Moneycontrol
Get App
Last Updated : Dec 26, 2013 03:13 PM IST | Source: Moneycontrol.com

Tax implications on assets under Gift, Will

Whether you receive the capital assets either by Gift or by Will the liability to Capital Gains tax will arise when you sell such assets. It's important for tax payers to understand how to arrive at the tax calculation.


By Subhash Lakhotia,
Tax and Investment Consultant,
Tax Guru: CNBC Awaaz


It may be land, building or jewellery or shares or for that purpose any Capital Asset which you might have received as a result of gift to you by your dear ones or it may be a situation that you might have received some of these assets by way of inheritance through Will of your dear ones.  The fact remains that whether you receive the Capital Assets either by Gift or by Will the liability to Capital Gains tax will arise when you sell such assets. 


The very important question that might come up in the minds of tax payers is how to arrive at the tax calculation in respect of all those assets which are acquired by an assessee by way of Gift or Will or by succession or by inheritance etc.

Close

Generally a person would think that his cost in respect of these assets would be nil because if he has received certain Capital Assets through Gift or through Will, without making any payment to the person from whom the assets were received.  However, from the point of view of tax planning there are specific provisions contained in the Income-Tax Act, 1961, which would grant substantial tax saving to all those persons who might have received certain Capital Assets either as a result of gift or they might have received the assets through the Will of a person. 


In the succeeding paragraphs in this article an attempt has been made to discuss the various aspects connected with computation of Capital Gains in respect of assets which are received by a person by way of Gift or by way of Will or by succession or by inheritance or may be by devolution.


Section 49 of the Income-Tax Act deals with the concept of determination of cost with reference to certain modes of acquisition in respect of the Capital Assets which are sold by a tax payer.  We have seen in practical life that most people generally go with the presumption that if they were to sell certain Capital Assets which were received in gift or which were inherited by them, then they would be required to make payment on account of Capital Gains on the full sale consideration because there was no cost attached to these assets as they had not paid a single penny for receiving these items.  The general thinking is based on the fact that whenever a person receives some assets by way of Gift or the asset is received consequent to the death of the person as per his Will, then the recipient will virtually get such asset free of cost. 


Hence, the recipient generally thinks that as there is no cost attached to the acquisition of the asset, therefore no amount of cost will be deducted from the sale consideration while selling such assets.  However, a specific look at the provisions contained in section 49 will bring a happy note for all such tax payers that under the above mentioned section 49 of the Income-Tax Act, 1961, it is specifically provided that where the Capital Asset becomes the property of the assessee under a Gift or a Will or by succession or inheritance or devolution etc. etc., then the cost of acquisition of the asset shall be deemed to be the cost for which the previous owner of the property acquired it.  Thus, the clear cut provisions as mentioned in section 49 of the said Income-Tax Act, 1961 very clearly explicitly mentions that the cost of the assets which were received in Gift or through Will will be the cost of the same will be deducted from the sale price and such amount which was the cost of the previous owner from whom such asset was received as a result of Gift or as a result of Will of such person.  In spite of the fact that the law is very clear cut on the subject but many a times the tax payers face a big problem with reference to the computation of the cost of the previous owner. 


The common question which might crop up in the minds of the tax authorities as well as in the minds of the tax payers is how to determine the cost of acquisition of the Capital Asset of the previous owner from whom such asset was received by way of Gift.  Well to determine the cost of the previous owner is not a difficult proposition.  It is that value at which the previous owner acquired such assets.  Moreover, the concept of Cost Inflation Index would also be applicable in the case of assets which were acquired as a result of Gift or Will and are being sold at a later stage.  The most important question that arises in the minds of the tax payers is the year in respect of which the Indexed Cost of acquisition is to be considered. 


There have been views that the Indexed Cost of acquisition of the previous owner is to be with reference to the year in which the Gift was made or another view is that the cost of acquisition with reference to the previous owner would be the year in which the previous owner acquired the asset originally and not in the year in which the assessee acquired such asset. It is because of these two diversities in the tax treatment of cost of acquisition of the previous owner that one has to find out the correct answer to compute the Capital Gain correctly.  To come to a critical analysis of the correct interpretation of the law it would be worthwhile to refer to a very interesting decision of the Bombay High Court in the case of CIT v. Manjula J. Shah (2013) 355 ITR 474.  In this case the question that was framed for being referred to the Honourable judges of the High Court was that while computing the Capital Gains arising on transfer of a Capital Asset acquired by the assessee under a Gift whether the Indexed Cost of Acquisition has to be computed with reference to the year in which the previous owner held the asset or the year in which the assessee became the owner of the property. 


Before coming to the opinion of the Honourabe judges on this point it would be worthwhile to refer to certain factual facts of the above case which will help easy understanding.  The relevant facts in the above case are that the assessee who was an individual derived his income from business, from house property, capital gains and other sources.  In the assessment year under question the assessee had declared a total income of Rs. 20,92,400.  The said return of income included long-term capital gains arising from the sale of a residential flat bearing No. 1202-A (“capital asset” for short) at Chaitanya Towers, Prabhadevi, Mumbai.  The said flat was originally purchased by the daughter of the assessee (‘previous owner” for easy reference) on January 29, 1993, at a cost of Rs. 50,48,350.  By a gift deed dated February 1, 2003, the previous owner gifted the said capital asset to the assessee.  On June 30, 2003, the assessee sold the said capital asset for a total consideration of Rs. 1,10,00,000 and offered the long-term capital gains to tax. 


During the assessment proceedings, the assessee contended that though the capital asset in question was acquired by the assessee under a gift deed dated February 1, 2003, and transferred on June 30, 2003, under section 48 read with section 49 and section 2(42A) of the Incoime-tax Act, 1961 the gains arising therefrom were liable to be computed as long-term capital gains by deducting from the total consideration received, inter alia, the amount of the indexed cost of acquisition.  The assessee contended that the indexed cost of acquisition has to be determined with reference to the cost inflation index for the year in which the cost of acquisition was incurred.  In the present case, the cost of acquisition was incurred on January 29, 1993, and, hence, the cost inflation index for 1993-94 would be applicable. 


The Assessing Officer was of the opinion that under Explanation (iii) to section 48 of the Act, the indexed cost of acquisition has to be determined with reference to the cost inflation index for the year in which the asset was first held by the assessee.  According to the Assessing Officer, the asset was held by the assessee from February 1, 2003, and, therefore, the cost inflation index for 2002-2003 would be applicable in determining the indexed cost of acquisition. 


On appeal filed by the assessee, the Commissioner of Income-tax (Appeals) allowed the claim of the assessee by holding that the long-term capital gains has to be determined by computing the indexed cost of acquisition with reference to the cost inflation index for 1993-94 instead of the cost inflation index for the assessment year 2002-03 as held by the Assessing Officer.  


When the matter came up before the Income-tax Appellate Tribunal, the Honourable members of the Tribunal concurred with the decision of the CIT (Appeals) and dismissed the appeal filed by the Income-tax Department. 


When the matter came up before the Honourable judges of the High Court, the learned counsel on behalf of the Income-tax Department argued that Explanation (iii) to section 48 specifically provides that the indexed cost of acquisition has to be determined with reference to the first year in which the capital asset was held by the assessee.  In the present case, admittedly, the capital asset was acquired by the assessee under a gift on February 1, 2003 and, therefore, the first year of holding the capital asset by the assessee is the financial year 2002-03.  Therefore, the indexed cost of acquisition in the present case has to be determined with reference to the cost inflation index for 2002-03. 


It may also be noted that as per the provisions contained in section 47(iii) of the Income-tax Act under a Gift or a Will, then such transaction shall not be regarded as transfer and, therefore, whenever a person receives some asset under a Gift or under a Will, no liability to pay Capital Gains would arise in such a situation.  However, the liability to pay Capital Gains tax would arise only when the assessee transfers the Capital Assets which were acquired under a Gift or a Will without consideration.  When the matter came up before the Honourable judges of the High Court, the Honourable judges opined that in the present case, the capital asset in question (Flat No. 1202-A) was originally acquired by the previous owner (daughter) on January 29, 1993 and the same was acquired by the assessee under a gift deed dated January 2, 2003 without incurring any cost. 


The assessee sold the said capital asset on June 30, 2003 for Rs. 1,10,00,000.  Since the assessee held the capital asset for less than thirty six months (January 2, 2003 to June 30, 2003) in the ordinary course, as per section 2(42A) of the Act the assessee would have held the asset as a short-term capital asset and, accordingly, liable for short-term capital gains tax.  However, in view of Explanation 1(i)(b) to section 2(42A) of the Act which provides that in determining the period for which any asset is held by an assessee under a gift, the period for which the said asset was held by the previous owner shall be included, the assessee is deemed to have held the asset as a long-term capital asset and,  accordingly, liable for long-term capital gains tax.  Thus, by applying the deeming provision contained in Explanation 1(i)(b) to section 2(42A) of the Act, the assessee is deemed to have held the asset from January 29, 1993, to June 30, 2003) (by including the period for which the said asset was held by the previous owner) and, accordingly, held liable for long-term capital gains tax.


Before coming to the conclusion in respect of this very important burning point, the Honourable judges of the High Court were of the view that the words of the statute are to be understood in their natural and ordinary sense unless the object of the statute suggests to the contrary.  Thus, on construing the words “asset was held by the assessee” in clause (iii) of Explanation to section 48 of the Act, one has to see the object with which the said words are used in the statute.  If one reads Explanation 1(i)(b) to section 2(42A) together with section 48 and 49 of the Act, it becomes absolutely clear that the object of the statute is not meely to tax the capital gains arising on transfer of a capital asset acquired by an assessee by incurring the cost of acquisition, but also to tax the gains arising on transfer of a capital asset, inter alia, acquired by an assessee under a gift or will as provided under section 49 of the Act where the assessee is deemed to have incurred the cost of acquisition. Therefore, if the object of the Legislature is to tax the gains arising on transfer of a capital asset acquired under a gift or will by including the period for which the said asset was held by the previous owner in determining the period for which the said asset was held by the assessee, then that object cannot be defeated by excluding the period for which the said asset was held by the previous owner while determining the indexed cost of acquisition of that asset to the assessee. 


In other words, in the absence of any indication in clause (iii) of the Explanation to section 48 of the Act that the words “asset was held by the assessee” has to be determined differently, the said words should be construed in accordance with the object of the statute, that is, in the manner set out in Explanation 1(i)(b) to section 2(42A) of the Act.  On the theme of indexation in respect of sale of capital assets, the Honourable judges of the High Court were of the view that the object of giving relief to an assessee by allowing indexation is with a view to offset the effect of inflation.  As per CBDT Circular No. 636, dated August 31, 1992, a fair method of allowing relief by way of indexation is to link it to the period of holding the asset. The said circular further provides that the cost of acquisition and the cost of improvement have to be inflated to arrive at the indexed cost of acquisition and the indexed cost of improvement and then deduct the same from the sale consideration to arrive at the long-term capital gains. If indexation is linked to the period of holding the asset and in the case of an assessee covered under section 49(1) of the Act, the period of holding the asset has to be determined by indicating the period for which the said asset was held by the previous owner, then obviously in arriving at the indexation, the first year in which the said asset was held by the previous owner would be the first year for which the said asset was held by the assessee. 


Since the assessee, in the present case, is liable for long-term capital gains tax by treating the period for which the capital asset  in question was held by the previous owner as the period for which the said asset was held by the assessee, the indexed cost of acquisition has also to be determined on the very same basis.  Finally, while deciding the issue with reference to cost of acquisition in respect of Capital Assets acquired under gift or Will etc. the Honourable judges came to the conclusion that in the above case the Income-tax Appellate Tribunal was justified in taking the indexed cost of acquisition with reference to the year in which the previous owner first held the asset and not the year in which the assessee became the owner of  the asset. 


In view of the findings of the Honourable judges in the above case one can definitely come to a conclusion that whenever certain assets are sold and particularly when such assets have been received by way of gift or through Will or by succession or by inheritance, then the cost of acquisition of the asset will be deemed to be the cost for which the previous owner of the property acquired it as increased by the Cost Inflation Index of that year in which the previous owner originally acquired the property.


The author is tax & investment consultant at New Delhi for last over 40 years. He is also Director of M/s R.N. Lakhotia & Associates & The Strategy Group.




Exclusive offer: Use code "BUDGET2020" and get Moneycontrol Pro's Subscription for as little as Rs 333/- for the first year.

First Published on Dec 26, 2013 03:13 pm
Sections
Follow us on