conversion of stock in trade to capital assets

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sandeep sahu (Querist)
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23 August 2010 Dear Sirs
One private limited company which deals purchse and sale of shares ,has stock in trade of 15 lakhs since 5 years. The shares which are shown as stock in trade are neither sold nor any new shares are being purchased.So in the balance sheet the opening stock and closing stock are remain same.
Now my question is
1.whether these shares can be treated as Capital assets as per Section 2(14) of the Income tax act?
2. If we convert these shares into capital assets,what is the tax and other inplication to the particual transaction.
3.Further whether the conversion would be treated as Sale or just the Investment account wiil be bebited by corresponding credit to closing stock.Because with this the current year profit figure of the company will get affected.

plese clarify my doubts

Regards

CA PRAMOD SARAOGI

CA PRAMOD SARAOGI (Expert)
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24 August 2010 While conversion of capital assets into stock-in-trade and taxability of resultant profit or loss is specifically dealt under Section 45(2) of the Income Tax Act there is no specific provision to deal with reverse situation involving conversion of stock-in-trade into capital asset or investment. Conversion of capital asset into stock: Sale of converted asset results into capital gain or capital loss in the year in which such stock is sold. This is calculated by subtracting the cost at which the original asset was carried from the fair market value on the date of conversion.

Conversion of stock into capital asset: Based on the interpretations of various sections and prudence my comments are as follows:

1. Stock may be converted into investment in a running business or at the time of closure.
2. No capital gain would arise on the date of conversion. However when the investment is sold, it will result into capital gain or loss to be calculated taking book value as cost of acquisition.
3. In view of differential tax rates applicable on type of capital gain, period of holding of capital asset is relevant to distinguish long term gain from short-term gain. Period of holding in this case will be reckoned from the date of acquisition of original stock of shares.

This technique of converting stock into investment or vice versa can be effectively used as tool of tax planning.