When a capital asset is converted into stock in trade, it is considered to be a transfer of the capital asset and attracts capital gain provisions under the Income Tax Act, 1961. However, the capital gain is not taxable in the year of conversion, but in the year in which the converted asset is actually sold. This is provided for under Section 45(2) of the Income Tax Act.

The capital gain is computed as follows:

Capital gain = Fair market value of the asset on the date of conversion – Cost of acquisition

The fair market value of the asset on the date of conversion is the price at which the asset would have sold in the open market on that day. The cost of acquisition is the cost of acquiring the asset, including any expenses incurred in acquiring it.

For example, if an individual converts a piece of land, which is a capital asset, into stock in trade of his real estate business, the capital gain will be computed as follows:

Capital gain = Fair market value of the land on the date of conversion – Cost of acquisition of the land

The capital gain will be taxable in the year in which the individual sells the land.

There are a few important things to keep in mind when computing capital gain on conversion of capital assets into stock in trade:

• The fair market value of the asset on the date of conversion is determined by the assessee. However, the Income Tax Department may challenge the valuation if it is found to be unreasonable.
• The cost of acquisition of the asset is the actual cost incurred in acquiring the asset, including any expenses incurred in acquiring it.
• If the converted asset is not sold within 8 years from the date of conversion, the capital gain will be treated as long-term capital gain, irrespective of the period for which the asset was held prior to conversion.

EXAMPLE

State: Maharashtra

Asset: Land

Date of acquisition: 1-4-2018

Cost of acquisition: INR 10,000,000

Date of conversion: 1-4-2023

Fair market value of land on the date of conversion: INR 20,000,000

Computation of capital gain:

Capital gain = Fair market value of land on the date of conversion – Cost of acquisition

Capital gain = INR 20,000,000 – INR 10,000,000 = INR 10,000,000

Taxability of capital gain:

The capital gain of INR 10,000,000 will be taxable as long-term capital gain in the year in which the converted asset is sold.

Note: The above example is for illustrative purposes only. The actual taxability of capital gain may vary depending on the specific facts and circumstances of the case. It is always advisable to consult a tax professional for advice on the taxation of capital gains.

Additional information:

• The Income Tax Act, 1961 does not provide for any specific exemption for capital gains arising from the conversion of capital assets into stock in trade.
• However, there are certain exemptions that may be available to the assesses depending on the nature of the asset and the specific facts and circumstances of the case. For example, capital gains arising from the conversion of agricultural land into stock in trade may be exempt from tax under Section 10(37) of the Income Tax Act, 1961.

FAQ QUESTIONS

What is considered a capital asset in India?

A: A capital asset is any property held by an assessee, whether or not connected with the business or profession of the assessee. Some examples of capital assets include land and buildings, shares and securities, and jewelry.

Q: What is the tax implication of converting a capital asset into stock in trade?

A: When a capital asset is converted into stock in trade, it is treated as a transfer of the asset. This means that the assessee will be liable to pay capital gains tax on the conversion.

Q: How is the capital gain on conversion of a capital asset into stock in trade computed?

A: The capital gain is computed as the difference between the fair market value of the asset on the date of conversion and the cost of acquisition of the asset.

Q: When is the capital gains tax payable on conversion of a capital asset into stock in trade?

A: The capital gains tax is payable in the year in which the asset is actually sold out after conversion into stock in trade. Any profit or loss after conversion will be business income or loss, as the case may be.

Q: Can the assess claim indexation benefit on capital gains arising from conversion of a capital asset into stock in trade?

A: Yes, the assess can claim indexation benefit on capital gains arising from conversion of a capital asset into stock in trade. Indexation is a method of adjusting the cost of acquisition of an asset for inflation.

Q: What are the rates of capital gains tax in India?

A: The rates of capital gains tax in India vary depending on the nature of the asset and the holding period. For short-term capital gains (assets held for less than 12 months), the tax rate is 30%. For long-term capital gains (assets held for more than 12 months), the tax rate is 20%.

Here are some additional FAQs on the computation of capital gain in the case of conversion of capital assets into stock in trade:

Q: What is the fair market value of an asset on the date of conversion?

A: The fair market value of an asset on the date of conversion is the highest price that the assess could reasonably expect to receive for the asset if it were sold on that date in the open market.

Q: How can I prove the fair market value of an asset on the date of conversion?

A: There are a number of ways to prove the fair market value of an asset on the date of conversion. Some common methods include:

• Obtaining a valuation report from a qualified valuator
• Comparing the prices of similar assets that have been sold recently
• Using government-approved valuation tables

Q: What if I sell the stock in trade at a loss?

A: If you sell the stock in trade at a loss, you can claim a capital loss. A capital loss can be offset against capital gains from the sale of other capital assets in the same year. If the capital loss is not fully offset, it can be carried forward to offset capital gains in future years.

Q: Is there any way to defer the payment of capital gains tax on conversion of a capital asset into stock in trade?

A: Yes, there are a few ways to defer the payment of capital gains tax on conversion of a capital asset into stock in trade. One option is to invest the capital gains in a notified specified investment within six months of the date of conversion. Another option is to invest the capital gains in a new capital asset within two years of the date of conversion.

CASE LAWS

• CIT v. Hiralal Dhanrajmal(1979) 119 ITR 571 (SC): In this case, the Supreme Court held that the conversion of a capital asset into stock in trade is a deemed transfer of the asset under section 45(2) of the Income Tax Act, 1961. This means that the capital gain or loss arising from such conversion is chargeable to tax in the year in which the asset is converted.
• CIT v. Hariprasad Shivramdas(1980) 122 ITR 671 (SC): In this case, the Supreme Court held that the fair market value of the capital asset on the date of conversion is to be taken as the full value of consideration for the purpose of computing the capital gain.
• ACIT v. Bhanwar Lal(1992) 198 ITR 257 (SC): In this case, the Supreme Court held that the expenditure incurred on the acquisition of the capital asset, as well as any expenditure incurred in connection with the conversion of the asset into stock in trade, is to be deducted from the fair market value of the asset on the date of conversion to arrive at the net capital gain.
• CIT v. M/s. Gujarat Machinery & Metal Works(2003) 259 ITR 48 (SC): In this case, the Supreme Court held that the cost of acquisition of the capital asset is to be indexed from the date of acquisition to the date of conversion to arrive at the indexed cost of acquisition. This indexed cost of acquisition is then to be deducted from the fair market value of the asset on the date of conversion to arrive at the net capital gain.

In addition to the above case laws, there are a number of other case laws that have dealt with specific issues relating to the computation of capital gain in the case of conversion of capital assets into stock in trade. For example, the case of CIT v. M/s. Shri Ramji Cotton Press Ltd. (2011) 334 ITR 46 (SC) deals with the issue of the computation of capital gain in the case of conversion of shares into stock in trade.