S. 115JB reads as follows:

115JB. (1) Notwithstanding anything contained in any other provision of this Act, where in the case of an assessee, being a company, the income-tax, payable on the total income as computed under this Act in respect of any previous year relevant to the assessment year commencing on or after the 1st day of April, 2007, is less than ten per cent of its book profit, such book profit shall be deemed to be the total income of the assessee and the tax payable by the assessee on such total income shall be the amount of income-tax at the rate of [ten per cent.

 

…..

 

(2) Every assessee, being a company, shall, for the purposes of this section, prepare its profit and loss account for the relevant previous year in accordance with the provisions of Parts II and III of Schedule VI to the Companies Act, 1956 (1 of 1956) :

 

…..

 

Explanation [1].For the purposes of this section, book profit means the net profit as shown in the profit and loss account for the relevant previous year prepared under sub-section (2), as increased by ….

As is evident, the moot question is whether Parts II and III of Schedule VI to the Companies Act permit the exclusion of capital profits from the Profit & loss account. In other words, can a P&L Account drawn up without considering the capital profits be said to be “in accordance with the provisions of Parts II and III of Schedule VI to the Companies Act”?

Part II and Part III of Schedule VI to the Companies Act read as under:

PART II

 

REQUIREMENTS AS TO PROFIT AND LOSS ACCOUNT

 

1. The provisions of this Part shall apply to the income and expenditure account referred to in sub-section (2) of section 210 of the Act, in like manner as they apply to a profit and loss account, but subject to the modification of references as specified in that subsection.

 

2. The profit and loss account—

 

(a) shall be so made out as clearly to disclose the result of the working of the company during the period covered by the account; and

 

(b) shall disclose every material feature, including credits or receipts and debits or expenses in respect of non-recurring transactions or transactions of an exceptional nature.

 

3. The profit and loss account shall set out the various items relating to the income and expenditure of the company arranged under the most convenient heads; and in particular, shall disclose the following information in respect of the period covered by the account:

 

(i) ….

 

(ii) ….

 

(xi) (a) The amount of income from investments, distinguishing between trade investments and other investments.

 

(b) Other income by way of interest, specifying the nature of the income.

 

(c) The amount of income-tax deducted if the gross income is stated under sub-paragraphs (a) and (b) above.

 

(xii) (a) Profits or losses on investments showing distinctly the extent of the profits or losses earned or incurred on account of membership of a partnership firm to the extent not adjusted from any previous provision or reserve.

 

Note: Information in respect of this item should also be given in the balance sheet under the relevant provision or reserve account.

 

(b) Profits or losses in respect of transactions of a kind, not usually undertaken by the company or undertaken in circumstances of an exceptional or non-recurring nature, if material in amount.

 

(c) Miscellaneous income.

 

(xiii) (a) ….

 

(b) ….

 

(xiv) ….

 

(xv) ….

As is evident from the above, the Profit and Loss A/c. of a company has to disclose every material feature including credits or receipts and debits or expenses in respect of non-recurring transactions or transactions of an exceptional nature. Further the company is also required to set out the various items relating to the income and expenditure of the company arranged under most convenient heads and disclosing profit or loss in respect of transactions of a kind not usually undertaken by the company or undertaken in circumstances of exceptional or non-recurring nature if material in amount.

This issue whether capital gains had to be included in book profits arose before the Bombay High Court in Veekaylal Investment Co 249 ITR 597. The Court held that if for computing the total income under the normal provisions, the capital gains computed u/s 45 hasd to be taken into account, it was not understood how in computing the book profits u/s 115J, the assessee could exclude capital gains. It was noted that under clause (2) of Part II of Schedule VI to the Companies Act where a Company receives the amount on account of surrender of leasehold rights, the Company is bound to disclose in the profit and loss account the said amount as non-recurring transaction or a transaction of an exceptional nature Irrespective of its nature i.e. whether capital or revenue and that it would be inappropriate to directly transfer such amount to capital reserve [see Companies Act by A. Ramaiya, page 1669 [Fourteenth Edition). It was also held that such receipts were covered by clause 2(b) of Part II of Schedule VI of the Companies Act which states that the profit and loss account shall disclose every material feature including credits or receipts and debits or expenses in respect of non-recurring transactions or transactions of an exceptional nature. It was also held that the reference in clause 3(xii)(b) to profits or losses in respect of transactions not usually undertaken by the Company or undertaken in circumstances of exceptional or non-recurring nature showed clearly that capital gains should be included for the purposes of computing book profits. It was noted that capital gains would certainly be one of the various items whose information was required to be given to the share holders under the said clause 3(xii)(b). So also, the disclosure was required to be made in respect of Investment in the capital of a partnership firm if the Company was a partner on the date of the balance sheet (page 1651 of the Companies Act by A. Ramaiya [Fourteenth Edition). Similarly, profits or losses on such investments are also required to be disclosed, (see clause 3(xii)(a) of Part II of Schedule VI of the Companies Act.

In Apollo Tyres Ltd 255 ITR 273 the Supreme Court held that the words “in accordance with the provisions of parts II and III of Schedule VI to the Companies Act” was made for the purpose of empowering the assessing authority to rely upon the authentic statements of accounts of the Company. It was held that while so looking into the accounts of the Company, the AO has to accept the authenticity of the accounts with reference to the provisions of the Companies Act which obligates the Company to maintain its accounts in a manner provided by the Companies Act and the same to be scrutinized and certified by the statutory auditors and will have to be approved by the Company in its General meeting and thereafter to be filed before the Registrar of Companies who has a statutory obligation also to examine and satisfy that the accounts of the Company are maintained in accordance with the requirement s of the Companies Act. It was held that if these procedures were complied with, it was not open to the AO to rescrutinize this account and satisfy himself that these accounts have been maintained in accordance with the provisions of the Companies Act. The same view was reiterated in Malayala Manorama 300 ITR 251 (SC).

This principle was applied by the Mumbai Bench of the Tribunal in DCIT vs. Bombay Diamond Co 33 DTR 59. Here, the assessee earned a capital profit of Rs. 10.38 crores on sale of rights to immovable property which was directly credited to the capital reserves in the balance sheet instead of being routed through the Profit & loss account. The accounts of the assessee company were duly certified by the auditors and were also adopted in the AGM. The audited accounts were filed with ROC. In the computation of “book profits” for s. 115JB, the said capital profits were not included. The AO took the view that by not crediting the capital profit to the P&L A/c, the assessee had contravened sub-clause (xi)(a) of clause (3) of Part II of the Schedule VI to the Companies Act and that he was, therefore, entitled to add the capital profit to the “book profit”. On appeal, the CIT (A) reversed the AO on the ground that the AO had no jurisdiction to go beyond the net profit shown in the P&L A/c except to the extent provided in the Explanation to s. 115JB. On appeal by the Revenue, the Tribunal upheld the stand of the AO on the ground that as the assessee had not routed the capital profits through the Profit and Loss A/c and directly credited it to the Balance Sheet, its accounts were not prepared in the manner provided in Part II and Part III of Schedule VI to the Companies Act. It was held that the fact that the auditors had certified the accounts was not relevant. The tribunal distinguished the judgements in Apollo Tyres Ltd 265 ITR 273 and Kinetic Motor Co. Ltd 262 ITR 340 on the ground that as the assessee had bypassed the provisions of Schedule VI and directly credited the capital profit to the reserve account, these judgements did not apply and the AO had the power to rework the book profit.

Update: 2nd July 2010: In Rain Commodities vs. DCIT the ITAT Hyderabad Special Bench has held that capital gains exempt u/s 47(iv) cannot be excluded from the “book profit” because no such exclusion was permitted under the Explanation to s. 115JB. The decision in Bombay Diamond Co 33 DTR 59 was referred to with approval.

Even if capital profits are credited to the capital reserves a/c in the balance sheet, they have to be added to the “book profits” for purposes of s. 115JB.

Profit on sale of property used for residence.

 

54. (1) Subject to the provisions of sub-section (2), where, in the case of an assessee being an individual or a Hindu undivided family, the capital gain arises from the transfer of a long-term capital asset, being buildings or lands appurtenant thereto, and being a residential house, the income of which is chargeable under the head Income from house property (hereafter in this section referred to as the original asset), and the assessee has within a period of one year before or two years after the date on which the transfer took place purchased, or has within a period of three years after that date constructed, a residential house, then, instead of the capital gain being charged to income-tax as income of the previous year in which the transfer took place, it shall be dealt with in accordance with the following provisions of this section, that is to say,

 

(i) if the amount of the capital gain is greater than the cost of the residential house so purchased or constructed (hereafter in this section referred to as the new asset), the difference between the amount of the capital gain and the cost of the new asset shall be charged under section 45 as the income of the previous year; and for the purpose of computing in respect of the new asset any capital gain arising from its transfer within a period of three years of its purchase or construction, as the case may be, the cost shall be nil; or

 

(ii) if the amount of the capital gain is equal to or less than the cost of the new asset, the capital gain shall not be charged under section 45; and for the purpose of computing in respect of the new asset any capital gain arising from its transfer within a period of three years of its purchase or construction, as the case may be, the cost shall be reduced by the amount of the capital gain.

 

(2) The amount of the capital gain which is not appropriated by the assessee towards the purchase of the new asset made within one year before the date on which the transfer of the original asset took place, or which is not utilised by him for the purchase or construction of the new asset before the date of furnishing the return of income under section 139, shall be deposited by him before furnishing such return [such deposit being made in any case not later than the due date applicable in the case of the assessee for furnishing the return of income under sub-section (1) of section 139] in an account in any such bank or institution as may be specified in, and utilised in accordance with, any scheme which the Central Government may, by notification in the Official Gazette, frame in this behalf and such return shall be accompanied by proof of such deposit; and, for the purposes of sub-section (1), the amount, if any, already utilised by the assessee for the purchase or construction of the new asset together with the amount so deposited shall be deemed to be the cost of the new asset:

 

Provided that if the amount deposited under this sub-section is not utilised wholly or partly for the purchase or construction of the new asset within the period specified in sub-section (1), then,

 

(i) the amount not so utilised shall be charged under section 45 as the income of the previous year in which the period of three years from the date of the transfer of the original asset expires; and

 

(ii) the assessee shall be entitled to withdraw such amount in accordance with the scheme aforesaid.

As is evident, there is no requirement in s. 54 that the sale proceeds of the old house have to be utilized for purchase of the new house. The fact that the section permits a purchase of the new house one year before the sale of the old house itself makes it clear that such utilization is not even possible. All that the section requires is that the new house property should be purchased within the time period specified. The source of funds is irrelevant.

The direct judgement on this point is that of the Bombay High Court in CIT vs. Dr. P. S. Pasricha. In this case also, the assessee sold a house and used the sale proceeds to buy commercial property. Subsequently (but within the specified period) he borrowed funds and purchased a new house. The AO denied deduction u/s 54 on the ground that the new house had been purchased out of borrowed funds and not out of the consideration received for the old house. On appeal, the Tribunal and High Court upheld the claim on the ground that s. 54 merely required the purchase of the new house to be within the specified period. The source of funds for the purchase was irrelevant.

The same view has been taken by the Kerala High Court in K. C. Gopalan 162 CTR 566.

The only requirement for availing deduction u/s 54 is that the new residential house must be purchased or constructed within the period specified in the section. The source of funds is irrelevant.

Regulation 33(7) of the Development Control Regulations of the Municipal Corporation of Greater Bombay, 1991 (‘DCR’) provide for the grant of additional FSI if an existing building is redeveloped. The said additional FSI can be utilized either for the extension of the existing building or for the construction of a new building or may be sold for a consideration.

U/s 2(14), “capital asset” is defined to mean “property of any kind”, held by the assessee whether or not connected with his business or profession, but excluding ‘stock in trade’. The definition is wide enough to cover development rights within its ambit.

U/s 45, any profits and gains arising from the transfer of a capital asset is chargeable to tax. U/s 48, the profits and gains have to be computed by deducting from the full value of the consideration, the cost of acquisition and cost of improvement of the asset.

Though development rights are a capital asset, the moot question is whether there is a ‘cost of acquisition’ attached to them.

The leading judgements on the issue are that of the Mumbai Bench of the Tribunal in ITO vs. Lotia Court Co-operative Housing Society Ltd (2008) 12 DTR (Mumbai) (Trib) and New Shailaja CHS vs. ITO (ITAT Mumbai)

In Lotia Court Co-operative Housing Society the society and its members entered into a development agreement with a builder pursuant to which Transferable Development Rights (TDR) entitled to be received under the Development Control Regulations was assigned to the developer for the repairs and redevelopment of the building and the construction of additional floors. The AO sought to assess the society on the ground that it had made capital gains. However, the Tribunal held that as the TDRs were owned by the flat owners individually and as no consideration for the transfer of the TDRs was received by the assessee society nor any area in the constructed portion was allocated to the assessee society, the society was not chargeable to tax.

In New Shailaja CHS, the assessee-society became entitled by virtue of the Development Control Regulations to Transferable Development Rights (TDR) and the same were sold by it for a price to a builder. On the question of taxability in the hands of the Society, the Tribunal noted that the Supreme Court had laid down the law in B. C. Srinivasa Setty 128 ITR 294 (SC) that if there was an asset for which a cost of acquisition was not determinable, the gains could not be assessed as ‘capital gains’. It was accordingly held that though the TDR was a ‘capital asset’, there being no ‘cost of acquisition’ for the same, the consideration could not be taxed.

The said view has been followed in Om Shanti Co-op Society vs. ITO (ITAT Mumbai). In this case, the assessee co-op housing society gave permission to a developer to construct 2 floors and 8 flats on the building belonging to the society by using the TDR / FSI available to the developer. In consideration, the developer paid Rs. 26 lakhs to the assessee and Rs. 66 lakhs to its members aggregating Rs. 92 lakhs. The AO took the view that the assessee had relinquished its right “to load TDR and construct additional floors” and as there was no cost of acquisition, the entire consideration of Rs. 26 L was assessable as long-term capital gains. On appeal, the CIT (A) took the view that even the amounts received by the Members were assessable in the assessee’s hands. He accordingly enhanced the assessment and directed that the consideration be taken at Rs. 92 L. However, the Tribunal reversed the AO and CIT (A) on the ground that the assessee and its members had no right to construct additional floors on the existing building as they had exhausted the right available while constructing the flats in the building. The TDR was not obtained by the assessee and sold to the developer. It was held that the assessee had not transferred any existing right to the developer nor any cost was incurred / suffered prior to permitting the developer to construct the additional floors. The Tribunal held that in the absence of a cost of acquisition, the judgement in B. C. Srinivasa Setty 128 ITR 294 (SC) applied and the consideration was not assessable as capital gains.

The taxability in the hands of the members of the society was considered in Jethalal D. Mehta vs. DCIT (2005) 2 SOT 422 (Mum). There also, following the judgment of Apex Court in CIT vs. B.C. Srinivasa Setty 128 ITR 294 (SC), it was held that as the TDR granted by DCR, 1991 qualifying for equivalent F.S.I had no cost of acquisition, the sale of the same did not give rise to assessable capital gains.

The entire case rests on there not being a ‘cost of acquisition’ of the development right / FSI obtained pursuant to the Development Control Regulations. In respect of buildings that have been erected after the DC Regulations of 1991 came into force, it is a possible argument in favour of the Revenue that some part of the cost of the building is attributable to the said development right / FSI and that the principle of B. C. Srinivasa Setty does not apply.

Long-term capital gains on shares are exempt from tax u/s 10 (38). To constitute a ‘long-term capital asset’ and a ‘long-term capital gain’, the shares must be held for a period of more than 12 months u/s 2 (29A) & 2 (42A). The term “capital asset” is defined in s. 2 (14) as property of any kind but not including stock-in-trade.

If the shares are held as stock-in-trade, the profits will be assessable as business profits u/s 28.

INCOME TAX CIRCULAR NO. 4/2007, DATED 15-6-2007

The Income Tax Act, 1961 makes a distinction between a capital asset and a trading asset.

 

2. Capital asset is defined in Section 2(14) of the Act. Long-term capital assets and gains are dealt with under Section 2(29A) and Section 2(29B). Short-term capital assets and gains are dealt with under Section 2(42A) and Section 2(42B).

 

3. Trading asset is dealt with under Section 28 of the Act.

 

4. The Central Board of Direct Taxes (CBDT) through Instruction No.1827 dated August 31, 1989 had brought to the notice of the assessing officers that there is a distinction between shares held as investment (capital asset) and shares held as stock-in-trade (trading asset). In the light of a number of judicial decisions pronounced after the issue of the above instructions, it is proposed to update the above instructions for the information of assessees as well as for guidance of the assessing officers.

 

5. In the case of Commissioner of Income Tax (Central), Calcutta Vs Associated Industrial Development Company (P) Ltd (82 ITR 586), the Supreme Court observed that:

 

Whether a particular holding of shares is by way of investment or forms part of the stock-in-trade is a matter which is within the knowledge of the assessee who holds the shares and it should, in normal circumstances, be in a position to produce evidence from its records as to whether it has maintained any distinction between those shares which are its stock-in-trade and those which are held by way of investment.

 

6. In the case of Commissioner of Income Tax, Bombay Vs H. Holck Larsen (160 ITR 67), the Supreme Court observed :

 

The High Court, in our opinion, made a mistake in observing whether transactions of sale and purchase of shares were trading transactions or whether these were in the nature of investment was a question of law. This was a mixed question of law and fact.

 

7. The principles laid down by the Supreme Court in the above two cases afford adequate guidance to the assessing officers.

 

8. The Authority for Advance Rulings (AAR) (288 ITR 641), referring to the decisions of the Supreme Court in several cases, has culled out the following principles :-

 

(i) Where a company purchases and sells shares, it must be shown that they were held as stock-in-trade and that existence of the power to purchase and sell shares in the memorandum of association is not decisive of the nature of transaction;

 

(ii) the substantial nature of transactions, the manner of maintaining books of accounts, the magnitude of purchases and sales and the ratio between purchases and sales and the holding would furnish a good guide to determine the nature of transactions;

 

(iii) ordinarily the purchase and sale of shares with the motive of earning a profit, would result in the transaction being in the nature of trade/adventure in the nature of trade; but where the object of the investment in shares of a company is to derive income by way of dividend etc. then the profits accruing by change in such investment (by sale of shares) will yield capital gain and not revenue receipt.

 

9. Dealing with the above three principles, the AAR has observed in the case of Fidelity group as under:-

 

We shall revert to the aforementioned principles. The first principle requires us to ascertain whether the purchase of shares by a FII in exercise of the power in the memorandum of association/trust deed was as stockin-trade as the mere existence of the power to purchase and sell shares will not by itself be decisive of the nature of transaction. We have to verify as to how the shares were valued/held in the books of account i.e. whether they were valued as stock-in-trade at the end of the financial year for the purpose of arriving at business income or held as investment in capital assets. The second principle furnishes a guide for determining the nature of transaction by verifying whether there are substantial transactions, their magnitude, etc., maintenance of books of account and finding the ratio between purchases and sales. It will not be out of place to mention that regulation 18 of the SEBI Regulations enjoins upon every FII to keep and maintain books of account containing true and fair accounts relating to remittance of initial corpus of buying and selling and realizing capital gains on investments and accounts of remittance to India for investment in India and realizing capital gains on investment from such remittances. The third principle suggests that ordinarily purchases and sales of shares with the motive of realizing profit would lead to inference of trade/adventure in the nature of trade; where the object of the investment in shares of companies is to derive income by way of dividends etc., the transactions of purchases and sales of shares would yield capital gains and not business profits.

 

10. CBDT also wishes to emphasise that it is possible for a tax payer to have two portfolios, i.e., an investment portfolio comprising of securities which are to be treated as capital assets and a trading portfolio comprising of stock-in-trade which are to be treated as trading assets. Where an assessee has two portfolios, the assessee may have income under both heads i.e., capital gains as well as business income.

 

11. Assessing officers are advised that the above principles should guide them in determining whether, in a given case, the shares are held by the assessee as investment (and therefore giving rise to capital gains) or as stock-in-trade (and therefore giving rise to business profits). The assessing officers are further advised that no single principle would be decisive and the total effect of all the principles should be considered to determine whether, in a given case, the shares are held by the assessee as investment or stock-in-trade.

 

12. These instructions shall supplement the earlier Instruction no. 1827 dated August 31, 1989.

 

(F.No.149/287/2005-TPL)

As is evident, the CBDT has accepted that an assessee can be both a dealer and an investor in shares. What is necessary is that there should be a clear demarcation between the two in the books of the assessee.

In Sarnath Infrastructure P. Ltd. v. ACIT the Tribunal has considered almost all the important judicial decisions laying down legal principles to determine the nature of transaction i.e. trading the transaction or investment. The Tribunal has also considered the CBDT circular No. 4 of 2007. The Tribunal has summarized these principles in para 13 of the said order.

“After considering above rulings we cull out following principles, which can be applied on the facts of a case to find out whether transaction( s) in question are inthe 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 (or any other item). 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 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 purchase and sale 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. Habitual dealing in that particular item is indicative 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 is for realizing profit or purchases are made for retention and appreciation in its value? Former will indicate intention of trade and later, 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 1 question are valued at cost, it would indicate that they are investments or where they are valued at cost or market value or net realizable value (whichever is less), it will indicate that items in question are treated as stock-in-trade.

 

(6) How the company (assessee) is authorized in memorandum of association/ articles of association? Whether for trade or for investment? If authorized only for trade, then whether there are separate resolutions of the board of directors to carry out investments in that commodity? And vice versa.

On the facts of that case, the Tribunal recorded the following findings:

(i) The assessee is dealing in shares both as a trader as well as investor. It has kept separate accounts for both types of dealings. Valuation of holdings has been done at cost (for investment portfolio). At least there is no allegation or material to come to the conclusion that valuation of investment portfolio has been done on cost or net realizable value whichever is low.

(ii) The shares which are sold out of investment portfolio, this year, were purchased two to three years ago showing that assessee had intention, while purchasing them, to hold them. They were reflected in the balance sheet as investment. The assessee has enjoyed dividend income and declared the same in return of income. The frequency of such purchase or sale in this portfolio is not large enough to doubt that this portfolio is only a device to pay lesser taxes by parking some stock-in-trade in investment portfolio. We notice that in trading portfolio the assessee had purchased during the year shares worth Rs. 21,38,353 and same shares were sold for Rs. 23,89,805. There was neither opening stock nor closing stock. In investment portfolio, opening stock of shares was Rs. 19,22,203 and closing stock was Rs. 46,23,274 whereas sales out of investment portfolio were Rs. 31,80,423. It shows that turnover to stock ratio in investment portfolio is very low as compared to that in trading portfolio.

(iii) There is no material to show that these shares in the investment portfolio were also traded in the same and like manner as those which were in stock-in-trade portfolio. The board of directors has passed resolutions for making investment whereas memorandum of association has only authorized to carry out trade in shares. It clearly shows intention of the assessee to maintain a separate investment portfolio. All the sales out of this portfolio are identifiable to purchases made in this portfolio.

(iv) The assessee has discharged its primary onus by showing that it is maintaining separate account for two portfolios and there is no intermingling. The onus now shifted on the Revenue to show that apparent is not real. The onus now shifted on the Revenue to show that apparent is not real. There is no material brought in by the Revenue to show that separate accounts of two portfolios are only a smoke screen and there is no real distinction between two types of holdings. This could have been done by showing that there is intermingling of shares and transactions and the distinction sought to be created between two types of portfolios is not real but only artificial and arbitrary.

This principle has been followed by the Bombay Bench of the Tribunal in Gopal Purohit vs. JCIT 122 TTJ (Mum) 87. In this case also, the assessee had separate portfolios and the Tribunal upheld his right to treat the investment portfolio as separate from the dealing portfolio. The Tribunal emphasized that the fact that the investment activity was an organized activity did not detract from the fact that it was a capital asset. It was noted that the stakes were high and so a person investing in shares in bound to study the news papers, business magazines, watch the business channels and use websites and other tools to keep a track of the developments which are happening on day- to-day basis and which may happen in the near future and for this, he may have assistance of the financial planner or investment consultant or may by his own expertise and capabilities do it on his own. The employment of such infrastructure did not turn an investment activity into a business activity it was held.
The fact that the AO had accepted the investment transactions in the past was held to be an important factor as well.

The Tribunal’s judgement has been affirmed by the Bombay High Court in CIT vs. Gopal Purohit. The High Court upheld the following:

(a) That it was open to an assessee to maintain two separate portfolios, one relating to investment in shares and another relating to business activities involving dealing in shares. Delivery based transactions were to be treated as being in the nature of investment transactions giving rise to capital gains.

(b) That though the principle of res judicata was not attracted, there had to be uniformity in treatment and consistency when the facts and circumstances are identical. As the assessee has followed a consistent practice in regard to the nature of the activities, the manner of keeping records and the presentation of shares as investment at the end of the year in all the years and there is no justification for a different view being taken by the AO.

(c) While entries in the books of account alone are not conclusive in determining the nature of income, it does have a bearing as to whether the shares are held on capital account or on revenue account.

In Janak Rangwala 11 SOT 627 (Mum) also, the fact that the AO had treated the shares as investment in the past was held to be an important factor.

Even in the case of brokers it has been held that the shares can be held on the capital account and as an investment. See J. M. Share & Stock Brokers vs. JCIT (ITAT Mumbai) and ACIT vs. Motilal Oswal (ITAT Mumbai)

Update: May 2010

See Management Structure & Systems vs. ITO (ITAT Mumbai) & Smt. Sadhana Nabera vs. ACIT (ITAT Mumbai) where these principles were applied.

One has to be careful to ensure that there is a proper segregation of the shares held on investment account from the shares held on trading account. The investment shares must be valued at cost while the trading shares can be valued at market price if that is lower.

U/s 3 of the RTI Act information as defined u/s 2(f) which is not exempt from disclosure u/s 8(1) or 9 and is held by a public authority has to be disclosed. There are exceptions built into section 8 of the RTI Act. S. 8(1) (b) exempts the disclosure of information which has been expressly forbidden by any court of law or tribunal. S 8(1) (d) exempts the disclosure of information which would harm the competitive position of a third party. S. 8(1) (e) exempts disclosure of information held in fiduciary relationship. S. 8(1) (h) exempts disclosure of information which would impede the process of investigation. S. 8(1) (j) exempts disclosure of information which relates to personal information the disclosure of which has no relationship to any public activity or interest, or which would cause unwarranted invasion of the privacy of the individual.

This issue was considered in detail by the Chief Information Commissioner in Rakesh Kumar Gupta vs. PIO. In that case, the Applicant filed a RTI application seeking inspection & copies of all records available with the income tax department including assessment orders of Escorts Ltd, Dr. Naresh Trehan and connected parties. The CIC upheld the right of the Applicant to call for the information after considering whether any of the exemptions of section 8 would apply. The CIC held that S. 8(1) (j) which exempts disclosure information which relates to personal information the disclosure of which has no relationship to any public activity or interest, or which would cause unwarranted invasion of the privacy of the individual did not apply to corporate entities and can only be claimed by natural persons and not by corporate entities. It held that there was a difference between having a legal personality and owning ‘personal information’. Personal information is information relating to a natural person, not a legal person.

The CIC also held that the argument that the disclosure of the information would lead to unwarranted invasion of the privacy of the individual did not apply for two reasons. Firstly, the information has been provided by the assessee to meet his legal obligations and the disclosure of the same to another person cannot be construed as being an unwarranted invasion of the privacy of the individual. It was held that the Citizen’s right to Information should be given greater primacy than privacy. Information provided by individuals in fulfillment of statutory requirements is not covered by the exemption u/s 8 (1) (j). Secondly, it held that as there has been large evasion of taxes by the group, if citizens monitor assessments through RTI, it could be a major gain for public revenue and perhaps a good check on corrupt officials.

The CIC further held that the Applicant, as informer, was assisting the Department by bringing instances of tax evasion to its notice, and if he was using information that he has received through RTI Applications for this purpose, it could not be considered to be misuse of information in any way, nor could it be considered to be an unwarranted invasion of privacy of the assessee. It was observed that even if the exemption clauses of s. 8 (1) is applicable it certainly served a larger public interest, if tax evasion is curbed.

The argument that the Applicant was likely to misuse the information and could endanger the life and property of the assessee was held to be a mere apprehension and could not be accepted as it would defeat the objective of the RTI Act.

The ruling of the CIC has far reaching implications because the income-tax records of anybody and everybody can be made public. The ruling does not appear to be correct. One should not be surprised if the ruling gets reversed by the High Court or superceded by a statutory amendment.

In Hind Construction 83 ITR 211, the Supreme Court held that when a partner introduces his asset into a firm as capital contribution such introduction did not constitute a “sale”. In Sunil Siddharthbhai 156 ITR 509 (SC), it was held that when a partner introduces his asset into a firm as capital contribution, there is a “transfer” though the gains are not chargeable to tax as the consideration is not determinable. It was clarified that this principle did not apply if the partnership was non-genuine or sham or where the transaction of transferring the personal asset to the partnership firm was a device or ruse to convert personal assets into money while evading tax on capital gains.

To supercede the law laid down in the aforesaid judgements, section 45(3) was added w.e.f 01.04.1988. It reads as follows:

“(3) The profits or gains arising from the transfer of a capital asset by a person to a firm or other association of persons or body of individuals (not being a company or a co-operative society) in which he is or becomes a partner or member, by way of capital contribution or otherwise, shall be chargeable to tax as his income of the previous year in which such transfer takes place and, for the purposes of section 48, the amount recorded in the books of account of the firm, association or body as the value of the capital asset shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of the capital asset.”

As is evident, section 45 (3) applies when there is a “transfer of a capital asset”. There is no law with respect to introduction of ‘stock-in-trade’ into a partnership.

However, the Special Bench, Delhi, has held in a majority judgement in DLF Universal vs. DCIT that though S. 45 (3) applies when a capital asset is introduced into a firm as capital contribution, it will also apply when stock-in-trade is introduced into a firm because the transaction is on the capital account and stock-in-trade does not retain its character as stock-in-trade at the point of time of introduction.

In that case, the assessee was engaged in the business of real estate development. It held land as stock in trade with a book value of Rs. 4.4 crs. The said land was introduced at its market value of Rs. 11.50 crs as capital contribution into a new firm. The surplus of Rs. 6.01 crore was credited to the profit and loss account. The assessee relied on Hind Construction 83 ITR 211 (SC) and claimed that the surplus of Rs. 6.01 crs was not liable to tax as the introduction of an asset into a partnership was not a sale. It was also claimed that s. 45 (3) was applicable only to capital assets and not to stock-in-trade. However, the majority of the Special Bench held that section 45(3) did apply and that the said surplus was chargeable to tax. The fact that the assessee had revalued the stock-in-trade to its market value prior to the introduction into the firm was cited as a factor to show that the stock-in-trade (which is valued at cost) had been converted into a capital asset.

On that facts of that case, the majority also held that though the partnership was genuine, the assessee had adopted a calculated device of converting land into money by withdrawing substantial sums from the firm and debiting the same to its current account. It was held that the contribution by the assessee of its personal land to the share capital of the firm was a device or ruse for converting land into money for its benefit. It was opined that the entry of Rs. 11.50 crs being the value of land credited in assessee’s capital account was not imaginary or notional and that it was chargeable to tax.

However, the issue cannot be treated as settled because the dissenting Member has opined that as section 45 (3) applies only to a “capital asset” which is defined in s. 2 (14) to exclude ‘stock-in-trade’, the same cannot appply to stock-in-trade. The dissenting member held that the finding of the majority that the stock-in-trade was converted into a capital asset on introduction was not correct. He opined that stock-in-trade could also be dealt with by the assessee in partnership given that partnership is not a distinct legal entity. He held that the introduced asset continues to be stock-in-trade and its character did not change as a result of introduction into partnership; He also differed from the view of the majority that the transaction was a sham or non-genuine.

The result of this conflict in law is that there is no clarity in the legal position. However, the better view appears to be that of the dissenting Member who correctly held that it is not right to hold that stock-in-trade gets converted into a capital asset at the point of introduction into the firm so as to attract section 45 (3).

The concept of “block of assets” was introduced with effect from 01.04.1988. To understand the concept, lets look at the statutory provisions.

Section 32 (1) reads as follows:

“32. (1) In respect of depreciation of -

 

(i) building, machinery, plant or furniture, being tangible assets;

 

(ii) know-how, patents, copyrights, trade marks, licences, franchises or any other business or commercial right of similar nature, being intangible assets acquired on or after the 1st day of April, 1998, owned wholly or partly, by the assesses and used for the purposes of the business or profession, the following deductions shall be allowed-

 

……..

 

(ii) in the case of any block of assets, such percentage on the written down value thereof as may be prescribed.”

Section 43 reads as follows:

“(6) “written down value” means:

 

……………

 

c) in the case of any block of assets.-

 

(i) in respect of any previous year relevant to the assessment year commencing on the 1st day of April, 1988, the aggregate of the written down values of all the assets falling within that block of assets at the beginning of the previous year and adjusted.-

 

(A) by the increase by the actual cost of any asset falling within that block, acquired during the previous year;

 

(B) by the reduction of the moneys payable in respect of any asset falling within that block, which is sold or discarded or demolished or destroyed during that previous year together with the amount of such reduction does not exceed the written down value as so increased.”

The term “block of assets” is defined in Section 2(11) as under:

“2(11) “block of assets” means a group of assets falling within a class of assets, being buildings, machinery, plant or furniture, in respect of which the same percentage of depreciation is prescribed.”

Prior to the introduction of new concept of block of assets with effect from 01.04.1988, depreciation used to be claimed separately on each asset. The Legislature found that this was a cumbersome procedure leading to various difficulties. This necessitated introduction of the concept of block of assets and allowability of depreciation on such a block.

The rationale behind such a provision is contained in Circular No. 469 dated 23.09.1986 issued by the Central Board of Direct Taxes (CBDT). After referring to the Budget Speech of the Finance Minister wherein reference was made to the proposal to introduce a system of allowing depreciation in respect of block of assets instead of the present system of depredation on individual assets, at paragraph 6.3 the Board stated as follows:

“As mentioned by the Economic Administration Reforms Commission (Report No. 12, para. 20), the existing system in this regard requires the calculation of depreciation in respect of each capital asset separately and not in respect of block of assets. This requires elaborate book-keeping and the process of checking by the Assessing Officer is time consuming. The greater differentiation in rates, according to the date of purchase, the type of asset, the intensity of use, etc., the more disaggregate has to be the record keeping. Moreover, the practice of granting the terminal allowance as per section 32(1)(iii) or taxing the balancing charge as per section 41(2) of the Income-tax Act, necessitate the keeping of records of depreciation already availed of by each asset eligible for depreciation. In order to simplify the existing cumbersome provisions, the Amending Act has introduced a system of allowing depreciation on block of assets. This will mean the calculation of lump-sum amount of depreciation for the entire block of depreciable assets in each of the four classes of assets namely, building, machinery, plant and machinery.”

The aforesaid legal position has been examined in great detail in two important judgements. In CIT vs. Bharat Aluminium the Delhi High Court held that the rationale and purpose for which the concept of block asset was introduced, as reflected in the CBDT’s Circular dated 23.09.1988 is that once the various assets are clubbed together and become ‘block asset’ within the meaning of s. 2(11), it becomes one asset. Every time, a new asset is acquired, it is to be thrown into the common hotchpotch, i.e., block asset on meeting the requirement of depreciation being allowable at the same rate. It was held that individual assets lose their identity and become an inseparable part of block asset insofar as calculation of depreciation is concerned.

The Court further held that the fusion of various assets into the block asset gets disturbed only when the eventuality contained in clause (iii) of s. 32 takes place, viz., when a particular asset is sold, discarded or destroyed in the previous year (other than the previous year in which first brought in use). Even in that event, the amount by which the moneys payable in respect of that particular building, machinery, etc. together with the amount of scrap value is to be deducted from total written down value of the ‘block asset’.

As regards the concept of “user” the Court held that though as per s. 32(1) the asset is to be owned and “used” for the purpose of business or profession, the expression “used for the purpose of business” when applied to block asset would mean use of block asset and not any specific items in the said block as individual assets have lost their identity after becoming inseparable part of the block asset.

The same view was reiterated on independent reasoning by the Bombay Bench of the Tribunal in Swati Synthetics vs. ITO. In that case, the factory was shut for more than 2 years and the question arose whether depreciation was allowable. The Tribunal reiterated the point that the “use” of an individual asset can be examined only in the first year when the asset is purchased. In subsequent years the use of block of assets is to be examined. The existence of an individual asset in block of asset itself amounts to use for the purpose of business.

The same view has been taken in several other judgements:

Likewise, in G. R. Shipping, the assessee’s barge sank to the bottom of the ocean and obviously could not be “used”. Nevertheless, the Bombay High Court upheld the Tribunal’s order that as the barge was a part of the block of assets, depreciation was admissible. The view of the Tribunal that after the insertion of the concept of “block of assets” by the T. L. (A) Act, 1988 w.e.f 1.4.1988 individual assets had lost their identity and only the “block of assets” had to be considered and that the test of “user” had to be applied upon the block of assets as a whole and not on individual assets was approved.

1. Packwell Printers Vs. ACIT [1996] 59 ITD 390 [Jab.]
2. DCIT Vs. Finolex Cables Ltd. [2008] 114 TTJ (Pune) 785
3. Unitex Products Ltd. V. ITO [2008] 22 SOT 429 (Mum.)
4. Nathani Steels Ltd., V. DcIT [1996] 57 ITD 584 (Bom.)
5. South Eastern Coalfields ltd. V. JCIT [2003] 260 ITR (AT) 1 (Nag.)
6. Inductothern (India) ltd. V. DCIT, [2003] 73 ITD 329 (Ahd.)
7. Natco Exports V. DCIT [2003] 86 ITD 445 (Hyd).
8. ACIT V. SRF Ltd. [2008] 21 SOT (Del.) 122
9. Goetx (India) Ltd. V. DCIT, [2008] 25 SOT 171 (Del.)

Accordingly, so long as the “block of assets” continues to be used, the user of the individual assets that make up the block cannot be seen. The assets of the closed factory are a part of the “block” and as the block continues to be used, depreciation even on the assets of the closed factory is eligible.