Partnership firm's capital asset conversion to stock-in-trade through JDA deemed transfer under section 2(47)(iv), capital gains taxable only on actual sale under section 45(2)

ITAT Bangalore held that a partnership firm's conversion of capital asset into stock-in-trade through JDA constituted deemed transfer under section 2(47)(iv), not section 2(47)(i). Capital gains computation under section 45(2) required actual sale of converted asset, not mere conversion. Section 45(5A) was inapplicable as it applied only to individuals/HUFs and was introduced after the relevant assessment year. Assessment orders were quashed for procedural violations - failure to issue notice under section 143(2) after recording satisfaction under sections 153A and 153C. No taxability arose in AY 2017-18 absent actual sale of stock-in-trade.

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The core legal questions considered by the Tribunal in these appeals pertain to: (1) the year of chargeability of income arising from a Joint Development Agreement (JDA) involving conversion of land (a capital asset) into stock-in-trade and subsequent development; (2) the applicability and interpretation of provisions under sections 2(47)(iv), 2(47)(v), 45(2), 45(5A), 143(2), 153B, and 153C of the Income Tax Act; (3) the validity and limitation of time for issuance of notices and completion of assessment under sections 143(2) and 153C; (4) the correctness of taxing the income as business income in the assessment year 2017-18 based on occupancy and completion certificates; (5) the applicability of judicial precedents including Supreme Court and High Court decisions on the timing and nature of transfer under JDAs; (6) the appropriate valuation of consideration for computation of income; and (7) accounting treatment of stock-in-trade and related valuation issues.

Regarding the year of chargeability and nature of income, the Tribunal examined the legal framework under sections 2(47)(iv) and (v) and section 45(2) of the Income Tax Act. Section 2(47)(iv) defines "transfer" to include conversion of a capital asset into stock-in-trade, while section 45(2) provides that profits or gains arising from such conversion are chargeable as income in the previous year in which such stock-in-trade is sold or otherwise transferred, with the fair market value on the date of conversion deemed as full value of consideration. Section 2(47)(v) relates to transfer involving possession under contracts covered by section 53A of the Transfer of Property Act (TOPA). The Tribunal extensively analyzed the JDA dated 17-01-2008 and related General Power of Attorney (GPA) documents to determine whether the conditions under section 53A TOPA were satisfied, thereby constituting a transfer under section 2(47)(v).

The Tribunal relied on precedents including the Bombay High Court decision in Chaturbhuj Dwarkadas Kapadia v. CIT, which held that the date of execution of the JDA and GPA, if registered and conferring possession and rights to the developer, constitutes transfer under section 2(47)(v). The Tribunal also considered ITAT decisions such as Jaico Automobile Engineering Company Pvt. Ltd. and Tamilnadu Brick Industries, which supported the view that execution of JDA with irrevocable GPA granting possession and development rights amounts to transfer for capital gains taxation. However, contrary precedents from Hyderabad ITAT were also noted, which held that mere execution of JDA without commencement of construction or performance by the developer does not amount to transfer under section 2(47)(v).

Applying these principles, the Tribunal found that the assessee had converted the capital asset (land) into stock-in-trade by entering into the JDA on 17-01-2008 with the developer, granting possession and irrevocable powers to the developer. The Tribunal held that the capital gain arising from this conversion was chargeable in the assessment year 2008-09, the year of conversion, and not in the assessment year 2017-18 as held by the Assessing Officer (AO) and CIT(A). The Tribunal distinguished the Supreme Court decision in Oriental Trading Co. Ltd. v. CIT, which involved exchange of shares in a merger and was not applicable to the facts of the present case involving stock-in-trade conversion and JDA. The Tribunal emphasized that section 45(5A), introduced by Finance Act 2017 and applicable only to individuals and Hindu Undivided Families (HUFs) for JDAs executed on or after FY 2016-17, was not applicable to the assessee, a partnership firm, and hence could not be invoked for taxing income in AY 2017-18.

On the issue of taxation of income in AY 2017-18 based on occupancy certificate dated 21-07-2016, the Tribunal noted that the AO had wrongly treated the date of obtaining the occupancy certificate as the date of transfer or exchange of assets. The Tribunal found that the transfer of stock-in-trade had already taken place in FY 2007-08 relevant to AY 2008-09, and the subsequent possession or receipt of constructed area did not trigger chargeability of income in AY 2017-18. The Tribunal relied on the advance ruling in Jasbir Singh Sarkaria, which held that receipt of consideration is not a criterion for capital gains tax exigibility; the transfer or deemed transfer is the relevant event. The Tribunal accordingly held that income arising from the JDA was to be computed under section 45(2) as business income in the year of actual sale of stock-in-trade and not in AY 2017-18.

On the issue of limitation and validity of notices, the Tribunal analyzed the provisions of sections 153B and 153C relating to assessment following search and seizure. The search on M/s Brigade Enterprises Ltd. was conducted on 02-11-2017 and concluded on 28-12-2017. The case of the assessee was notified on 17-07-2018. The AO issued notice under section 143(2) on 24-09-2018 and later issued notice under section 153C on 24-03-2020 after recording satisfaction on the same date. The Tribunal observed that the AO had initiated assessment proceedings by issuing notice under section 143(2) before recording satisfaction under section 153C, which is contrary to the statutory scheme requiring satisfaction to be recorded before issuing notice under section 153C. The Tribunal held that the assessment completed under section 153C without recording satisfaction prior to issuance of notice under section 143(2) was invalid and void ab initio.

Further, the Tribunal considered the limitation period under section 153B, which prescribes a period of nine months from the end of the financial year in which seized documents are handed over to the AO or the period specified under clauses (a) or (b), whichever is later. The Tribunal found that the assessment order dated 12-07-2021 was beyond the prescribed limitation period reckoned from 24-09-2018 (date of notice under section 143(2)) and thus barred by limitation. The Tribunal, however, kept the question of limitation open for future adjudication as the assessment was already held void on other grounds.

The Tribunal also dealt with the issue of non-issuance of mandatory notice under section 143(2) after filing of return of income in response to notice under section 153C. The assessee had filed return on 26-02-2021 but it was not e-verified. The AO treated the return as invalid and completed assessment under section 153C read with section 144. The Tribunal referred to Supreme Court decisions in ACIT v. Hotel Blue Moon and CIT v. Laxmandas Khandelwal, which held that non-issuance of notice under section 143(2) within prescribed time renders assessment void and such defect is incurable. The Tribunal also cited coordinate bench decisions of ITAT Bangalore following these precedents. The Tribunal rejected the CIT(A)'s reliance on Madras High Court decision in B. Kubendran, which held notice under section 143(2) is not mandatory in section 153A/C cases, on the ground that in the present case the AO had sufficient time after filing of return to issue notice under section 143(2). The Tribunal held that the AO's failure to issue notice under section 143(2) after return filing rendered the assessment void ab initio.

Regarding valuation of consideration for computation of income, the Tribunal noted that the CIT(A) directed the AO to adopt guideline value/circle rate of Rs. 3,085.50 per sq.ft. for the built-up area, which was not available at the time of AO's assessment. The Tribunal held this approach reasonable and allowed the ground of appeal challenging the AO's higher valuation. The Tribunal also allowed the ground relating to inclusion of car parking slots and MLCP block area in valuation, holding that income computation should be on actual sale of super built-up area including parking area, consistent with section 45(2) principles.

On accounting treatment, the Tribunal accepted the assessee's submission that crediting closing stock value requires corresponding debit entry as per double entry accounting, making the transaction revenue neutral. The Tribunal allowed the ground challenging the CIT(A)'s treatment which ignored this principle.

In conclusion, the Tribunal held that: (i) the capital asset (land) was converted into stock-in-trade by the assessee on 17-01-2008 by entering into JDA and irrevocable GPA with the developer, constituting transfer under section 2(47)(iv); (ii) the capital gain arising from such conversion is chargeable in AY 2008-09 under section 45(2), with business income arising on sale of stock-in-trade taxable in the year of sale, not in AY 2017-18; (iii) provisions of section 45(5A) are not applicable to the assessee, a partnership firm, and to JDAs executed prior to FY 2016-17; (iv) the assessment completed under section 153C without prior recording of satisfaction and without issuance of mandatory notice under section 143(2) after return filing is void ab initio; (v) the assessment is barred by limitation under section 153B; (vi) valuation of consideration should be based on guideline/circle rates and actual sale area excluding non-saleable areas; and (vii) accounting principles of double entry system require recognition of debit entries corresponding to closing stock credits, rendering the transaction revenue neutral until actual sale.

Accordingly, the Tribunal allowed the appeals of the assessee, set aside the impugned assessments, and dismissed the stay petitions as infructuous.

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