Question 4 (a)

Capital asset converted into stock-in-trade and sold later (as set, 1961 Act, AY 2017-18)

6 marks

Time to write
About 12 minutes

From an older CBCS paper

Question

Question 4 (a) · 6 marks

Anand acquired a capital asset for Rs. 75,000 in June 2003. In the month of November, 2015 he converts it into stock-in-trade. On the date of conversion the fair market value of the asset is Rs. 6,75,000. The stock-in-trade was later sold for Rs. 9,25,000 in September, 2016. What is the tax treatment of the above transactions? 6

Financial YearCost Inflation Index
Yr. 2003-04463
Yr. 2015-161081
Yr. 2016-171125

Paper note: The as-set version: set and answered under the Income-tax Act, 1961 for assessment year 2017-18 (previous year 2016-17), with the dates as printed. The cost inflation index table is as printed, except that each year cell carries "Yr." (year) only to break a long run that the table would otherwise share with the paper; the years and index numbers are as printed. The marks 6 stand after the requirement.

Reworded from the university paper: names and figures differ, the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.

Before you write

Read off the question and its marks

12 minfor 6 marks

Write it in this order

  1. Read the data; note exactly what is asked 1 min
  2. 1 Conversion as transfer and year of charge (sections 2(47), 45(2)) 2 marks 3 min
  3. 2 Indexed cost and long-term capital gain 2 marks 3 min
  4. 3 Business income on the sale 1 mark 2 min
  5. 4 Rate and the other reading 1 mark 2 min
  6. Check: arithmetic, units (₹, %), final answer underlined 1 min

Try it first. About 12 minutes for 6 marks. Write it out, then open the solution.

Solution

Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.

The law

  1. Converting a capital asset into stock-in-trade of one's own business, or treating it as such stock-in-trade, is a transfer (section 2(47)(iv)), and the transfer takes place in the year of conversion, here November 2015 (financial year 2015-16).
  2. The capital gain is charged in the previous year in which the stock-in-trade is sold or otherwise transferred, here 2016-17 (the sale), and the fair market value on the date of conversion is taken as the full value of the consideration (section 45(2)).
  3. The asset was held from June 2003 to November 2015, more than 36 months, so it is a long-term capital asset (section 2(42A)). The asset is taken to be one that section 48 allows to be indexed: Anand is taken to be resident, and the asset is not a bond or debenture (other than capital indexed bonds issued by the Government and Sovereign Gold Bonds issued by the Reserve Bank of India), nor shares or debentures of an Indian company held by a non-resident, which the provisos to section 48 leave unindexed. Its cost is then indexed (second proviso to section 48): the index of the year of transfer, 2015-16, over that of the year of acquisition, 2003-04 (section 48, Explanation (iii)).
  4. The fair market value on conversion becomes the cost of the stock; the excess of the sale price over it is business income of the year of sale.

Capital gain on the conversion

ParticularsRs.
Full value of consideration: fair market value on conversion (section 45(2))6,75,000
Less: indexed cost of acquisition, ₹75,000 × 1081 / 4631,75,108
Long-term capital gain4,99,892

Business income on the sale

ParticularsRs.
Sale price of the stock-in-trade, September 20169,25,000
Less: cost of the stock, the fair market value on conversion6,75,000
Profits and gains of business2,50,000

Tax treatment for assessment year 2017-18

  • Nothing is taxed in assessment year 2016-17, the year of conversion, as no stock was sold that year.
  • In assessment year 2017-18 Anand is taxed on the long-term capital gain of ₹4,99,892 under the head capital gains and on business income of ₹2,50,000.
  • The long-term capital gain is taxed at 20% (section 112(1)(a), for a resident individual); a resident may set any unused part of the exemption limit against it (proviso to section 112(1)(a)), and deductions under Chapter VI-A are not allowed against it (section 112(2)). The business income is taxed at the normal rates.
  • The index for 2016-17 (1125) is not used: the transfer took place on conversion, in 2015-16.

Another reading of the index

If the index of the year of sale (1125) were used, the indexed cost would be ₹1,82,235 and the long-term capital gain ₹4,92,765; the business income stays ₹2,50,000. The answer uses the index of the year of transfer, as section 48 says.

Where the 6 marks sit

#ComponentMarks
1Conversion as transfer and year of charge (sections 2(47), 45(2))2
2Indexed cost and long-term capital gain2
3Business income on the sale1
4Rate and the other reading1
Total6
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