Rate of Taxation and Deemed Short-term Capital Gains

Issue for consideration

Any
profits or gains arising from the transfer of a property, held as a capital
asset, is liable to be taxed under the head “capital gains”. Such gains are
classified into short term capital gains and long term capital gains, where the
former is subjected to tax at the ordinary rates, while the later qualifies for
concessional rate of taxation, besides being eligible for the benefit of
reinvestment related exemptions from tax.

Ordinarily,
a short term capital gains arises on transfer of a short term capital asset and
long term capital gain arises on transfer of a long term capital asset. An
asset held for a period exceeding 36 months is usually treated as a long term
capital asset. Under a fiction of section 50 however, the act provides for a
separate treatment for an asset on which depreciation has been claimed, even
where such an asset is otherwise held for a period exceeding 36 months.

Section
50 has been the subject matter of two important controversies; one relating to
the eligibility of the deemed short term capital gains to the benefit of
sections 54E, 54f, 54EC, etc. and the other relating to the eligibility of such
gains for the concessional rate of taxation. While the former has now been
settled with the recent decision of the Supreme Court in the case of CIT vs.
V.S. Dempo Co. Ltd. 387 ITR 354, the later continues to be debatable as is
confirmed by conflicting decisions of the courts on the subject. While the Pune
and the Kolkata Tribunal are against conferring the benefit of concessional
rate on the deemed short term capital gains, a series of decisions of the
Mumbai Tribunal favour the grant of the benefit of concessional rate of
taxation for such gains.

Reckitt Benckiser (India)
Ltd.’s case

The  issue recently arose in the case of Reckitt
Benckiser (India) Ltd. vs. ACIT, 181 TTJ 384(Kol.) before the Kolkata Tribunal
involving the determination of rate of tax payable by the assessee on capital
gains arising from the sale of flats on which depreciation was claimed. In the
year under consideration, flats owned by the assessee were sold and since the
sold flats were held by the assessee for more than 36 months, the capital gains
arising from the sale thereof was offered to tax by the assessee at the
concessional rate applicable to long-term capital gains. Since the flats sold
by assessee were depreciable assets, the AO invoked the provisions of section
50 and brought to tax the capital gains arising from the sale thereof at normal
rate applicable to short-term capital gains.

On
appeal, the CIT(A) upheld the action of the AO on the issue, by observing that
the provisions of section 50 were clearly applicable to the capital gains
arising on account of sale of depreciable assets not only for computation but
also for the rate of tax.

The
Tribunal, on hearing the arguments from both the sides on the issue and perusal
of the relevant material available on record, held that the relevant provisions
of section 50 as applicable in the context were very clear and specific, as
rightly held by the learned CIT (A). As per the said provisions, which were
overriding in nature, the capital gains arising from the sale of depreciable
assets was chargeable to tax at the rate applicable to short-term capital
gains, irrespective of the holding period. Certain judicial pronouncements,
relied upon by the appellant, were found to be not applicable in the context,
involving the issue relating to rate of tax applicable to the capital gains
arising from sale of depreciable assets. The Tribunal did not find merit in
ground raised by the assessee and dismissed the same.

Smita Conductors Ltd.’s case, 152 ITD 417 (Mum.)

The  issue arose before the Tribunal in the case
of Smita Conductors Ltd. vs. DCIT, 152 ITD 417(Mum.) wherein the assessee had
filed an additional ground for contesting the tax rate applied in case of
capital gains computed u/s 50 r.w.s 50C of the income-tax act. In that case,
the assessee had sold a flat after holding the same for more than 36 months. It
had claimed depreciation on the flat and had claimed that the gains arising
thereon be taxed at the concessional rate u/s. 112.

In
the appeal to the Tribunal,  it was
submitted that the flat sold by the assessee had been held for a long time
exceeding more than three years and, therefore, the capital gains, though
required to be computed u/s. 50 of the it act, had to be treated as long term
capital gain in view of the judgment of the high Court of Bombay in case of Ace
Builders Ltd.,281 ITR 410, in which it had been held that the factum of deemed
short term capital gains u/s. 50 of the it act was applicable only to
computation of capital gains, and for the purpose of other provisions of the
act, such as section 54EC, the capital gains had to be treated as long term
capital gains, if the asset was held for more than three years. it was
contended that section 50(1) made it quite clear that the capital gains in
respect of depreciable asset was deemed as short term capital gains for the
purposes of sections 48 and 49 of the it act, which related to computation  of capital gains. Therefore, the deeming
provision was only limited to the provisions for computation of capital gains.

Reference
was made to the decision of the mumbai bench of the Tribunal in case of
Mahindra Freight Carriers vs. DCIT, 139 TTJ 422, in which it had been held that
prescriptions of section 50 were to be extended only to stage of computation of
capital gains and, therefore, capital gain resulting from transfer of depreciable
asset which was held for more than period of three years would retain the
character of long term capital gains for all other provisions of the act and
consequently qualify for set off against brought forward loss of long term
capital gains. reference was also made to another decision of mumbai bench of
the Tribunal in case of Prabodh Investment & Trading Company Vs. ITO in
(ITA No. 6557/Mum/2008), in which following the judgment of the high Court of
Bombay in case of Ace Builders P. Ltd. (Supra), the Tribunal held that section
50 created a legal fiction only for a limited purpose i.e. for the purpose of
sections 48 and 49 and for the purposes of section 54E, the gains had to be
treated as long term capital gains. the Tribunal in that case also accepted the
arguments of the assessee that in case capital gains was assessed as long term
capital gain the rate of tax as provided in section 112 of the it act would
apply.

It
was explained that provisions of section 50, deeming the capital gains as short
term capital gains was only for the purposes of section 48 and 49, which
related to computation of capital gains. The deeming provisions therefore was
to be restricted only to computation of capital gain and for the purpose of
other provisions of the act, the capital gain has to be treated as long term
capital gain. it was, therefore, argued that in the case of the assessee, rate
of tax applicable to long term capital gain had to be applied as per the
provisions of section 112 of the IT act.

The
same view had been taken by the mumbai bench of Tribunal in case of Manali
Investments vs. Assistant CIT, 139 TTJ 411, in which it had been held that the
prescriptions of section 50 were to be extended only to the stage of
computation of capital gain and, therefore, capital gain resulting from
transfer of depreciable asset, which was held for more than three years would
retain the character of long term capital gain for the purpose of all other
provisions of the act.

It
was highlighted that the flat had been held for 15 to 20 years, which was
supported by the fact that cost of the flat as shown in the balance sheet was
only Rs.1, 30,000/-, and if the flat was held for more than three years, the
tax rate as provided in section 112 of the it act applicable in respect of capital
gains arising from transfer of long term capital asset, had to be applied.

The  Tribunal held that, for the purpose of
computation of capital gains, the flat had to be treated as short term capital
gains u/s. 50 of the it act, but for the purpose of applicability of tax rate,
it had to be treated as long term capital gains if held for more than three
years. It accordingly directed the AO to compute the capital gains from the
sale of flat and apply the appropriate tax rate, after necessary verification
in the light of observations made in the order.

Observations

The
basis of the claim for the benefit of concessional rate of taxation for the
deemed gains, besides being founded in law, has largely been founded on the
decisions of the high Courts delivered in the context of the eligibility of
such deemed gains for the benefit of exemption u/s. 54E, 54EC, etc. the   high Courts have consistently held that such
gains are eligible for the benefit of exemption u/s. 54E, 54EC, etc. CIT vs.
Assam Petroleum 263 ITR 587 (Gau), CIT vs. Ace Builders 281 ITR 240 (Bom), CIT
vs. Pole Star Industries, 41taxmann.com 237 (Guj), Aditya Media Sales Ltd.,
38taxmann 244 (Guj), Rajiv Shukla 334 ITR 0138 (Del) and CIT vs. Delite Tin
Industries in ITA no. 118 of 2008 dated 26/09/2008. The Bombay high Court is
deciding the case of delite tin industries (supra), had followed its own
decision in the case of ace Builders (supra). The Special leave Petition of the
income tax department against the said decision has been rejected by the Supreme
Court vide order dated 20/10/2009 in SlP. (c) no. 21450 of 2009, 322 itr (st)
8. The delhi high Court in the case of rajiv Shukla (supra) has taken note of
the said dismissal of SLP by the apex court. The issue has recently been
settled in favour of allowability of the benefit in the case of CIT vs. V.
S.Dempo Co. Ltd. (supra).

The   issue under consideration had also arisen
before the Pune bench of the Tribunal in the case of Rathi Bros. Madras Ltd.
vs. ACIT in ITA No. 787/PN/2813. In a decision dated 30/10/2014, the Tribunal
decided the issue against the assesssee, interestingly, by holding that the
issue on hand has been decided by the decision of the Bombay high Court in the
case of ace Builders (supra). the Tribunal noted that the Bombay high Court in
para 23 of the order while confirming the grant of benefit of exemption u/s.54,
had observed that the deemed short term capital gains, though taxable at the
ordinary rates would nonetheless be eligible for the tax exemption. It is
respectfully submitted that such observations, not made in the context of the
case, should not have been the guiding force in adjudicating an issue that was
otherwise decided by the co-ordinate bench in favour of the assessee. The issue
before the high Court was about the eligibility of an assessee for the benefit
of section 54E and not for the concessional rate of taxation u/s. 112 of the
Act. In any case, the final findings of the Court on the issue before it are
clearly placed in para 25 of the order, which has no observations on the
subject of rate of taxation.

In
Rathi Bros.’ case (supra), the Tribunal, under an error, did not follow the
decision of the co-ordinate bench in the case of  P.D. Kunte and Co., by observing that in the
said case the issue though raised, had remained to be adjudicated by the Tribunal.
The fact of the matter, as was noted by the AO, is that the said assessee had
filed an MA on the ground that the issue had remained to be adjudicated by the Tribunal
and the Tribunal had rectified the error by adjudicating the issue and deciding
the issue in favour of the assessee. The Tribunal had followed the decision of
the Bombay high Court in the case of Ace Builders (supra). Accordingly, it was
the decision in the case of Rathi Bros. that requires rectification. It seems
that the order in the MA was lost sight of while adjudicating the issue.

On
a comprehensive reading of the various provisions of the income-tax act,
namely, sections 2(14), 2(29A), 2(42A), 45, 48, 49, 50 and section 112, all of
which are relevant to the issue under consideration, the following things
emerge: