by Section 45(2) of Income Tax Act deals with the cases where a capital asset is converted into stock in trade. Whenever a capital asset is converted into stock in trade by an assessee it is deemed as transfer of capital asset and attracts capital gain provisions, in spite of the fact that the ownership of such capital asset doesn’t change by such conversion.
Relevant provisions:
Section 2(47)(iv) while defining the term “Transfer” in relation to a capital asset provides for that it includes “in a case where the asset is converted by the owner thereof into, or is treated by him as, stock-in-trade of a business carried on by him, such conversion or treatment”
Section 45(2): “Notwithstanding anything contained in sub-section (1), the profits or gains arising from the transfer by way of conversion by the owner of a capital asset into, or its treatment by him as stock-in-trade of a business carried on by him shall be chargeable to income-tax as his income of the previous year in which such stock-in-trade is sold or otherwise transferred by him and, for the purposes of section 48, the fair market value of the asset on the date of such conversion or treatment shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of the capital asset.”
Section 2(22B) defines the Fair Market value in relation to a capital asset as follows:
(i) The price that the capital asset would ordinarily fetch on sale in the open market on the relevant date; and
(ii) Where the price referred to in sub-clause (i) is not ascertainable, such price as may be determined in accordance with the rules made under this Act
From the above relevant provisions, the following points can be summed up:
Capital Gain shall be computed in the year when such converted asset is sold: Although conversion of a capital asset into stock in trade is treated as transfer in relation to a capital asset but section 45(2) provides that capital gain/loss shall be calculated on such converted asset in the year in which such asset is actually sold.
Cost indexation shall be done till the year of conversion: Although the transfer of capital asset in case of its conversion into stock in trade, is deemed to have taken place in the year of conversion but the capital gain/loss is computed in the year of sale of such asset.
Hence the indexation of cost of acquisition and improvement will be done (in case of long term capital asset) by considering the C.I.I of the year of conversion. In the above example the C.I.I of year 2009-10 will be considered (since it’s the year of conversion) while calculating capital gain/loss in the year 2010-11.
F.M.V to be the sale consideration in case of conversion while calculating capital gains: As per above discussion transfer of capital asset into stock in trade is treated as transfer in relation to capital asset and capital gain/loss is computed in the year of sale of such asset. The question arises in mind that in such case what shall be the sale consideration which is to be used while calculating capital gain/loss. As per section 45(2) the sale consideration will be equivalent to the Fair Market Value of such asset as existing on the date of conversion. F.M.V has been defined u/s 2(22B) as provided above.
Business Income also to be calculated in the year of sale: After the conversion of capital asset into stock in trade of business of assessee, where the Fair Market Value on the date of conversion is considered as full sale consideration of such capital asset for the purpose of capital gain/loss computation, such fair market value is considered as cost of such asset as converted into stock in trade in the books of accounts and at the time of sale of such stock in trade the sale price (as realized from sale of such stock in trade asset) will be deducted from the fair market value of such asset as existing on the date of conversion(Since it’s the cost price of stock in trade) and the profit arising therefrom, if any shall be treated as Income U/H business and profession.
