Acquisition cost computation for assets received in company liquidation under Section 49(1)(iii)(c) and Section 55(2)(b)(iii) clarified

The HC addressed computation of acquisition cost under Income Tax Act, 1961 for assets distributed during company liquidation. The case involved two transactions in the same financial year: share extinguishment upon receiving company assets and subsequent asset sale. Both Section 49(1)(iii)(c) and Section 55(2)(b)(iii) applied concurrently. The HC criticized the Tribunal's procedural approach in rejecting the assessee's computation method without referring the matter to a Larger Bench despite conflicting precedents. The court ruled in favor of the assessee, establishing proper methodology for capital gains computation in such dual transactions, deciding against revenue.

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The core legal questions considered by the Court revolve around the correct interpretation and application of provisions of the Income Tax Act, 1961, specifically concerning the computation of the cost of acquisition of assets distributed to shareholders upon the liquidation of a company. The principal issues are:

1. Whether the Income Tax Appellate Tribunal (ITAT) was correct in holding that earlier orders in related cases were not per incuriam despite those orders not considering the applicability of Section 55(2)(b)(iii) of the Income Tax Act.

2. Whether judicial discipline requires that orders deemed per incuriam be treated as binding precedents.

3. Whether, in the facts and circumstances, the cost of acquisition for assets distributed on liquidation should be determined under Section 49(1)(iii)(c) or Section 55(2)(b)(iii) of the Income Tax Act.

4. Whether the ITAT erred in applying the provisions relating to the cost of acquisition of shares when assets are received by a shareholder on liquidation.

Detailed analysis of these issues is as follows:

Issue 1 & 2: Binding Nature of Earlier Tribunal Orders and Applicability of Section 55(2)(b)(iii)

The Court examined whether the ITAT was justified in relying on earlier decisions which did not consider Section 55(2)(b)(iii). The appellants contended that those orders were per incuriam because they overlooked a crucial statutory provision. The ITAT had declined to treat those orders as per incuriam and followed them, thereby allowing the Revenue's appeals.

The Court noted that judicial discipline does not mandate following orders that are per incuriam if they overlook relevant statutory provisions. The proper course in such circumstances is to refer the matter to a Larger Bench for authoritative determination rather than mechanically following earlier adverse orders. The Court found the ITAT's procedure in this case to be incorrect, particularly given the detailed and favorable analysis towards the appellants in the speaking order under consideration.

Issue 3 & 4: Correct Provision for Computation of Cost of Acquisition on Liquidation

The crux of the dispute was the interpretation and application of Sections 49(1)(iii)(c) and 55(2)(b)(iii) of the Income Tax Act concerning the cost of acquisition of an asset distributed on liquidation.

Section 55(2)(b)(iii) states that where a capital asset becomes the property of the assessee on distribution of a company's assets on liquidation, and the assessee has been assessed to capital gains tax under Section 46 in respect of that asset, the cost of acquisition shall be the fair market value (FMV) of the asset on the date of distribution.

Section 49(1)(iii)(c) provides that if the capital asset becomes the property of the assessee on distribution of assets on liquidation, the cost of acquisition shall be deemed to be the cost for which the previous owner acquired it, increased by any cost of improvement.

Section 46 deals with the chargeability of capital gains on distribution of assets by companies in liquidation, specifying that the shareholder is chargeable to tax on the money or FMV of assets received, reduced by any dividend assessed.

Section 48 prescribes the mode of computation of capital gains by deducting from the full value of consideration the expenditure incurred and the cost of acquisition/improvement.

The appellants had purchased shares before liquidation and upon voluntary liquidation, received a proportionate share of an immovable property. They computed capital gains under Section 55(2)(b)(iii), taking the FMV of the asset on the date of distribution as the cost of acquisition. The Revenue contended that Section 49(1)(iii)(c) applied, which would result in a higher taxable capital gain.

The Court relied heavily on the detailed reasoning in the Tribunal's speaking order in the case of one appellant, which methodically analyzed the transactions involved:

• Transaction A: Transfer of shares by extinguishment of rights on liquidation, where the assessee receives the asset instead of money. This is the first taxable event, and capital gains are computed by deducting the cost of shares from the FMV of the asset received.
• Transaction B: Sale of the asset received on liquidation. The question arises regarding the cost of acquisition to be used for computing capital gains on this sale.

The Tribunal illustrated three computational scenarios with hypothetical figures:

1. If capital gains from Transaction A are offered for tax in the year of accrual, then under Section 55(2)(b)(iii), the cost of acquisition for Transaction B is the FMV of the asset on the date of distribution, resulting in a total capital gain of Rs. 70.
2. If capital gains from Transaction A are not offered for tax in the year of accrual, then under Section 49(1)(iii)(c), the cost of acquisition for Transaction B is the cost to the previous owner (the company), resulting in a higher capital gain of Rs. 90.
3. If the transactions occur in different years, the computations are done separately; if in the same year, computations may be integrated.

In the present case, both transactions occurred in the same financial year, and the appellants offered capital gains arising from Transaction A for taxation in that year. Hence, Section 55(2)(b)(iii) applies, and the cost of acquisition for the asset should be the FMV on the date of distribution. The appellants' integrated computation (Computation 4) was correct, and the Revenue's contention (Computation 5) to apply Section 49(1)(iii)(c) was only appropriate where capital gains from Transaction A were postponed, which was not the case here.

The Court emphasized that accepting the Revenue's view would impose an additional tax burden on the assessee for no fault of theirs, which would be unjust.

Thus, the Court concluded that the proper methodology for computing the cost of acquisition in such cases is as per Section 55(2)(b)(iii), provided the capital gains on the transfer of shares (Transaction A) have been assessed to tax.

The Court declined to delve into other cited cases, finding the detailed discussion in the Tribunal's speaking order to be sufficiently authoritative and persuasive.

Significant Holdings

The Court held:

"If capital gains arising in transaction A are treated as assessed to tax earlier, then, whether the computations are separately done as per computation (1) and (2) or they are integrated into one as in computation (4), it makes no difference."

"In our considered view, if this interpretation is to be accepted [by the Revenue], it would amount to saddling the assessee with higher tax liability for no fault of his."

"The manner of computation as adumbrated in Computation 4 above, would be the proper methodology for computation of cost of acquisition."

"The substantial questions of law are answered in favour of the appellant and against the revenue."

The Court also underscored the procedural impropriety of the ITAT in not referring the conflicting decisions to a Larger Bench and instead mechanically following adverse precedents without considering the applicability of Section 55(2)(b)(iii).

In conclusion, the Court allowed the appeals, holding that where a shareholder has been assessed to capital gains tax on the transfer of shares on liquidation, the cost of acquisition of the asset received on liquidation shall be the fair market value of the asset on the date of distribution under Section 55(2)(b)(iii), overriding the application of Section 49(1)(iii)(c).

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