From inventory to capital asset – Will amendments to key sections of the Income Tax act impact real estate sector?

Published: November 21, 2018 4:46 AM

The Finance Act 2018 has made crucial amendments to key sections of the Income-tax Act, which are expected to have a far-reaching impact on taxpayers.

income tax, income tax deposit, income tax filed, income tax assessment, income tax return, income tax filed, GST, goods and service tax, unified tax, tax returns, tax payment, economyAs per existing provisions of section 45(2), gains accrued on account of capital asset conversion into inventory are to be taxed in the year when such inventory is sold/transferred.

By Rajesh Narain Gupta

The Finance Act 2018 has made crucial amendments to key sections of the Income-tax Act, which are expected to have a far-reaching impact on taxpayers. The amendments specifically need to be examined in greater detail in the light of their impact on the developer fraternity in the country. These amendments will take effect from April 1, 2019, and will, accordingly, apply in relation to the assessment year 2019-20 and subsequent assessment years.

With the new provisions brought on statute, the leasing of any part of a property being part of inventory as on date by a developer converts its status from “inventory” into “capital asset”. Profits accrued from the lease will be taxable under income from business head. The value to be included under section 28 of the Income-tax Act would be the fair market value (FMV) of the asset on the date of its conversion. If the capital asset is sold or its ownership is transferred, gains from the transaction will be taxed under the head of capital gain under section 45(1) of the Act.

The date to be considered for converting inventory into capital would be date of holding under section 2(42A) for the purpose of ascertaining the holding period of the asset. The cost of converted asset would be determined on the basis of its cost of acquisition under section 49 of the Income-tax Act determined on the date of conversion considered under section 28. By being part of inventory, the annual letting value of a vacant/unoccupied property—that is more than one year old from the date of completion certificate issued by a competent authority—would be taxed as income from house property.

As per existing provisions of section 45(2), gains accrued on account of capital asset conversion into inventory are to be taxed in the year when such inventory is sold/transferred. The FMV on the date of conversion would be the value of full consideration received in such case. However, there was no provision to tax conversion of inventory to capital asset prior to amendment in the Income-tax Act. Amendment to section 28 of the Act has brought conformity in the provision of taxability at the time of categorising inventory as capital asset.

These amendments rationalised the provision related to conversion of stock-in-trade into capital asset. Section 45 of the Act, inter alia, provides that capital gains arising from capital asset conversion into stock-in-trade shall be chargeable to tax. However, in cases where the stock-in-trade is converted into, or treated as, capital asset, the existing law does not provide for taxability.

For providing symmetrical treatment and discouraging practice of deferring tax payment through inventory conversion into capital asset, certain amendments were made to several Income-tax Act provisions:

  • Amendments made to section 28 to provide that any profit or gains arising from conversion of inventory into capital asset or its treatment as capital asset shall be charged to tax as business income. It is proposed to provide that the FMV of the inventory on date of conversion or treatment determined in the prescribed manner shall be deemed to be the full value of the consideration received or accruing as a result of such conversion or treatment;
  • Amendments made to clause (24) of section 2 to include such FMV in the definition of income;
  • Amendments made to section 49 to provide that for the purposes of computation of capital gains arising on transfer of such capital assets, the FMV on the date of conversion shall be the cost of acquisition;
  • Amendments made to clause (42A) of section 2 to provide that the period of holding of such capital asset shall be reckoned from the date of conversion or treatment.

The amendments are not specifically targeted towards real estate developers. Using car inventory for running a cab service will be liable for tax under amendments to section 28. It will be applicable upon converting a business asset into a capital asset and its exploitation as capital asset. The government, banks and entities providing financial support to the real estate industry remain concerned that developers treat inventory as an investment or long-term asset rather than as movable assets.

The author is managing partner, SNG & Partners

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