Income Tax

Cost Inflation Index for Transfer of Capital Asset Acquired by Inheritance

• Under the provisions of the Income Tax Act, 1961^[1] an assessed can acquire a Capital Asset as defined under section 2(14) of the Act with or without consideration.
• As per section 49(1) of the Act, where the capital asset is acquired without paying any consideration, the cost of acquisition of such asset would be considered shall be the cost as was in the hands of the previous
• However, there has been a lot of dispute on how to compute Indexed Cost of Acquisition whenever an assessee acquires capital asset without any consideration as there is no specific provision regarding the same has mentioned in the Act.
• Further, there has been a split in the judiciary as discussed above on this aspect, especially because no decision rendered by any High Court is available, which puts an assessee in the state of uncertainty.

Case Law:

• CIT v/s Manjula Shah [2011] The Bombay High Court after analyzing the facts of the case has laid down an important legal proposition that while computing capital gain arising on transfer of capital asset acquired by an assessee under a gift, indexed cost of acquisition has to be computed with reference to the year in which the previous owner first held the asset and not from the year in which the assessee became owner of that asset.
• Facts of the case:

1. The assessee acquired a residential flat as a gift from her daughter under a gift deed dated 02/01/2003 without incurring any cost.
2. The said flat was originally acquired by the previous owner .i.e. daughter on 29/01/1983 at a cost of 50,48,350/-. The assessee sold the asset on 30/06/2003 for Rs.1, 10,00,000/- and offered long-term capital gain tax.
3. During the course of assessment proceedings, the Assessing officer recomputed the long-term capital gain providing the indexation benefit only from the year 2002-03. i.e. the year in which the flat is acquired by the assessee for the first time under the gift deed as against the claim by the assessee of indexed cost of acquisition being calculated from the date from which the flat is acquired by the owner .i.e. during 1993-94.
4. However, the assessee preferred an appeal against the order of the Assessing Officer before the Commissioner of Income Tax (Appeals) which was allowed in favor of the assessee, claiming that indexation should be calculated with reference to the cost of inflation index for the year 1993-94
5. Against the above order of the CIT (A) the revenue preferred an appeal before the Tribunal. The Tribunal, vide an order reported asDy. CIT v. Manjula J. Shah [2009] 126 TTJ 145/[2010] 33 SOT 105 (Mum.), upheld the order of the CIT(A), thereby dismissed the appeal of the revenue. Feeling aggrieved, the Revenue preferred a further appeal before the Bombay High Court against the above order of the tribunal.

• The decision of the High Court:

The High Court, after analyzing the entire facts on record as well as the position, in law, dismissed the appeal of the Revenue and held that, although the assessee became the owner of the flat in the year 2003 by way of a gift, yet as per section 2(42A) of the Income-tax Act, 1961 (‘the Act’), for determining the period of holding of an asset, the period of holding of the previous owner is also included, and the cost of acquisition of the previous owner is deemed to the cost of the assessee, then, there was no justification for giving different treatment for allowing the benefit of indexation only from the year in which the capital asset was first acquired by the assessee, as against the year in which it was acquired by the previous owner.

• Comments:

1. As section 48 of the Act, the income chargeable under the head Capital gains is to be computed after deducting the cost from the full value of consideration.
2. To determine the nature of capital gain, section 2(42A) provides that where a capital asset except share and securities is held for less than a period of 36 months then such a capital asset will be termed as a Short Term capital Asset and capital gains shall be short-term capital gain arising from transfer of short-term capital asset. Further as per section 2(29A) read with section 2(29B) of the act, capital arising on transfer of the capital assets which are not short-term capital assets would be taxed as Long Term Capital gain
3. As per proviso to section 48 which state that while computing Long Term Capital Gain the assessee will get the benefit of Indexed Cost of Acquisition.
4. As per section 48 the indexed cost of acquisition would mean the amount which bears the cost of acquisition the same proportion as cost inflation index for the year in which the asset is transferred bears to CII for the first year in which the asset is held by the assessee or the year beginning after 1^st April 1981 whichever is later.
5. In the case of Manjula J. Shah (supra), the Bombay High Court was confronted with a question whether while calculating capital gains on transfer of a capital asset, which was acquired by the assessee by way of a gift, indexed cost of acquisition would be considered by considering the CII of the year in which the capital asset was first acquired by the assessee by way of gift, or would it be of that year in which the said asset was acquired by the previous owner. The Bombay High Court, in a very elaborative and reasoned manner, laid down that when the law provides to consider the period of holding of the previous owner also, then different treatment cannot be accorded for calculation of the indexed cost of acquisition by not adopting the CII of the year in which the asset was acquired by the previous owner. The Court further substantiated its above view by noticing that even as per section 55(1)(b)(2)(ii) of the Act, ‘cost of improvement’ incurred by the previous owner needs to be deducted from the total consideration. The Court also observed that as per the CBDT’s Circular No. 636, dated 31-8-1992, the purpose of providing indexation benefit was to counter-balance the effect of inflation. That being so, since the cost of the asset was first incurred by the previous owner, and no consideration was passed on to such previous owner by the subsequent acquirer by way of section 49(1), the indexation should be allowed from the year in which such an asset was acquired by the previous owner.
6. The above decisions of the High Court would definitely provide a sigh of relief as well as certainty in the minds of the taxpayers as to which year’s CII should be adopted in case of a capital asset acquired by way of modes mentioned under section 49(1) of the Act.

2) Case Law:

ITO Vs. Sudip Roy (ITAT Kolkata) Appeal number IT Appeal tax No. 2864 (Kol.) of 2013

Date of Judgement/ Order: 19/10/2016 Related Assessment Year: 2007- 08

• Facts of the case:

1. In the present case, the assessing officer has applied cost inflation index applicable for the financial year 2002-03 is the year in which the assessee intended the property..i.e. the year in which the assessee first held the capital assets which is interpreted by him to be the year in which the assessee succeeded the assets.
2. We somewhat find that section 2(42A) also holds a similar expression. As per explanation 1 to section 2(42A) provides that while determining the period for which any capital asset is held by the assessee, in the case of the capital asset which turns the property of the assessee in any of the circumstances mentioned in section 49(1), there shall be included the period for which the previous owner has held the capital asset
3. If for the purpose of determining the period of holding of the capital asset by an assessee, the period for which the previous owner has held the capital asset is to be included, then different consideration cannot be applied for the purpose of section 48. If sections 2(42A), 47(iii), 49(1)(ii)(iii) and section 55(2)(b)(ii) are read co-jointly then it appears that in law no “transfer” of a “capital asset” is considered to take place on inheritance and succession. The liability of capital gain arises only when the capital asset is actually transferred by the successor. It is only when the ultimate successor transfers the capital asset for a consideration the capital gains are assessed to tax. In assessing the capital gain in the hands of a successor, date of acquisition and period of holding, is determined to take into consideration the date on which and the cost of which the first owner acquires the capital asset. It is for this reason section 2(42A) uses the expression “in determining the period for which capital asset held by the assessee”. As per Section 48 of the Income Tax Act includes the computation mechanism for qualifying the ‘capital gain’ and therefore the expressions used in the computation formula should be given the schematic interpretation. The scheme of taxation of “capital gain” can, however, be understood by applying provisions of sections 2(42A), 2(47), 47(ii), 48, 49(i)(ii) and 55(2)(b)(ii) of the Act. As per the provisions of the Act where an assessee sells an inherited capital asset, the capital gain is computed with reference to the period of holding and cost of acquisition incurred by the previous owner.
4. As assessee inflated the market value of the property as on 1-4-1981 with the motive of avoiding capital gain, the action of AO in making reference to DVO while not accepting valuation shown by the assessee on basis of registered valuer’s report was well permissible under law.

The content of the ITAT order is as follows:

• This appeal is made by the Revenue against the order of Commissioner (Appeals) – XIV Kolkata dated 10/09/2013. The assessment order was originally framed by ITO Ward 23(3) Kolkata under section 143(3) /263 of the Income Tax Act,1961 (hereinafter referred to as the Act) vide his order dated 14/12/2012 for the assessment year 2007-08. The grounds raised by Revenue per its appeal are as under:

1. The commissioner stated that in the law as well as in facts by giving relief to the assessee on the grounds of Cos Inflation Index factor that in the event of adoption of Fair Market Value of 1981, the Cost Inflation index factor of 1981 (100) could only be taken , ignoring the Cost Inflation Index factor of F.Y. 2002-03 (447) prevailing on the subsequent inheritance of the ownership of the property.
2. Further the commissioner stated that by giving relief to the assessee on the ground that the reference to the Department Valuation Officer under section 55A is been contrary to law and as such the said valuation does not warrant acceptance and effect the assessment completely relying on the assessee’s submission without considering the facts.
3. The only issue that is raised by the revenue is that assessee considered the cost inflation factor of 100 .i.e. for 1981 and also disregarding the valuation report made by the DVO under section 55A of the act.
4. The facts of the case are that the assessee is an individual and has income from salary, capital gains, and other sources. In this case, assessee inherited the property from his father residing at 57, Jyotindra Mohan Avenue, PS. Shyampukur, Kolkata-05 in the financial year 2002-03. The assessee was having a 1/8th share in that property. During the year under consideration, the assessee has sold his share of property and disclosed Long Term Capital Gains (LTCG for short) of Rs. 24,91,950. The assessee made investment for Rs. 25 lakh in the bonds to claim deduction under section 54EC of the Act from the income of LTCG.
5. However, the assessee worked out the Long Term Capital gain as follows:

Particulars	AO’s observation	Appellant 1/8th undivided share
Sale Price (gross consideration)	8137500	8137500
Brokerage & commission	182671	182671
Net sale price (net consideration)	7954829	7954829
FMV as on 1/04/1981	486500 ( as per DVO’s report)	1083375 (as per valuation report)
FMV as on 01/04/1981 with indexation	564862   (486500*519/447) Cost Indexation factor for F.Y. 2002-03 – 447	5622710   (1083375*519/100) Cost Indexation factor for F.Y. 1981 -100
Long Term capital gain	7146655	2491952
Deduction availed by the appellant under section 54EC	2491952	2491952
Taxable Long-Term Capital Gain	4646655	NIL

From the above case, it is clear that the assessing officer has disregarded the valuation report of the assessee for valuing property as stood on 01/04/1981 and also disregarded the cost inflation index factor as taken by the assessee for the year 1981. The assessing officer has taken the reference of  DVO’s valuation report considering the property was first held by the assessee .i.e. 447for the financial year 2002-03. Thus the assessing officer worked out the Long Term Capital gains which are taxable in the hands of the assessee for Rs.4646655/-

However, the assessee aggrieved by the same filed an appeal before the Commissioner (Appeals). The assessee submitted the reference made by the Assessing Officer to the DVO under section 55A of the Act for the valuation of the property as on 01/04/1981is against the provision of law as per section 55A of the Act.

The assessing officer can make the reference to the DVO if he is of the opinion that the value so claimed is less than its market value. In the instant case, the market value as on 1-4-1981 has been shown by assessee greater than the value shown by DVO. It was further submitted that there was an amendment to the Finance Bill, 2012 which came into force with effect from 1-7-2012. As per the provisions of section 55A of the Act which is amended, the assessing officer is authorized to make the reference to the DVO if he is of the opinion that the value so claimed is at variance with its fair market value. However, assessing officer was authorized to make the reference to the DVO with effect from 1-7-2012 and instant case pertains to the assessment year 2007-08. Therefore, the assessing officer cannot make the reference to the DVO as the assessee has shown more value of the property as on 1-4-1981 than the value of the DVO.

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With regard to action of the assessing officer for adopting the index factor for the F.Y. 2002-03, assessee submitted that the ownership of the property was inherited in the year 2002-03 but as per law the value of the property will be taken as on 1-4-1981 and accordingly cost inflation index for that year i.e. 100 should be adopted. Accordingly, learned Commissioner (Appeals) deleted the addition made by assessing officer after having reliance in the case of Umedbhai International Ltd. 330 ITR 506 and 134 TTJ 23 by observing as under:–

In the above judgment the Hon’ble Kolkata Tribunal, has pointed out the unintended absurdity and inconsistency in situation of adoption of some remote index factor to some distant and discrete FMV, prevailing in two different years, in the light of the clarification CBDT Circulars and concluded that in the event of adoption of FMV of 1981, the indexed factor of 1981 only could be taken, ignoring the indexed factor prevailing around or on the subsequent inheritance of acquisition of ownership vide section 49. This judgment from the jurisdictional Tribunal being applicable to the facts of the present appeal. I feel it incumbent to follow the above verdict and principle. This ground is allowed. The assessing officer is directed to adopt the index factor of 519/100 in place of 519/447 and apply the former to the FMV of Rs. 1083375 which is submitted by the Appellant by means of Valuation Report and recomputed the Capital Gain accordingly.”

Being aggrieved by this order of Commissioner (Appeals) Revenue is in appeal before us.

Before us, the DR submitted that property in question was inherited in the financial year 2002-03 and therefore the cost inflation index for that year should be considered. He further submitted that the assessing officer is very much authorized to refer the matter to DVO in terms of provision of section 55A of the Act. The DR submitted the assessee further intentionally has shown the valuation of the property as on 01/04/1981 at a higher value with the motive of avoiding capital gains. Therefore, the action of assessing officer for making the reference to DVO is within the provision of law. In this connection, learned DR relied on the judgment of Hon’ble jurisdictional High Court in the case of Nirmal Kumar Ravindra Kumar- HUF v. CIT (2016) 70 taxmann.com 339 (Cal), where the Hon’ble jurisdictional High Court has held:–

“Section 55A of the Income Tax Act, 1961 — Capital gains — Reference to Valuation Officer (General) — Assessment year 1996-97 — Whether clause (b)(ii) to section 55A empowers Assessing officer to make reference to DVO where in his opinion fair market value estimated by assessee is not proper — Held, yes — Assessee had sold its property for Rs. 97,50,000 which was purchased by assessee on 31-7-1979 at a purchase price of Rs.2,80,882 — However, while calculating long-term capital gain, assessee adopted the market value of property at Rs. 34,55,000 as on 1-4-1981 — Assessing officer considered such estimation of fair market value at a higher side and referred matter to DVO who computed the fair market value of property at Rs. 377250 & completed the assessment accordingly Whether since assessee inflated market value of property as on 1-4-1981 with motive of avoiding capital gain, action of assessing officer in making reference to DVO while not accepting valuation shown by assessee on basis of registered valuer’s report was well permissible under law — Held, yes [In favor of revenue]”

Finally, learned DR vehemently relied on the order of assessing officer.

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