The Hindu Business Line : No cost, no taxable gains

THERE IS an old idiom `No pain, no gains'. The Gujarat High Court has laid down a new principle "no cost-no gains". This stand has been taken not in a case where there is actually no cost of the asset but where the cost and date of acquisition cannot be ascertained, as usually happens in the case of old assets and inherited property.

In CIT v B. C. Srinivasa Setty (128 I.T.R. 294), the Supreme Court categorically laid down in the context of self-generating assets, such as goodwill, that in the absence of any cost, no capital gains can be made exigible to tax.

However, the Gujarat High Court's decision is based on different facts where neither the cost of acquisition nor the date of acquisition of the asset was known to the assessee as it was inherited by him from his forefathers.

Needless to add, if the decision of the Gujarat High Court in CIT v Mandharsinhji P. Jadeja ([2005] 148 Taxman 110) is to be applied, every tax-payer who has inherited an asset or a property will feign ignorance of the cost of acquisition or the date of acquisition by the original purchaser of the asset and, therefore, pay no tax whatsoever.

The facts in this case pertaining to a former ruler are that he inherited property known as `Ranjit Vilas Palace' alongwith appurtenant and adjacent land located at Rajkot on the death of his father, Pradumansinhji, on November 9, 1973. It appears that for assessment years 1974-75 to 1977-78 certain tax demands along with the estate duty payable on the death of his father were outstanding against the assessee. To recover these outstandings the Income-Tax Department attached 22,059 square yards of vacant land on February 1, 1983.

The Department divided 5,727 sq. m out of the aforesaid parcel of land and sold 33 plots through a public auction held on March 21 and 22, 1983. A sum of Rs 65,50,870 was the gross realisation from the auction sale. The return of income filed by the assessee was accompanied by a letter dated June 6, 1983 wherein the assessee advanced reasons for showing long-term capital gains at `Nil' in the return of income. The case of the assessee was that he was not liable to the charge of capital gains tax as the land in question was received by him from his forefathers by way of inheritance.

In support of his stand, the assessee relied on the decision of the apex court in the B. C. Srinivasa Setty case and stated that he was not liable to capital gains tax on a correct reading of Sections 48(ii), 49 and 55(2) of the Income-Tax Act, 1961. On a reference, the Gujarat High Court went into the scheme of taxing capital gains. According to Section 45, on transfer of a capital asset effected the previous year, the profits or gains would be chargeable to income-tax under the head `Capital gains' and shall be deemed to be the income of the previous year in which the transfer happened. The terms `capital asset' and `transfer' are defined respectively in Sections 2(14) and 2(47) of the Act. For the purpose of computing the income chargeable under Section 45, the mode of computation is prescribed in Section 48. In a case where the capital asset becomes the property of the assessee before January 1, 1964, (now, January 1, 1981) the assessee gets the option to either adopting the actual cost of acquisition of the asset to the assessee or the fair market value on January 1, 1964. Section 49 lays down the modality of ascertaining the cost of acquisition with reference to certain modes specified under sub-section (1). In the present case, the admitted position between the parties is that the capital asset was transferred during the previous year and hence attracted the provisions of Section 45.

The only dispute between the parties is the cost of acquisition under Sections 48, 49 and 55 of the Act read together. The Assessing Officer had called upon the assessee to exercise the option under Section 55(2).

However, the assessee did not agree to adopt the fair market value as on January 1, 1964, as his case was that there was no actual cost of acquisition.

It is also an admitted position between the parties that the asset in question has been acquired by inheritance, that is, by a mode of acquisition specified in Section 49(1)(iii). The case of the assessee was that even after applying the Explanation to Section 49, the cost of acquisition in the hands of the previous owner could not be ascertained.

The reason, according to the assessee, was that the previous owner of the capital asset acquired it by conquest, that is, without paying any price. As noted earlier, the Tribunal has categorically found after referring to the history of Jadeja rulers of Rajkot State, that the property was never purchased by the assessee's forefathers but acquired by conquest.

Section 48 specifies the mode of computation and deduction. The income chargeable under the head `Capital gains' has to be computed by deducting from the full value of the consideration received or accruing as a result of the transfer of the capital assets — expenditure incurred wholly and exclusively in connection with such transfer and cost of acquisition of the capital asset and the cost of any improvement thereto.

The Gujarat High Court held that it is not possible to accept the contention raised on behalf of the Revenue that where the cost is not ascertainable it has to be adopted as Nil. The opening portion of Section 48 states that while computing income chargeable under the head `Capital gains' the income shall be computed by deducting from the full value of the consideration the specified items and one of them is cost of acquisition.

Therefore, in the absence of an ascertained cost of acquisition, the charge under the head `Capital gains' cannot be fastened to the full value of the consideration.

The Gujarat High Court further held that the amendment to Section 55 only ropes in taxability of goodwill on transfer of the same, if there is no cost of acquisition. Similarly, Section 55 has been amended from time to time to enable the taxation of other assets wherein no cost of acquisition is envisaged: tenancy rights, stage carriage permits and looms hours by the Finance Act, 1994 with effect from April 1, 1995; right to manufacture, produce or process any article or thing by the Finance Act, 1997 with effect from April 1, 1998; trademark or brand name associated with business by the Finance Act, 2001 with effect from April 1, 2002; and right to carry on any business by the Finance Act, 2002 with effect from April 1, 2003.

Therefore, even if the amendment is taken into consideration, Section 55 can be invoked in cases of Nil cost of acquisition for the purpose of bringing to tax entire sale consideration only in relation to the specified assets. The Legislature having amended the section from time to time has roped in only specified assets set out above.

In the circumstances, the amendment, instead of working to the advantage of the Revenue, goes to indicate that the Legislature does not want to bring within the purview of tax net all the assets (except the specified assets) which does not have cost of acquisition.

Hence, the entire sale consideration cannot be treated as profits and gains chargeable under the head `Capital gains' by adopting the cost of acquisition as Nil. According to the court, the importance of date of acquisition cannot be lost sight of taking into consideration the scheme of the Act.

Under the Act, both short-term gains and long-term capital gains are chargeable to tax but the treatment thereof is different. The court held that in the present case, admittedly, the assets have been acquired by a mode of acquisition specified in Section 49(1)(iii)(a) and thus the asset in question is a long-term capital asset but neither the cost nor the date of acquisition are ascertainable. Therefore, no amount can be made liable to tax.

This judgment raises interesting questions of taxability of capital gains. Undoubtedly, the I-T Department will lose huge amounts of revenue if a tax-payer takes a stand in case of inherited property that the cost and date of acquisition are unknown to him.

This would be so especially in the case of items such as jewellery, gold, etc., where there is no way of identifying the date of acquisition and in the absence of such date the cost of the gold, jewellery, etc. also cannot be ascertained.

Undoubtedly, the Government will have to consider amending the law to bring capital gains to tax in such cases. If the assessee has to avoid litigation with the I-T Department possibly the best he can do is to invest the full sale proceeds in the notified bonds under Section 54-EC so that whatever stand the Department may take on the quantum of capital gains, it will not result in a tax liability.

(The author is a Mumbai-based advocate. He can be contacted at ranina@bom2.vsnl.net.in)

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