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Deeming fiction u/s. 50 for taxing short term capital gains cannot deny benefit of exemption or set off of loss!

      Section 50 of the Income-tax Act prescribes a special provision for computation of capital gains arising on the transfer of depreciable assets. As per the same, where the consideration received or accruing on the transfer of such an asset exceeds the written down value of the block of assets to which such an asset belongs, the excess is deemed to be capital gains arising from the transfer of short term capital assets.

      Whereas various exemptions, such as under Sections 54, 54EC and 54F can be enjoyed in respect of long term capital gains (LTCG), the benefit of such exemptions is not available in respect of short term capital gains (STCG). Moreover, while taxable LTCG is liable to tax at a concessional rate of 20.6%, no such concession is allowed for STCG, which is taxed at normal rates that can scale upto as high as 30.9% or even 32.445% (where surcharge is attracted).

       In the above context, an interesting issue that would arise for consideration is that if the depreciable asset has been held for a period of more than three years, whether the taxpayer can claim the benefit of any of the exemptions prescribed for long term capital gains.


        Both Bombay and Gauhati High Courts have conclusively held this issue in favour of the taxpayer. In the case of ‘Commissioner of Income-tax v/s. Ace Builders (P.) Ltd.’ 281 ITR 210, the Court was required to consider the question whether a taxpayer is entitled to deduction under section 54E (corresponding to the present Section 54EC) in respect of the capital gain arising on the transfer of a capital asset on which depreciation has been allowed and which is deemed as short-term capital gain under Section 50 of the Income-tax Act.

        The High Court in its well reasoned and logical judgement held that, “it is true that Section 50 is enacted with the object of denying multiple benefits to the owners of depreciable assets. However, that restriction is limited to the computation of capital gains and not to the exemption provisions. In other words, where depreciation has been availed on long-term capital asset, then the capital gain has to be computed in the manner prescribed under Section 50 and the capital gains tax will be charged as if such capital gain has arisen out of a short-term capital asset, but if such capital gain is invested in the manner prescribed in Section 54E, then the capital gain shall not be charged under Section 45.”

         With the aforesaid observations, the Court firmly concluded that, “to put it simply, the benefit of Section 54E will be available to the taxpayer irrespective of the fact that the computation of capital gains is done either under Sections 48 and 49 or under Section 50. The contention of the Revenue that by amendment to Section 50, the long-term capital asset had been converted into to short-term capital asset was also without any merit. The legal fiction created by the statute is to deem the capital gain as short-term capital gain and not to deem the asset as short-term capital asset. Therefore, it cannot be said that section 50 converts long-term capital asset into a short-term capital asset.”

         The Bombay High Court concurred with the similar view taken earlier by the Gauhati High Court in the case of ‘CIT v. Assam Petroleum Industries (P.) Ltd. 262 ITR 587. It is pertinent to point out that there is no judicial view of any High Court or Tribunal against the taxpayer on the above issue.


         Recently, the Mumbai Bench of the Income-tax Appellate Tribunal (ITAT) in the case of ‘Komac Investments & Finance (P.) Ltd. v/s.Income-tax Officer’ 13 185 had occasion to consider a situation where the brought forward long term capital loss had been set off by the taxpayer against the capital gain arising from the sale of its office premises.  The Assessing Officer rejected the taxpayer’s claim on the ground that the capital gain derived was short-term capital gain on transfer of a depreciable asset in view of deeming provisions of Section 50(2). He further held that under the provisions of Section 74(1)(b), a long term capital loss could not be set off against a short term capital gain for the year. The Commissioner (Appeals) also concurred with the view of the Assessing Officer.

        While deciding the appeal preferred by the taxpayer, the Tribunal noted the language of Section 74(1)(b) which reads that “in so far as such loss relates to a long term capital asset, it shall be set off against income, if any, under the head ‘capital gains’ assessable for that assessment year in respect of any other capital asset not being a short term capital asset.” The ITAT allowed the appeal relying on the ratio of the above referred High Court decision of ‘Ace Builders,’ holding that although the gain (if required to be taxed) was to be treated as a short term capital gain due to the fiction created by the provisions of Section 50(2), the asset still remained as a ‘long term capital asset.’ Thus, there was nothing in Section 74(1)(b), which could deny the taxpayer the benefit of set-off of long term capital loss against capital gain arising from a depreciable asset, which infact is a long term capital asset held for more than 36 months.

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