The cost indexation allowed for tax set-off includes the period the asset was with the earlier owner.
Almost every tax payer is conversant with terms like capital gains tax and cost indexation. Yet, there are finer details regarding these which need to be understood if one has to take advantage of possible tax benefits. There have been several instances where the difference of opinion between the tax payer and the Income Tax department has resulted in the matter being debated in the courts. However, the litigation has helped clarify the fine print. One such issue was the calculation of the cost indexation benefit with respect to gifted property that has been sold.
Based on the time for which assets are held by tax payers, capital gains are either classified as long-term or short- term. Tax-payers are also allowed to index the costs linked to inflation while acquiring a capital asset, during the period of holding, while calculating long term capital gains under the Income Tax laws. The provision is a benefit given to the taxpayers to index their cost to inflation, denoted by the Cost Inflation Index (CII) released by the government every year.
| CAPITAL GAINS PRIMER * No capital gains tax to be paid by recipient of a gift; * When this asset is further sold, the sale will attract capital gains tax; * To determine if the gains were long-term or short-term, include the period for which the asset was with the previous owner; * For long-term capital gains, costs indexation linked to the cost inflation index is allowed; * Indexation also allowed for the entire period where the asset was with the previous owner. |
As per the relevant provisions of the Income Tax Act, a tax payer can index his cost of acquisition with reference to the year in which the tax payer became owner of the asset. For instance, if a property is acquired in the year 1985 and sold in 2011, the tax payer can index his cost of buying the property for the period 1985 to 2011 and offer only the difference between the sale consideration and indexed cost as long term capital gains.
Further, the law provides that if any capital asset was acquired by way of gift, at this point there is no liability to pay capital gains tax for the recipient and it would be deferred to the point of sale of asset. In such cases, the cost of the asset shall be deemed to be the cost to the donor of the gift and the indexation shall be allowed with reference to the year the tax payer became owner of the asset. But, if one goes by a recent ruling in a case that came before the high court at Mumbai, this understanding of the law might change.
In the said case, the tax payer had filed her return of income for the assessment year 2004-05, which included long-term capital gains from the sale of a residential flat. The was originally purchased by her daughter for Rs 50.48 lakh on January 29, 1993. By a gift deed dated February 1, 2003, she gifted it to her mother. On June 30, 2003, the mother sold the flat for Rs 1.1 crore and offered the long-term capital gains to tax.
During assessment proceedings, the tax officer decided that as the tax payer had become the owner of the asset only in the year 2002-03, the cost of the property (deemed to be the same as cost at which the property was purchased by her daughter) could be indexed only since then. However, the tax payer contended that as the cost of acquisition was incurred in January 1993, the property had to be indexed with reference to 1993-94. The tax officer disallowed the claim and the matter went to the tribunal.
At the first appellate level, the authority ruled in favour of the tax payer and allowed the cost to be indexed from the year 1993-94. At the second level. too, the tax tribunal ruled the case in favour of the tax payer. The income tax department then appealed to the High Court. There, it contended that although there were specific provisions in the Act which state that in the case of a gift, the period for which the previous owner held the asset had to be taken into consideration for determining if the asset was a long-term or short-term one, the same cannot be said for indexation of the cost. The relevant provisions were clear in providing that the indexation can be done only from the year in which the tax payer first owned the asset.
In its judgement, the High Court held that by virtue of the Act’s provisions, the tax payer was deemed to have held the property from January 29, 1993, to June 30, 2003, which included the period for which it was owned by her daughter, the previous owner. The court further held that the indexed cost of acquisition had to be determined with reference to the cost inflation index for the first year in which the property was held by the tax payer. In the absence of any definition for the words ‘held by the tax payer’, by virtue of the provisions for determining the period of holding as discussed earlier in this paragraph, the tax payer must be treated as having held the property from January 29, 1993. So, the cost inflation index for the year 1992-93 would be applicable in determining the indexed cost of acquisition for computing-long term capital gains.
The High Court further said the words used in the Act had to be understood in the background of the object of the provisions. Thus, although the term ‘held by the assessee’ was nowhere defined, the other relevant provisions made it clear that the object of the Act was not merely to tax the capital gains arising on transfer of an asset acquired by a tax payer but to also tax the gains arising on sale of assets acquired under a gift or will. The object could not be allowed to 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 tax payer.
This decision comes as a major relief for tax payers. Indexing the cost for the period for which the property or asset was held by the previous owner extends the indexation period. This would offer tax-payers a substantial relief from capital gain taxes.
The writer is a certified financial planner
