The Central Board of Direct Taxes (CBDT) has notified the rules relating to the determination of ‘Fair Market Value’ of inventories converted into capital assets.

The rules, which will come into effect from April 1 — assessment year 2019-20 — will help remove uncertainty surrounding valuation of assets which are converted into capital assets.

The rules follow an amendment in the Income Tax Act inserted in the Finance Act 2018. The amendment provides that any profit and gain from the conversion of inventory into the capital asset or its treatment as capital asset will be charged to tax as business income. It has also been provided that for this purpose the fair market value of inventory on the date of conversion or treatment determined in prescribed manner will be deemed to be the full value of consideration.

The inventory has been distributed into three categories for determining the fair market value. The first category comprises an immovable property, being land or building or both and here the value adopted or assessed or assessable by any authority of the Central Government or a State Government for the purpose of payment of stamp duty in respect of such immovable property on the date on which the inventory is converted into, or treated, as a capital asset will be the fare market value.

The second category talks about jewellery, archaeological collections, drawings, paintings, sculptures, any work of art, shares or securities and fair market value will be value on the date of conversion. The third category says that fair market value will be the price that such property would ordinarily fetch on sale in the open market on the date of conversion.

Remove uncertainty

Rakesh Nangia, Managing Partner at Nangia Advisors, said the rules will help in removing the existing uncertainty and mandate taxpayers to undertake an objective assessment of valuation of their inventories, while converting them to capital asset.

“They provide for a specific binding condition that any internal restructuring for conversion of inventories to capital assets ought to be undertaken at a fair valuation as laid down in the rules,” he said adding, “We are witnessing a sharp trend towards fair value as also increased commitment of the CBDT to align transactions towards fair market value and prescribing valuation norms surrounding most transactions. This is perhaps designed to avoid artificial avoidance of tax through innovative intra group arrangements and similar other strategies.”

Vikas Vasal, Partner at Grant Thornton, said conversion of stock-in-trade into capital asset is a prevalent business practice, like conversion of shares held as stock-in-trade to investments. However, the tax laws did not provide a mechanism to tax the income arising from such conversion or the basis for determining the value of the resulting capital asset, which had led to considerable dispute and litigation.