Capital gains on converted stock-in-trade arise on sale, while section 14A disallowance needs recorded dissatisfaction first.

Where land is converted into stock-in-trade, capital gains are stated to arise under section 45(2) only on actual sale or transfer of the converted stock, not merely on execution of a development agreement or handing over possession for development purposes. For valuation, the fair market value as on 1.4.1981 should be determined on proper evidence and valuation machinery rather than by an untested circle rate or an inadequately adjusted comparable sale. A disallowance under section 14A read with rule 8D is stated to require prior objective dissatisfaction recorded from the accounts before the prescribed computation method is applied.

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Issues: (i) Whether capital gains arose in the year of the project development agreement on the transfer of land under section 2(47)(v) or section 2(47)(vi), or only in the year of sale of the converted stock-in-trade under section 45(2); (ii) Whether the fair market value of the land as on 1.4.1981 adopted for computing capital gains was correctly determined; (iii) Whether the disallowance under section 14A read with rule 8D was valid without recording objective satisfaction.

Issue (i): Whether capital gains arose in the year of the project development agreement on the transfer of land under section 2(47)(v) or section 2(47)(vi), or only in the year of sale of the converted stock-in-trade under section 45(2).

Analysis: The land had been converted into stock-in-trade and the development agreement showed that the alleged advance was refundable and was received to meet project-related obligations. The possession handed over was only for development purposes and not as an absolute transfer of title or possession within the meaning of section 2(47)(v). Once the asset became stock-in-trade, the timing of capital gains was governed by section 45(2), which postpones taxability to the year in which the converted stock is sold or otherwise transferred.

Conclusion: No capital gains were chargeable in the year of the development agreement. The gain was taxable only in the year of sale of the converted stock-in-trade, and the assessee succeeded on this issue.

Issue (ii): Whether the fair market value of the land as on 1.4.1981 adopted for computing capital gains was correctly determined.

Analysis: The assessee relied on a registered valuer's report based on comparable auction instances, while the Assessing Officer adopted the circle rate. The Tribunal found that neither approach was fully satisfactory: the valuer had not properly scaled down the later auction rate, and the Assessing Officer had rejected the report without obtaining a departmental valuation. The proper course was fresh determination of fair market value, preferably with reference to the valuation machinery available under the Act.

Conclusion: The issue was remanded for fresh adjudication by the Assessing Officer. Neither side obtained a final finding on the quantum issue.

Issue (iii): Whether the disallowance under section 14A read with rule 8D was valid without recording objective satisfaction.

Analysis: The Assessing Officer applied rule 8D straightaway without first recording objective dissatisfaction, on the basis of the accounts, with the assessee's claim regarding expenditure relatable to exempt dividend income. The statutory scheme requires an objective satisfaction before resorting to the prescribed computation method. In the absence of such satisfaction, the disallowance could not stand.

Conclusion: The disallowance under section 14A was deleted and the assessee succeeded on this issue.

Final Conclusion: The Revenue's challenge to the timing of capital gains failed, the valuation question was sent back for reconsideration, and the section 14A disallowance was deleted, resulting in a mixed outcome with substantial relief to the assessee.

Ratio Decidendi: Where land is converted into stock-in-trade, capital gains on the conversion are taxable only under section 45(2) in the year the stock-in-trade is actually sold or otherwise transferred, and disallowance under section 14A read with rule 8D cannot be made unless the Assessing Officer first records objective dissatisfaction with the assessee's claim on the basis of the accounts.

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