Court allows fair market value substitution for acquisition cost under Income-tax Act

The court held that the option under section 55(2)(i) of the Income-tax Act, 1961, allowing the substitution of fair market value for the cost of acquisition on 1st January 1954, was available to the assessee. The court found that the principle of averaging did not apply to the determination of fair market value on the specified date. The question of averaging the cost of acquisition under section 48(ii) did not arise due to the resolution of the first issue. The Department was ordered to pay the costs of the reference to the assessees.

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Issues Involved:
1. Availability of the option under section 55(2)(i) of the Income-tax Act, 1961, to substitute the fair market value of the asset on 1st January, 1954, for the cost of acquisition.
2. Applicability of the principle of averaging the cost of acquisition under section 48(ii) of the Income-tax Act, 1961.
3. Applicability of the principle of averaging to the determination of the fair market value of the asset on 1st January, 1954, under section 55(2)(i) of the Income-tax Act, 1961.

Issue-Wise Detailed Analysis:

1. Availability of the Option under Section 55(2)(i):
The primary issue was whether the assessee could opt to substitute the fair market value of the shares on 1st January 1954, for their cost of acquisition, under section 55(2)(i) of the Income-tax Act, 1961. The court examined the statutory provisions, including sections 45, 47, 48, and 55 of the Act. It was noted that section 45 charges profits or gains from the transfer of a capital asset to income tax, while section 48 outlines the computation method for capital gains, including the deduction of the cost of acquisition. Section 55(2)(i) allows the assessee to substitute the fair market value of the asset on 1st January 1954, for its cost of acquisition if the asset was acquired before that date. The court concluded that this option was available to the assessee even if the transferred capital asset (sub-divided shares) was derived from another asset (original shares) acquired before 1st January 1954. Thus, the court answered the first question in the affirmative, allowing the substitution of the fair market value for the cost of acquisition.

2. Applicability of the Principle of Averaging under Section 48(ii):
Given the affirmative answer to the first question, the second issue regarding the principle of averaging the cost of acquisition under section 48(ii) did not arise. The court declined to answer this question, as it was rendered moot by the resolution of the first issue.

3. Applicability of the Principle of Averaging to the Determination of Fair Market Value on 1st January, 1954:
The third issue was whether the principle of averaging should apply to determine the fair market value of the asset on 1st January 1954, under section 55(2)(i). The court referred to the Supreme Court's decision in Shekhawati General Traders Ltd. v. ITO, which held that the issue of bonus shares after 1st January 1954, was irrelevant to determining the fair market value of shares on that date. Consequently, the court concluded that the issuance of bonus shares on 15th June 1955, did not affect the fair market value of the original shares as of 1st January 1954. Therefore, the principle of averaging based on the bonus shares was not applicable. The court answered the third question in the negative.

Conclusion:
The court's answers to the referred questions were as follows:
1. The option under section 55(2)(i) to substitute the fair market value of the asset on 1st January 1954, for the cost of acquisition is available to the assessee.
2. The question regarding the applicability of the principle of averaging under section 48(ii) does not arise.
3. The principle of averaging is not applicable to the determination of the fair market value of the asset on 1st January 1954, under section 55(2)(i).

The Department was directed to pay the costs of the reference to the assessees.

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