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Budget 2007
Capital gains and 'personal effects' in view of recent proposed amendments
[Submitted by Mr. Dev Kumar Kothari,
B.Com, Grad.CWA,ACS ,FCA
Kolkata]
April 9, 2007
Preliminary:
The expression 'Capital asset' is very wide but it does not include
'personal effects' as per S. 2 (14) of the Income Tax Act. If an item of
asset is not a capital asset, any gain arising from sale of it will not be
subject to tax under thehead 'capital gain tax'.
Scope of 'personal effect' is to be restricted:
Many more items are proposed to be excluded from meaning of 'personal
effect' to widen tax by way of tax on capital gains.
Restricting 'personal effect' to enlarge scope of 'capital
asset' and capital gain tax:
Definition of capital asset is very wide and inclusive, but personal
effects like furniture and wearing apparel are specifically excluded.
There is proposal to treat some items of 'personal effects' as not
personal effect but as 'capital asset'. The proposed definition of
'personal effects' read as follows:-
'(ii) personal effects, that is to say, movable property (including
wearing apparel and furniture) held for personal use by the assessee or
any member of his family dependent on him, but excludes:
(a) jewellery; - ( presently also excluded)
(b) archaeological collections;
(c) drawings;
(d) paintings;
(e) sculptures; or
(f) any work of art.
In new proposed explanation the term jewellery will be defined on the
same line as it is defined presently, therefore the same is not reproduced
and discussed.
Therefore, amendment will change treatment only for other items as
mentioned above at serial (b) to (f), and sale of such items is intended
be considered as sale of a capital assets gains as taxable capital gain
from assessment year 2008-09.
Whether amendment is required?
It seems that it is not necessary to amend the meaning of personal effect
because a possible and reasonable view is that once a person puts an item
of his personal belonging hitherto in nature of his personal effect, for
sale or disposal, it looses the character of personal effect. One can go
to say that even wearing apparel and furniture used for quite a long time
by a person, looses the character of personal effect once he decides to
discard or dispose off the same. For example, suppose a person decides to
distribute his old wearing apparel amongst his domestic helps or other
poor people, it can be said that once such decision is taken, these items
remain no longer personal effects of the donor. Though after transfer by
way of gift or donation or even sale they may become personal effect of
the donee or transferee. Similarly if old furniture is put to sale, it no
longer remains personal effect. Once an item is not a personal effect at
the time of sale, there is sale of a capital asset and it is liable to tax
under the head capital gains or to the benefit of loss under the head
'capital gains' after taking into account the indexed cost of acquisition
and indexed cost of improvement in case of long term capital assets.
An example:
Suppose a winner of beauty contest decided to sells her outfit which she
wore in the contest, it can be said that the dress lost the character of
her 'personal effect' and therefore becomes a capital asset. However, the
sale proceeds may not be taxable being a realization of capital because
there is an appreciation in the value of such wearing apparel, due to tag
of 'winning outfit of miss India/ world .', but she did not incur any cost
of such improvement. Therefore the sale proceed will be capital receipt
and not amenable to computation under the head capital gain, and
accordingly will not be taxable.
Personal furniture are still included in personal effect:
As noted earlier furniture and wearing apparel used by assessee
or his dependents, are specifically included in the definition of personal
effect. Therefore, a question arises as to whether the items proposed to
be excluded are furniture?
Let us examine these items with the normal meaning of 'furniture' which
is defined as follows:
As per Oxford Dictionary and thesaurus:
Furniture- the movable objects that are used to make a room or
building suitable for living or working in.
Thesaurus:
Antiques, chattels, effects, equipment, fitments, fittings, fixtures,
furnishings, household goods, informal movables, possessions.
In general sense we consider all things kept in rooms for making lively
environment and suitable for intended use as bed room, kitchen room,
drawing room, dining room, dressing room, guests room etc. as furniture
including tables, chairs, dressing tables, bed, bedside table, dining
table, palmate for curtains, show case with sculptures, murals, statutes,
drawings, paintings, artistic murals, sculptures , statutes, curtains,
soft furnishings etc as part of furniture and items for furnishing the
room. Therefore, anything used to furnish the room will be furniture or
furnishing for the room.
It depends on person to person how he furnishes his room.
In view of the definition of furniture and furnishing it can be said
that at least drawings, paintings, sculptures, work of art and even
archaeological collections can be considered as furniture, if they are
used to furnish the rooms.
If the items is furniture and is used for personal purposes of assessee
or his dependents, it is specifically included in 'personal effect', and
therefore, without excluding such items from the scope of furniture, the
proposed amendment will not give desired result and will lead to
litigation.
Capital gains on items excluded from personal effect and
included in meaning of capital assets:
If the asset is held for more than 36 months, it will be
considered long term capital asset with benefit of cost indexatation ,
otherwise a short term capital asset. The period of holding by previous
owners in certain circumstances will also be included. Where the asset was
acquired prior to l st April, 1981, the assessee will also be eligible to
adopt fair market value of such asset on the lst April, 1981 and apply the
cost inflation index to such fair market value.
A word of caution: In this regard it is likely that the revenue
authorities will contend that the item became a capital asset only when
definition is amended, therefore, the date of acquisition of 'capital
asset' should be taken from the date of amendment. To avoid confusions,
and to avoid litigation it is desirable to clearly specify that the
original date of acquisition, as determined in other cases will be
applicable in case of such assets also.
Nil cost items:
There will be large number of cases where the asset is acquired
without incurring any cost, for example drawings and paintings made by
assessee or his relatives etc. furthermore in most of cases there would
not be any cost of improvement incurred in terms of money, in such cases
the sale value will be capital value and the gains would not be taxable.
This is because for computation of capital gains as per scheme of section
45 read with section 48 the asset should have been acquired for a cost of
acquisition in terms of money and it must also be capable of improvement
in terms of money. If an asset is acquired without any cost of acquisition
or it is improved without incurring any cost of improvement, then the sale
value of such an asset would represent capital value and realization of
capital and not capital gains in nature of profit or gains u/s 45.
In this regard we can rely on the following rulings:
It is essential to deduct the cost of acquisition as well as the cost
of improvement. And if there is no cost of acquisition or even if there
is cost but there is no cost of improvement then excess of sale value
over cost value cannot be called "profit" or "gain" under Section 45
(1), because the provisions of computation cannot be applied. The
charging section and computation provisions being integral code, the
charge will not apply when the computation cannot be made strictly as
per prescribed provisions.
The main reliance can be placed on CIT V B.C.Sriniwas Setty 128 ITR
294 (SC) and various judgments approved therein and many subsequent
judgments as discussed below:
CIT VS. Jaswantlal Daya Bhai 114 ITR 798 (MP) -approved in 128 ITR
294 (SC):
in this case it has been held that asset in the context of section 45
and 48 is such which can be acquired by incurring money and after
acquisition it must be capable of improvement by incurring cost of
improvement in terms of money. If an asset is not capable of acquisition
at an ascertainable cost or it improves but cost of improvement is not
ascertainable in terms of money then it is not a capital asset in the
context of capital gains u/s 45 read with section 48.
CIT Vs. Home Industries & Co. (1977) 107 ITR 609 (Bom).
( in this case it was also held at page 631- 632 of the report that "
Similarly, the aspect that the capital asset in question must be such
that it is capable of improvement at an ascertainable cost in terms of
money would be equally important.)
Evans Fraser & Co. Ltd. V. CIT (1982) 137 ITR 493 (Bom) -
(In this case the court held that even in case of purchased capital
asset ( goodwill in that case ), the cost of improvement was not
incurred or capable of quantification, so sale of purchased goodwill ,
having cost of acquisition was not taxable because there was no cost of
improvement.)
CIT Vs. Pushpraj Singh (1998) 232 ITR 754 (MP).
( In this case shares were received as reward and assessee did not incur
any cost of acquisition, so the sale value was held to be capital
receipt not liablt to tax as capital gains.)
CIT V Ganpati Raju Jogi (1993) 200 ITR 612 (SC):
In this case it was held that route permits improved or gained value
over a period of time due to various factors like road development ,
passengers traffic, and frequency etc. Thus, sale value of route permits
was not taxable as capital gains.
In this case also the improvement in quality of asset over a period of
time is considered as accretion of capital and sale of such asset
resulted in realization of capital..
CIT Vs. Suman Tea & Plywood Industries Pvt, Ltd. 226 ITR 34 (Cal). In
this case it was held that if an asset was acquired without cost of
acquisition or improved without incurring cost of improvement then sale
of such asset will not bring in taxable profit or gain. Revenues SLP has
also been dismissed by the Supreme Court due to lack of any merit.
The high court held :
" If there is no cost of acquiring an asset or improving the same, it
cannot be assumed that the sale of such an asset will bring in any gain
or profit.
CIT Vs. Octavious Steel & Co. Ltd. (1996) 221 ITR 810 (Cal).
In this case it was
Held, that the asset in question being a tenancy right , the value of
such a right is unascertainable whatever expenditure might have been
incurred on stamps and registration. There is no means by which the cost
of the tenancy right itself, which was increasing in value over time,
could ever be ascertained nor could the cost of improvement in such
asset be determined. The tenancy right was acquired by the assessee
without any expenditure incurred by it. ( page 222 H)
A reading of the above cases, we find that the Rule laid down is that
cost of acquisition and cost of improvement, both are to be deducted. If
there is no cost of improvement incurred in terms of money, there will be
no capital gains within the meaning u/s 45 read with section 48.
The amendment should not be applied for earlier periods:
The amendment to specifically excluded such items is with effect
from lst April, 2008. Therefore, if transfer of such asset takes place
after 31st March, 2007 (previous year ending on 31.3.2008 relevant to
assessment year 2008-09) then only gains will be taxable. Therefore, the
assesses who want to realize the capital blocked in such assets without
paying capital gain tax, can take a chance by transferring such assets
before end of 31st March, 2007. However, a word of caution is necessary
that the department is disputing such claims on various grounds like that
the asset was not a personal effect or it was a trading asset or it
belongs to asset which results into income from other source etc.
However, in view of amendment being clearly made with effect from lst
April, 2008, it is expected that the revenue officials will consider that
prior to assessment year 2008-09, gains on sale of such assets is not
taxable as capital gains because the legislative intention is not to
impose tax on capital gains arising on transfer of such assets till 31st
march, 2007.
Reality in some cases will be wrongly applied in all cases:
The amendment seems to recognize the reality that many people purchases
these items for trading or investment purposes.
In such cases the revenue can establish the purpose of trading or
investment and treat the profit or gains accordingly even without
amendment. However, where the item is really an item of personal effect,
like paintings made by family members or friends, paintings received as
gifts from artist / painter friends, work of art of family members or
assessee himself which he used as personal effect (and not as his stock of
profession) should not be excluded from 'personal effect'. The test of
reality should be applied and for that purpose the following factors can
be considered:
a. period of holding - a short duration of holding of purchased items
can lead to trading or investment activity.
b. Circumstances of acquisition can through light on intention. For
example items received as gifts and used as personal effect cannot be
considered as item of trading or investment.
c. Circumstances in which sold or transferred. In fund crisis
situation one may have to sale such assets also which are very personal
belonging to him.
d. Volume of activity of buying and selling of such assets. A regular
course of buying and selling, advertisement of articles for sale,
regular activity of participating in exhibitions for buying and selling
can be considered as indicative of trading activity.
e. Use of borrowed funds can in some circumstances lead to assessee
taking adventure in nature of trade or commerce, but it is not a
conclusive factor. In fact banks lend money for furnishing of
residential houses for personal use of borrower, in such cases,
borrowing will not change the character of personal effect into an items
of trading nature.
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