Capital gain

This query is : Resolved

Querist : Anonymous

Querist : Anonymous (Querist)

21 August 2012 What will be the tax treatment when Inventory will be converted in to Investment.
For Example
Inventory value 10 Lacs
Transfer to investment at Rs 12 Lacs

CA AYUSH AGRAWAL

CA AYUSH AGRAWAL (Expert)
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21 August 2012 Dear Sir,

Unlike, Sec 45(2) [conversion of Capital Asset into SIT ] there is no express provision that restricts conversion of SIT into Capital Asset or defines the treatment to be followed in such case.
The controversial judgment in case of DLF Universals cannot be applied in this case bcos it was linked with Sec 45(3) - where Asset is introduced in a Firm. [ I mentioned this bcos I came across some of the views which says that judgment in case of DLF prohibits the above conversion]
Since Income Tax is silent, so as of now u can convert held as SIT into Capital asset & can easily walk away by claiming Sec 10(38)
But I feel one should be careful -
1) Courts can Tax it if assessee fails to justify the conversion.
2) If at all Govt. decides to address this issue I feel that it will be retrospective since this is a clear example of Tax Aviodance. {So even if u might not get caught as of now but in future ur AO will not leave you especially when you had taken a bread from his mouth}

CA AYUSH AGRAWAL

CA AYUSH AGRAWAL (Expert)
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21 August 2012 Also Apart From This, This is Pure Tax Planning:-

When a capital asset is converted into stock in trade then capital gain u/s 45(2) of Income Tax Act arises in the year of sale and not in the year of conversion. But in vice versa situation i.e conversion of stock in trade into capital asset there does not arise any capital gain. If an assessee is in the business of real estate and on closure of his business he retains the existing stock in trade of immovable properties of the business with him and holds it as investment then it will become his capital asset from the time of closure of his business. In such case if he later on sells the same capital asset say after three years from the date of purchase of such asset then the gain arising therefrom will be a long term capital gain and and the benefit of indexation and paying of tax @ 20% instead the normal rate can be planned.

Similar case can also happen in case of a business of trading in shares. Even during the continuation of the business the assessee may transfer some of his stock in trade into his capital asset by deciding to hold it as an investment and can sell the same at a later stage and can pay tax on the profit as capital gain instead of business profit.

It is here to be noted that long term capital gain from equity shares sold in stock exchange and on which Security Transaction Tax has been paid, is exempt u/s 10(38) of Income Tax Act. Thus in case of conversion of shares held as stock in trade into capital asset, the benefit of exemption u/s 10(38) will be available if such converted capital asset is sold later and long term capital gain arises from it. .

In such cases, there will not be any capital gain at the time of conversion and if the assessee sells such converted asset at a later date, the profit will certainly give rise to capital gain and in order to ascertain whether such profit is long-term capital gain, the period of holding would have to be reckoned from the date of acquisition of the asset as stock in trade and not from the date of conversion into capital asset, as section 2(42A) does not lay down that the holding of the asset for the required period has to be as capital asset.

Thus the assessee can go for tax planning and save the tax by treating as the long term capital gain which is taxable @ 20% instead of normal rate and benefit of indexation can also be taken.

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Guest

Guest (Expert)

21 August 2012 You are converting your inventory into investment so book entry will be as under
Investment A/c dr 12lakh
To Inventory A/c 10 lakh
To profit on conversion 2 lakh
But this will be a normal business profit and not a capital gain
Capital gain arise only when the asset transferd is a capital at the time of transfer. And inventory is a not a capital asset as per I.T.Act. But when you will sale the investment then capital gain/loss would arise.

Querist : Anonymous

Querist : Anonymous (Querist)

21 August 2012 can we convert inventory in to capital assets at any valu?

CA AYUSH AGRAWAL

CA AYUSH AGRAWAL (Expert)
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21 August 2012 for Book Purpose as per ur wish.
but as per IT act, it will be as per market value only.
u have to prove the value.

Guest

Guest (Expert)

21 August 2012 Should be converted at market value i.e. value at which you can ordinarly sale. if its shares of any company then closing price pf the share on the conversion.

For reduce profit on conversion convert it on such day on which its market value is less(possible for shares)