How to find the period of holding in case stock –in-trade is converted as capital asset?

Section 45(2) of the Income Tax Act cover a case of conversion of investments to stock-in-trade. But , there is no provision to cover a case of reverse conversion i.e conversion of stock-in-trade to investment. Now , the taxation of gains on transfer of capital asset is dependent on the nature of transfer of asset . That is whether the gain is Short Term or Long Term. This nature of asset is found out by counting the period of holding of capital asset . In case of conversion of stock-in-trade to investment , the first issue to grapple with is computation of period of holding. This post is going to restrict itself to answer the question regarding determination of period of holding in case stock-in-trade is converted to capital asset.

Period of Holding from Date of Birth of Capital Asset

The period of holding in case of capital asset is computed in accordance with definition given u/s 2(42A) of the Income Tax Act. The capital asset is defined u/s 2(14) which specifically excludes stock-in-trade. So , any asset , so long as it is stock-in trade is not a capital asset and therefore , the period of holding , applicable on a capital asset cannot be applied in that case. In other words, the period of holding has to be computed from the date stock-in-trade took birth as investment , i.e date of conversion of stock-in-trade to capital asset.

The first case to rely on is of ITAT Delhi Bench in the case of Splendor Constructions (P.) Ltd.v. Income-tax Officer, Ward 9(2), New Delhi- October 24, 2008 and reported in (2009)-27-SOT-39(Del). wherein the fact involved was that the assessee bought land in the year 1998-99 and treated it as stock-in-trade. The assessee converted the said land as investment on 01/04/2002 and same was sold on 20/12/2002. In the return, it showed long term capital gain, which was not correct as per A.O, who treated the gain as short-term capital gain on the ground that the capital asset was held by the assessee for 9 months only before selling it.

The decision of A.O was approved by CIT(A) . When the matter reached Tribunal, it also confirmed the order by holding as under :

12. As rightly held by the Assessing Officer as well as by the ld. CIT(A), capital asset is defined in section 2(14) as property of any kind held by the assessee whether or not connected with his business or profession, but the same does not include inter alia any stock-in-trade, consumable stores or raw materials held for the purpose of his business or profession. In the present case the property in questioni.e., land was held by the assessee-company up to 31-3-2002 as the stock-in-trade for the purpose of its business and this being so, we are of the view that the period for which the said property was held by the assessee-company as stock-in-trade of its business could not be reckoned for ascertaining as to whether it was a long-term capital asset or a short-term capital asset within the meaning given in section 2(29A) and 2(42A) as the same was not held by it as a capital asset. It is only when the same was converted by the assessee-company into investment i.e., with effect from 1-4-2002 that the same was held by it as capital asset and as the same was held by it for not more than 36 months immediately preceding the date of its transfer i.e., 12-12-2002, it was a short-term capital asset as defined in section 2(42A) and the capital gain arising from the sale thereof was chargeable to tax as ‘short-term capital gain’ as defined in section 2(42B). In that view of the matter, we find no infirmity in the impugned order of the ld. CIT(A) upholding the action of the Assessing Officer in treating the profit arising from the sale of the said property as short-term capital gain and upholding the same, we dismiss this appeal filed by the assessee.

The second decision is that of ITAT, Chennai in CS Holding vs ACIT [2014] 41 taxmann.com 305 (Chennai – Trib.) in which the facts involved is that of the assessee-company purchased shares with borrowed funds and held the same as investment. In the next year, the assessee converted the entire shares held as investment into stock-in-trade and claimed interest on borrowal as deduction. For the relevant assessment year, the assessee converted the shares held as stock-in-trade in to investment and sold shares and income from sale of shares was shown as Long Term Capital Gain. The assessee claimed exemption of the dividend earned during relevant period as well as Long Term Capital Gain.

The Assessing Officer held that the action of assesse to convert the shares from stock-in-trade to investment was for evasion of tax . He held the gains as business income.

The Commissioner (Appeals) confirmed the findings of the Assessing Officer.

On appeal by assesse , the ITAT , Chennai relying on the ITAT Delhi’s decision in case of Splendor Constructions (P.) Ltd. v. ITO [2009] 27 SOT 39.that  the period for which the shares were held as stock in trade by the assessee is to be excluded from the total period for which the shares were held by the assessee.

The third  decision in the regard is of ITAT Kolkata in ACITvs B.K.A.V. Birla [1990] 35 ITD 136 (CAL.), ITAT wherein the Tribunal clearly held that the period for which the asset was held as stock-in-trade should be reduced from the total period of holding for counting whether the asset is short term or long term capital asset. The facts and conclusion was as under :

The brief facts relating to the controversy are that the assessee acquired 11,533 shares of Zenith Steel in the year 1961. These shares were retained as “investment” till 1972 when the shares were converted into stock-in-trade. Between the years,1975 and 1979 the assessee was further allotted 14,430 bonus shares of Zenith Steel. The total shareholding of the above Company was again converted to investment on 9th September, 1982. All the shares were sold in August 1984. The assessee earned a profit of Rs. 6,18,141 on sale of shares and claimed the same to be long term capital gain.

The A.O treated the gain as short term , as the shares were required to be held for 36 months for being counted as long term , at that point of time, and as per A.O the shares were held for less than 36 months at the time of sale.

The CIT(A) however, gave a verdict in favor of assessee.

When department appealed to Tribunal against the order , the Tribunal confirmed the order of A.O and concluded as under :

The definition of term “short-term capital asset” as per section 2(42A) makes clear that it is “capital asset” which should be held for a period less than 36 months and not “an asset”. The definition uses the words “capital asset” and we see no reason for ignoring the word “capital” in it. The distinction and the dividing line between “long-term capital asset” and “short-term capital asset” is period of 36 months. The scale of time is to be applied to a “capital asset” and not to an ordinary “asset”. The word “asset” is not defined and “short-term capital asset” is defined only for computing income under Chapter ‘E’ relating to capital gains. The capital gain arises on the transfer of a capital asset and, therefore, holding as an asset is not relevant for purposes of Chapter E. The clear scheme the Income-tax Act is to move backward in time from the date of the transfer of “capital asset” to determine whether gain or loss arising is long-term or short term. If capital asset is held for less than 36 months, it is short term. Otherwise it is long term. We therefore, see no justification for including the period for which the shares were part of stock-in-trade for determining whether these were held as long term capital assets. For all the above reasons, we hold that the assessee-HUF held shares in question for a period of less than 36 months and as short term capital assets. Modifying the order of the CIT(A), we direct the ITO to compute the capital gain as accruing on transfer of short-term capital assets.[Para 10]