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Bombay & Delhi High Courts hold that taxpayers can enjoy indexation even on assets received via gift or inheritance

    If your grandfather had acquired a plot of land for Rs.10,00,000 in late 1981, which you received by way of inheritance on his death in 2012 and you are planning to sell the same in early 2013 for a consideration of Rs.85,00,000, what would be the income-tax you would be required to pay on your capital gains? Difficult to believe, but ‘zero tax’ is the correct answer.


Section 49(1) of the Income-tax Act provides that where the capital asset has been acquired by the taxpayer in any of the modes such as on partition of a Hindu Undivided Family or under gift or will or by succession or inheritance, etc., the cost to the previous owner shall be deemed to be cost of acquisition of the taxpayer.

Similarly, Section 2(42A) provides that where a capital asset is acquired by way of gift or inheritance as mentioned in Section 49(1), period of holding of the previous owner shall also be included in the period of holding of the taxpayer.


    In the case referred to hereinabove, if just the above two concessional provisions were taken into consideration, your taxable capital gains (deemed as long term) would still have worked out to Rs.75,00,000 (85,00,000 – 10,00,000), attracting a tax liability of Rs.15,45,000 (at 20.6%).

However, as per the decisions of the Hon’ble Bombay High Court in the case of ‘CIT v. Manjula J. Shah’ [2012] 204 Taxman 691 (Bom.) and the Hon’ble Delhi High Court in the case of ‘Arun Shungloo Trust v. CIT [2012] 205 Taxman 456 (Del.)’, the benefit of computing ‘Indexed Cost of Acquisition’ (ICA) can also be availed in cases of transfer covered under Section 49 such as assets received via gift or inheritance.

Considering the ‘Cost Inflation Index’ (CII) of 852 for 2012-13 with reference to the CII of 100 for 1981-82, the ICA of the plot of land inherited and proposed to be sold by you in the above mentioned case would work out to Rs.85,20,000. Since your sale consideration is expected to be Rs.85,00,000, you will end up with the good fortune of enjoying zero tax.

In both these decisions, the courts have rejected the plea of the Revenue that the indexation factor in such cases was required to be determined only with reference to the date of  acquisition by the taxpayer selling such asset. The courts have conclusively held that while computing the capital gains arising on transfer of a capital asset acquired by a taxpayer under a gift or inheritance, the indexed cost of acquisition has to be computed with reference to the year in which the previous owner first held the asset and not the year in which the taxpayer became the owner of the asset.

The Bombay High Court noted that as per the CBDT Circular No. 636 dated 31/8/1992, a fair method of allowing relief by way of indexation is to link it to the period of holding the asset. If indexation is linked to the period of holding an asset and in the case of a taxpayer covered under Section 49(1) of the Act, the period of holding the asset has to be determined by including the period for which the same was held by the previous owner, then obviously for arriving at the indexation, the first year in which the said asset was held by the previous owner would be the first year for which the same was held by the taxpayer. The High Court concluded that since the taxpayer in the present case is held liable for long term capital gains tax by treating the period for which the capital asset in question was held by the previous owner as the period for which the said asset was held by the taxpayer, the indexed cost of acquisition has also to be determined on the very same basis.

The Delhi High Court, relying on purposive interpretation, observed that normally literal rule of construction is applied and the words of the statute are to be understood in their ordinary and popular sense, but this is subject to the rider that this should not lead to absurdity, contradiction or stultification of the statutory objective. Literal construction should be avoided, if it leads to unwarranted repugnance or inconsistencies. In such circumstances the expression/words can be interpreted by the Courts to avoid absurdities and inconsistencies between the provisions. The Court noted that in the present case, the construction placed by the Revenue will result in absurdities because the holding of predecessor has to be accounted for the purpose of computing the cost of acquisition, cost of improvement and indexed cost of improvement, but as per the Revenue not for the purpose of indexed cost of acquisition. The High Court concluded that benefit of indexed cost of inflation is given to ensure that the taxpayer pays capital gain tax on the ‘real’ or actual ‘gain’ and not on the increase in the capital value of the property due to inflation. Accordingly there is no justification or reason to not allow the benefit of indexation to the cost of acquisition in cases covered by Section 49.

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