its option for substitution of fair market value of the undertaking as on 1st Jan., 1954 it was not open to the assessee to contend that cost of acquisition was not computable and, therefore, the AO was right in arriving at the figure of capital gains fixed by him at Rs. 1,65,34,709.
  4. At this stage, it may be noted that on the request of the assessee the Tribunal referred the matter to the High Court under s. 256(1) of the 1961 Act in which the impugned judgment had been given by Delhi High Court. In the impugned judgment, the High Court relied upon the decision of this Court inCIT vs. Artex Manufacturing Co. (1997) 141 CTR (SC) 290 : (1997) 227 ITR 260 (SC) to hold that “in the case of a slump transaction when the business is sold as a going concern, it is not impossible to determine the actual cost, namely, the cost of acquisition, even though, in a given case, it may be a self-generated asset.”
  5. The question which arises for determination in this civil appeal is whether judgment of this Court inArtex Manufacturing Co. (supra) is applicable to the present case. In that case, the assessee, a partnership firm, entered into an agreement with the company to sell its business as a going concern for a consideration of Rs. 11,50,400. From the information supplied by the assessee to the AO, it was evident that the sale consideration stood arrived at after taking into account the value of plant, machinery and dead stock as computed by the valuer. The Tribunal held that, the surplus arising on the sale was taxable under s. 41(2) of the Act and not as capital gains. The High Court reversed that finding of the Tribunal and held that the surplus was taxable as capital gains under s. 45 and not under s. 41(2). At the instance of the Revenue, this Court on an appeal held that on the facts and in the circumstances of the case s. 41(2) was applicable as the amount of Rs. 11,50,400, being the consideration, stood arrived at by taking into consideration the value of the plant, machinery and dead stock. It was further held that, the surplus resulting from transfer of plant, machinery and dead stock was either taxable as income under s. 41(2) or as capital gains under s. 45. It was held that since income was chargeable to tax under s. 41(2), the impugned decision of the High Court that such income was chargeable to tax as capital gains was erroneous.
  6. In order to decide the applicability of the judgment of this Court inArtex Manufacturing Co. (supra) we need to examine the scope of s. 41(2). At the outset, it may be noted that, in this case, the Department has not relied upon s. 41(2). In fact, none of the authorities below, apart from the High Court, has relied upon s. 41(2). For the first time, relying upon s. 41(2), the High Court has dismissed the reference initiated at the behest of the assessee.
  7. Sec. 41(2) stands attracted only in the case of a sale of building, machinery, plant or furniture in the previous year. In other words, s. 41(2) applies to a sale of depreciable assets. Secondly, the amount received from such a sale must exceed the WDV of such building, machinery, plant or furniture. Sec. 41(2) states that certain gains from disposition of building, machinery, plant or furniture shall be deemed to be profits of the previous year. Sec. 41(2) refers to the concept of a “balancing charge” which arises only when depreciable asset is sold. Sec. 41(2) brings to tax the balancing charge (difference between WDV and historical cost of depreciable asset) on sale. The object underlying s. 41(2) is to recoup the depreciation allowed by way of deduction under the 1961 Act to the seller of depreciable asset. To attract s. 41(2) the subject-matter should be depreciable asset and the consideration received should be capable of allocation between various assets.
  8. Sec. 41(2) and s. 45 operate in different fields. In the case ofCIT vs. Mugneeram Bangur & Co. (Land Department) (1965) 57 ITR 299 (SC) this Court held that where the entire business of the undertaking together with its assets including the depreciable assets and liabilities was sold for a composite price without any item-wise earmarking, s. 41(2) was not attracted. But, where the transfer of the entire business as a going concern is involved and the contract indicates item-wise consideration, s. 41(2) would stand attracted with regard to the amount of surplus to the extent of the difference between the WDV of the depreciable asset(s) so transferred and the actual cost thereof.
  9. In the case ofArtex Manufacturing Co. (supra) this Court found, that a valuer was appointed, that valuer submitted his valuation report in which itemized valuation was carried out and on that basis the consideration was fixed at Rs. 11,50,400. Therefore, the sale consideration had been arrived at after taking into account the value of plant, machinery and dead stock as computed by the valuer and, consequently, it was held that the surplus arising on the sale was taxable under s. 41(2) of the Act and not as capital gains. In the circumstances, the judgment of this Court in the case of Artex Manufacturing Co. (supra) was not applicable to the present case. Further, this Court in the case of CIT vs. Electric Control Gear Mfg. Co. (1997) 141 CTR (SC) 302 : (1997) 227 ITR 278 (SC) has held that whether the business of the assessee stood transferred as a going concern for slump sale price, in the absence of evidence on record as to how the slump price stood arrived at, s. 41(2) had no application. It is interesting to note that the judgment in the case of Electric Control Gear Mfg. Co. (supra) is given by the same Bench which decided the case of Artex Manufacturing Co. In fact, both the judgments are reported one after other in 227 ITR at pp. 260 and 278 respectively. In the present case, as can be seen from the impugned judgment of the Delhi High Court, the judgment of this Court in Electric Control Gear Mfg. Co. (supra) is missed out. That judgment has not been considered by the High Court. As stated above, this Court has clarified its judgment in Artex Manufacturing Co. (supra) in its judgment in the case of Electric Control Gear Mfg. Co. (supra). Therefore, s. 41(2) has no application to the facts of the present case.
  10. As regards applicability of s. 45 is concerned, three tests are required to be applied. In this case, s. 45 applies. There is no dispute on that point. The first test is that the charging section and the computation provisions are inextricably linked. The charging section and the computation provisions together constituted an integrated code. Therefore, where the computation provisions cannot apply, it is evident that such a case was not intended to fall within the charging section, which, in the present case, is s. 45. That section contemplates that any surplus accruing on transfer of capital assets is chargeable to tax in the previous year in which transfer took place. In this case, transfer took place on 18th July, 1969. The second test which needs to be applied is the test of allocation/attribution. This test is spelt out in the judgment of this Court inMugneeram Bangur & Co. (supra). This test applies to a slump transaction. The object behind this test is to find out whether the slump price was capable of being attributable to individual assets, which is also known as item-wise earmarking. The third test is that there is a conceptual difference between an undertaking and its components. Plant, machinery and dead stock are individual items of an undertaking. Business undertaking can consist of not only tangible items but also intangible items like, goodwill, manpower, tenancy rights and value of banking licence. However, the cost of such items (intangibles) is not determinable. In the case of CIT vs. B.C. Srinivasa Setty (1981) 21 CTR (SC) 138 : (1981) 128 ITR 294 (SC), this Court held that s. 45 charges the profits or gains arising from the transfer of a capital asset to income-tax. In other words, it charges surplus which arises on the transfer of a capital asset in terms of appreciation of capital value of that asset. In the said judgment, this Court held that the “asset” must be one which falls within the contemplation of s. 45. It is further held that, the charging section and the computation provisions together constitute an integrated code and when in a case the computation provisions cannot apply, such a case would not fall within s. 45. In the present case, the banking undertaking, inter alia, included intangible assets like, goodwill, tenancy rights, manpower and value of banking licence. On facts, we find that item-wise earmarking was not possible. On facts, we find that the compensation (sale consideration) of Rs. 10.20 crore was not allocable item-wise as was the case in Artex Manufacturing Co. (supra).
  11. For the aforestated reasons, we hold that on the facts and circumstances of this case, which concerns asst. yr. 1970-71, it was not possible to compute capital gains and, therefore, the said amount of Rs. 10.20 crore was not taxable under s. 45 of the 1961 Act. Accordingly, the impugned judgment is set aside.
  12. Before concluding, we may state that in this case, s. 55(2)(i) did not operationalize. Under s. 55(2), fair market value as on 1st Jan., 1954 could have substituted the figure of cost of acquisition provided the figures of both “cost of acquisition” and “fair market value as on 1st Jan., 1954” were ascertainable. The letter dt. 30th Sept., 1970 does not indicate the choice. Even the working done by the AO based on capitalization of last 5 years’ profits would give the enterprise value of the undertaking and not the cost of acquisition. Hence, s. 55(2) was not applicable.
  13. Consequently, the civil appeal filed by the assessee stands allowed with no order as to costs.

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