Can you believe that the cost of acquisition can be of a date prior to the date of acquisition? Well, this happens to be the case for gifted or inherited assets.
Sec. 45 defines capital gains. Sec. 47(iii) of the Income Tax Act (ITA) states that any transfer of a capital asset (other than ESOP) under a gift or Will or an irrevocable trust, will not attract provisions of capital gains. When the donee eventually sells the property, the cost and the date of acquisition is to be taken as that of the previous owner, the donor.
Now, let us move to Sec. 48, Explanation-iii which defines indexed cost of acquisition to mean an amount which bears to the cost of acquisition the same proportion as the Cost Inflation Index (CII) for the year in which the asset is transferred bears to the CII for the first year in which the asset was held by the assessee or for the year beginning on 1.4.81, whichever is later.
Moreover, Explanation-iv defines ‘Indexed cost of any improvement’ to mean an amount which bears to the cost of improvement the same proportion as the CII for the year in which the asset is transferred bears to the CII for the year in which the improvement to the asset took place.
Note the difference between the costs of acquisition and improvement. The phrase, ‘first year in which the asset was held by the assessee’ is absent in the case of improvement.
Sec. 49(1) states that where the capital asset became the property of the assessee the cost of acquisition of the asset shall be deemed to be the cost for which the previous owner of the property acquired it, as increased by the cost of any improvement of the assets incurred or borne by the previous owner or the assessee, as the case may be. The situations covered by this section are, inter alia, under a gift or Will and by succession, inheritance or devolution.
The Explanation under this subsection states, “The expression ‘previous owner of the property’ in relation to any capital asset owned by an assessee means the last previous owner of the capital asset who acquired it by a mode of acquisition . . .” It is clear that in the case of gifted or inherited property the cost of acquisition or improvement is the cost to previous owner. What about the date of acquisition? Have you noticed that Sec. 48 deals with only the cost of acquisition and cost of improvement but not the date of acquisition or improvement? Therefore, the index on cost of acquisition should be related with the date of the gift or inheritance but the index on cost of improvement would be related with the date of improvement. Strange indeed.
Let us take an instance. Father purchased a residential house for ` 5 lakh in FY 84-85. He passed away on 21.8.99. The son sold the property on 13.7.00. His cost of acquisition would be taken as ` 5 lakh, the cost to his father and the date of acquisition as 21.8.99, the date when his father died. Even though the son sold the property within one year of his date of acquisition, it is a long-term asset. The son can claim the benefit of long-term gains since u/s 47(iii) the date of acquisition lies in FY 84-85. The method of calculating indexed cost u/s 48 defines the date as that on which asset was held by assessee.
This is as far as acquiring the property under a Will, gift, succession, inheritance or devolution is concerned. Imagine the absurd situation that may arise where a husband gifts the property to his wife and the wife subsequently sells the property. First of all, since gift to spouse attracts clubbing provisions u/s 64, all income, including the capital gains if any, generated from the house property would be clubbed in the husband’s hands. Due to such bewildering provisions, the husband would have to pay a much higher capital gains tax than what he would, had he himself sold the house. The reason is simple — the indexed cost of acquisition would be lower to the extent of the time elapsed between his buying the house and gifting it to the wife.
In 81taxmann.com261 Arun Shungloo Trust v CIT [2012] the Delhi High Court has observed that the benefit of indexed cost is given to ensure that the taxpayer pays capital gain tax on the ‘real’ or actual gain and not on the increase in the capital value of the property due to inflation. This is the object or purpose in allowing benefit of indexed cost of improvement, even if the improvement was by the previous owner in cases covered by Sec. 49. Accordingly, there is no justification or reason to not allow the benefit of indexation to the cost of acquisition. The expression ‘held by the assessee’ used in the Explanation (iii) of Sec. 48 should be interpreted to include the period during which the property was held by the previous owner.
Unfortunately, the decisions of the High Courts are mandatory only for the state where the court is located. Yes, it has a persuasive effect for other states, but the ITOs in the other states can still take decisions on the basis of whether they like your face or not. Of course the previous sentence appears in a lighter vein – bit in all seriousness, if for any reason the ITO were to disagree with the stance, then the only recourse left is to go in for an appeal. Much better if the Act were to be amended in accordance with the actual intention of the law.
(The authors may be contacted at wonderlandconsultants@yahoo.com)
