Cost of acquisition in case of Property of Ex-Rulers

The Supreme Court in the
case of CIT v. B. C. Srinivasa Setty, 128 ITR 294, held that no capital
gains tax is payable by an assessee where it was not possible to compute
the capital gains u/s.48 of the Act. It held that capital gains could
not be computed in cases where the cost of acquisition could not be
conceived at all. Of course, this position of law has been slightly
altered by the insertion of section 55(2)(a), which provides that the
cost of certain assets shall be deemed to be nil in cases of the assets
specified therein. Sale of such specified assets, though not having any
cost of acquisition, is now subjected to capital gains tax by virtue of
this amendment. Section 55(2)(a) however does not include such property
of ex-rulers.

The question has arisen before the courts as to
whether such property of ex-rulers acquired by their forefathers by way
of conquest or by way of jagir has no cost of acquisition, and the gains
arising on sale of such property is not subject to capital gains tax,
or whether such property has a cost of acquisition and the gains thereon
is subject to capital gains tax on sale. While the Madhya Pradesh,
Madras, and Gujarat High Courts have taken the view that the sale of
such property would not be subject to capital gains tax, the Full Bench
of the Punjab and Haryana High Court has recently taken a contrary view
that the provisions relating to capital gains tax do apply to such
properties. The decision, though rendered in the context of an ex-ruler,
has far-reaching implications inasmuch as it seeks to chart a new
course of thinking by relying on the provisions of section 55(3) for
bringing to tax gains arising even in cases not covered by section
55(2).

Lokendra Singhji’s case : The issue first came up before
the Madhya Pradesh High Court in the case of CIT v. H.H. Maharaja Sahib
Shri Lokendra Singhji, 162 ITR 93.

In this case, the assessee
was the ex-ruler of the erstwhile State of Ratlam, which was founded by
Maharaja Ratansinghji. A jagir of the entire state of Ratlam was
conferred on Ratansinghji in the 17th century by Emperor Shahjahan for
his daring feat of killing a mad elephant with a dagger. The assessee
sold certain land and building within the compound of Shri Ranjit Vilas
Palace, Ratlam during the relevant year, which property was a part of
the estate received as jagir, and which had been inherited by the
assessee in his capacity as the ruler.

The assessee initially
included the capital gains (loss) on sale of the property in his tax
return, by claiming the fair market value of the land and building on
1st January 1954 as the substituted cost of acquisition. The Assessing
Officer computed the assessment by taking such fair market value as on
1st January 1954 at a lower figure, which figure was slightly enhanced
by the Commissioner (Appeals).

Before the Tribunal, for the 1st
time the assessee raised an additional ground claiming that there was no
cost of acquisition of the asset and as such there could be no capital
gains as a result of the transfer of the property. The Tribunal admitted
the additional ground and came to the conclusion that no capital gains
arose as a result of the sale of the land and building.

Before
the Madhya Pradesh High Court, on behalf of the Revenue, it was argued
that the Tribunal was not justified in holding that no capital gains
arose, and that the main controversy was whether the sale proceeds of
the property were in the nature of capital receipts and whether such
receipts attracted the provisions of section 45. It was argued that as
the assessee had received the property by way of inheritance and himself
opted for substitution of the cost of the capital asset as on 1st
January 1954, the Tribunal was not right in concluding that there being
no cost of acquisition of the property to the initial owner, there was
no question of capital gains.

On behalf of the assessee, it was
submitted that though the property was a capital asset, there was no
gains because the forefathers of the assessee were not required to pay
any cost in terms of money for acquiring the property, given the history
of Ratlam State. It was argued that in the absence of any cost of
acquisition, no liability to capital gains could be fastened on the
assessee, though he might have accepted the valuation as on 1st January
1954 and had disclosed the capital loss in his return of income.
Reliance was placed on the decisions of the Bombay High Court in the
case of CIT v. Home Industries and Co., 107 ITR 609, of the Madhya
Pradesh High Court in CIT v. Jaswantlal Dayabhai, 114 ITR 798, and of
the Supreme Court in CIT v. B. C. Srinivasa Setty, 128 ITR 294, all of
which decisions were rendered in the context of goodwill, for the
proposition that the charging section and the computation provisions
together constituted an integrated code, and where the computation
provisions could not apply at all, such a case was not intended to fall
within the charging section. Reliance was also placed on the decisions
of the Delhi High Court in the case of Bawa Shiv Charan Singh v. CIT,
149 ITR 29, and the Bombay High Court in the case of CIT v. Mrs.
Shirinbai P. Pundole, 129 ITR 448 in the context of tenancy rights.

The
Madhya Pradesh High Court noted that though none of the cases cited by
the assessee related to the sale of an immovable property as was the
case before it, but the gist of all these decisions was that if there
was no cost of acquisition, then the gains on sale would not attract the
provisions of capital gains. According to the Madhya Pradesh High
Court, the liability to capital gains tax would arise in respect of only
those capital assets in the acquisition of which the element of cost
was either actually present or was capable of being reckoned and not in
respect of those assets in acquisition of which the element of cost was
altogether inconceivable, as in the case before it.

The Madhya
Pradesh High Court observed that a case where a person acquired some
property by way of gift or reward (for instance, jagirs from a ruler)
and the property passed on by inheritance to succeeding generations, and
was sold for a valuable consideration, because the initial owner had
not acquired it at some cost in terms of money, it would not attract
capital gains tax in such a transaction of sale, there being no gains
that could be computed as such. The Madhya Pradesh High Court therefore
held that the gains on sale of the property would not attract capital
gains tax.

This view taken by the Court in this case was
followed subsequently by the Court in the case of CIT v. Pushparaj
Singh, 232 ITR 754 (shares/securities transferred to the assessee by the
government as a moral gesture), by the Gujarat High Court in the case
of CIT v. Manoharsinhji P. Jadeja, 281 ITR 19 (property acquired by
forefathers by conquest), and by the Madras High Court in the case of
CIT v. H.H. Sri Raja Rajagopala Thondaiman, 282 ITR 126. The Punjab and
Haryana High Court also took a similar view in the case of CIT v. Amrik
Singh, 299 ITR 14, in the context of ownership acquired by the assessee
by Court’s sanction in terms of section 3 of the Punjab Occupancy
Tenants (Vesting of Proprietary Rights) Act, 1952.

Raja
Malwinder Singh’s case :

The Assessing Officer assessed the capital gains by taking the cost of acquisition equal to the market value as on 1st January 1954/1964. The Commissioner (Appeals) rejected the assessee’s appeal and the contention that cost of acquisition was incapable of ascertainment, but the Tribunal reversed the decision, following the judgment of the Supreme Court in the case of B. C. Srinivasa Setty (supra). The Division Bench of the Punjab and Haryana High Court prima facie differed with the view taken by the same court in the case of Amrik Singh (supra), and therefore referred the matter to a large Bench.

On behalf of the Revenue, before the Full Bench, a distinction was sought to be drawn between the judgment of the Supreme Court in the case of B. C. Srinivasa Setty (supra) and the case before the Court, on the ground that in a newly started business the value of goodwill was not ascertainable, whereas in the case of acquisition of land, the same was either acquired at some cost or without cost, and under the scheme of the Act, there could be no situation where the cost was incapable of ascertainment.

The Punjab and Haryana High Court noted that in the case before it, the assessee acquired the property by succession from the previous owner. It also noted that according to the assessee, the cost of acquisition by the previous owner could not be ascertained and had failed to exercise the option of adopting the market value on the date of acquisition or the cost of the previous owner. Therefore, according to the Court, the only option available to the Assessing Officer was to compute capital gains by taking the cost of asset to be the fair market value on the specified date (1st January 1954/1964, as the case may be).

According to the Full Bench of the Punjab and Haryana High Court, even in a case where the cost of acquisition could not be ascertained, section 55(3) statutorily prescribed the cost to be equal to the market value on the date of acquisition. Therefore, capital gains was not excluded even on the plea that value of the asset in respect of which capital gains was to be charged was incapable of ascertainment.

The Full Bench of the Punjab and Haryana High Court therefore held that the view taken by it earlier in Amrik Singh’s case was not correct, being against the statutory scheme. The Court also held that the view taken by the Madhya Pradesh High Court in Lokendra Singhji’s case (supra) could not be accepted, as it did not give effect to the mandate of section 55(3), which provided for a situation where the value of the asset acquired could not be ascertained. According to the court, if the market value of an asset on the date of its acquisition could be ascertained, the cost of acquisition had to be taken to be equal to that, and if the value could not be so ascertained, the cost had to be equal to the market value on a specified date (for example, 1-4-1964 or 1-4-1981) at the option of the assessee. The Court observed that it was not the case of the assessee that the land had no market value on the date of its acquisition.

The Full Bench of the Punjab and Haryana High Court therefore held that once an asset had a market value, on the date of its acquisition, capital gains tax would be attracted by taking the cost of acquisition to be fair market value as on the specified date or at the option of the assessee, the market value on the date of acquisition where no cost was incurred. The Court accordingly held that the gains made on sale of the property of the ex-ruler was subject to capital gains tax.

Observations:

Computation of capital gains is possible where all of the following information is available :

•     Date of acquisition,

•     Cost of acquisition,

•     Mode and manner of acquisition,

•     Date of transfer,

•     Consideration for transfer, and

•     Mode and manner of transfer.

These requirements are sought to be taken care of by provisions of section 45(2) to (6), section 46 to 49, 50 and section 55(1) to (3) and section 2(42A). Further, the decision of the Supreme Court provides for the course of action, to be adopted, where the cost of acquisition and the date of acquisition are not known or cannot be determined. One dimension however, i.e., the mode and the manner of acquisition remains unexplored where no information is available about the mode of acquisition of the previous owner who had acquired the asset by any of the modes not specified by section 49(1). On a harmonious reading of the provisions of Chapter IVE, it appears that the capital gains cannot be brought to tax where the information in relation to any of the above referred dimensions is not available.

The Supreme Court in the case of B. C. Srinivasa Setty, 128 ITR 294 was concerned with the taxability of the receipts on transfer of goodwill. The Court in the context of the said case observed and held as under :

•     It was impossible to predicate the moment of the birth of goodwill and there can be no account in value of the factors producing goodwill. No business possessed goodwill from the start which generated on carrying on of business and augmented with the passage of time.

•     The charging section 45 and the computation provisions of section 48 together constituted an integrated code.

•     All transactions encompassed by section 45 must fall under the governance of its computation provisions. A transaction that cannot satisfy the test of computation must be regarded as never intended to be covered by section 45.

•     Section 48 contemplated an asset in the acquisition of which it was possible to envisage a cost, an asset which possessed the inherent quality of being available on the expenditure of money to a person seeking to acquire it.

•     The date of acquisition of an asset was a material factor in applying the computation provisions and for goodwill, it was not pos-sible to ascertain such date.

•     Taxing the goodwill amounted to taxing the capital value of the asset and not the profits or gains.

The Supreme Court in the above-referred case observed that what was contemplated for taxation was the gains of an asset in the acquisition of which it was possible to envisage a cost; the asset in question should be one which possessed the inherent quality of being available on the expenditure of money to a person seeking to acquire it. Importantly, it observed that it was immaterial that although the asset belonged to such a class it might have been acquired without the payment of money, in which case section 49 would determine the cost of acquisition for the
purposes of section 48. This finding is heavily relied by the taxpayers to canvass that the Court implied that an asset for which no payment is made and which is not covered by section 49 is outside the scope of section 48.

The Court on a reference to section 50 and section 55(2) as also section 49 gathered that section 48 dealt with an asset that was capable of being acquired at cost; these provisions indicated that section 48 excluded such assets for which no cost element could be identified or envisaged and the goodwill was one such asset.

Significantly the Court observed that it was impossible to determine the cost of acquisition of goodwill even in the hands of the previous owner who had transferred the same in one of the modes specified in section 49(1). It also held that section 55(3) could not be invoked in such a case, because the date of acquisition of the previous owner re-mained unknown. In cases where the cost of an asset cannot be conceived at all, it appears that the fair market value as prescribed by section 55(3) cannot be adopted even where the date of acquisition of the previous owner is known. Whether the cost of acquisition is ascertainable or not should be examined from the standpoint of the assessee or the previous owner, as the case may be and in doing so, due importance should be given to the mode of acquisition by the assessee. An asset may be the one which is capable of being acquired at cost and may have a fair market value, but in the context of the assessee, it may not be possible to conceive any cost for him on account of his mode of acquisition.

The observation, findings and the ratio of the decision in the said Srinivasa Setty’s case when applied to the issue under consideration, the following things emerge:

•     It is essential to determine the cost of acqui-sition in the hands of previous owner where the asset was acquired in any of the modes specified in section 49(1). If such cost to the previous owner cannot be determined, there will be no liability to Capital Gains tax. It is impossible to determine the cost of acquisition of goodwill having regard to the nature of asset.

•     S/s. 55(3) cannot be invoked in cases where the date of acquisition by the previous owner remains unknown.

The asset i.e., the immovable property, in the facts of the cases under consideration, is an asset that was originally acquired by the forefathers of the transferor on conquest and/or ascension. The assessee transferor acquired the asset by inheritance. In computing the capital gains of the transferor, it was essential to adopt the cost of the previous owner and also determine the date of acquisition of the previous owner. It is an admitted fact that the immediate previous owner of the asset did not incur any cost of acquisition. In such cases, by virtue of the Explanation to section 49(1), one was required to travel back in time to reach such an owner who had last acquired it by a mode of acquisition other than that, that is referred in clause (i) to (iv) of section 49(1). Following the mandate provided by the said Explanation, it was essential to find out the cost of acquisition of the persons from whom the asset was acquired by the forefathers of the assessee, on conquest. Admittedly this was not possible for scores of reasons and therefore the cost to the assessee could not have been ascertained by resorting to the provisions of section 49(1) for computing the capital gains. Accordingly, while it was possible to ascertain the date of acquisition and the period of holding of the asset, the cost of acquisition of such asset remains to be determined as it is unknown and therefore the capital gains could not be computed and be brought to tax in the facts of the case. Further, no cost could have been envisaged in the cases ‘of conquest and/ or ascension. Similarly, where the property was acquired by conquest in a war, it cannot be said that the cost incurred on the war is the cost of acquisition of the property. Therefore, in all such cases of property of ex-rulers, one cannot envisage a cost of acquisition at all, and it is not merely a case of difficulty of determination or ascertainment of cost of acquisition.

One has to at the same time examine whether the conclusion reached in the above paragraph meets the test provided by section 55(3) of the Act. The Full Bench of the Punjab & Haryana High Court has heavily relied on the provisions of section 55(3) for the purposes of overruling the decision of Madhya Pradesh High Court. The said section 55(3) reads as : “where the cost for which the previous owner acquired the property cannot be ascertained, the cost of acquisition to the previous owner means the fair market value on the date on which the capital asset became the property of the previous owner”. Ordinarily, an assessee is required to ascertain his cost only and not of the previous owner unless where section 49(1) apply. From a reading of section 55(3), it is clear that the provision applies only in cases where an assessee is required to ascertain the cost of the previous owner which requirement arises only in cases where the asset is acquired by any of the modes specified in section 49(1) and not otherwise. Section 55(3) appears to take care of situations where the cost of previous owner can-not be ascertained.

On insertion of the said Explanation to section 49(1) w.e.f. 1-4-1965 by the Finance Act, 1965, an assessee is required to adopt that cost of acquisition which was the cost of the previous owner in time who had last acquired the asset under a mode other than the one specified in section 49(1). It appears that the said Explanation is specifically inserted to take care of the situations where it is difficult to ascertain the cost of the previous owner. It requires an assessee to travel back in time and adopt the cost of that owner, previous in time, who last acquired it by any of the mode not specified in section 49(1). It appears that the provisions of section 55(3) are rendered redundant on introduction of the said Explanation. The attention of the Full Bench of the Court was perhaps not invited to the presence of the said Explanation. Had that been done, the Court might not have relied solely on the provisions of section 55(3) for reaching the conclusion derived by it.

The said Explanation has the effect of defining the term ‘previous owner of the property’ to mean the last previous owner of the capital asset who acquired it by a mode of acquisition other than that referred to in section 49(1). The notes to clauses and the memorandum explaining the provi-sion of the Finance Bill, 1965 reported in 55 ITR 131 explain the objective behind the introduction of the said Explanation to section 49(1). Please also see Circular No. 31, dated 21-9-1962 and Circular No. 3-P, dated 11-10-1965.

The Supreme Court on page 301 specifically held that having regard to the nature of the asset, it was impossible to determine the cost of acquisition even of the previous owner for the purposes of section 49(1). It also held that section 55(3) could not be invoked because the date of acquisition by the previous owner remained unknown. It is relevant to note that the Court in that case was concerned with A.Y. 1966-67 and the said Explanation was inserted w.e.f. 1-4-1965. Even assuming that the provision of section 55(3) continues to be relevant, it may be difficult to substitute the fair market value prevailing on the date of conquest or ascension on account of the fact that the asset is acquired on conquest and due to the manner of acquisition of the asset no cost can be envisaged for acquisition of such an asset.

It is relevant to note that presently section 55(2) provides for adopting the cost of acquisition of certain specified assets, including the goodwill at Nil. It provides for cases of the goodwill, tenancy rights, loom hours, stage carriage permits, trade mark or a brand name associated with the business, no-compete rights, right to manufacture, etc. On a closer reading, it is seen that the assets specified for are the ones which are not acquired on a given day for a cost and whose value has been generated over a period of time on regular efforts made over a period. The cost of such an asset including the cost of the regular efforts cannot be identified and quantified. The said section does not provide for such a fiction in cases of the assets acquired on conquest and/or ascension. In the circumstances, it is fair for the assessee to contend that the capital gains in his case cannot be computed as the cost of an asset so acquired could not be taken to be Nil. Wherever the government has intended no cost assets to be subjected to capital gains tax, such assets have been specifically included in the provisions of section 55(2)(a). The very fact that such property of ex-rulers has not been included in this section over the years in spite of so many courts taking the view that the sale of such property is not subject to capital gains tax, clearly indicates that the intention is not to tax such sale proceeds. It is intriguing to note that the Revenue in the past has not relied on section 55(3) while defending the cases of tenancy rights and goodwill. The better view therefore is that such property of an ex-ruler acquired by way of conquest or grant by his ancestors does not have any cost of acquisition, and the capital gains on sale of such property is not subject to tax.

The Direct Tax Code, proposed to be introduced from Financial Year 2012-13, provides that the cost of acquisition will be taken as Nil in all cases where the asset is acquired for no cost in any of the modes for which the cost of the previous owner is not permitted to be adopted.

Neither section 49 nor section 55(3) shall apply in cases where no cost is paid for an asset by the assessee, and the asset is acquired by him by any of the modes not specified by section 49, inas- much as there is no previous owner. Even if there is one, his cost would be ascertainable and therefore section 55(3) does not apply in his case and that section 49(1) cannot apply as the asset is not acquired by any of the modes specified therein.