Assessment of Capital Gain Tax under the Income Tax Act on transfer of a capital

asset being land or building or both.

The Finance Bill 2002 intend to insert Section 50C in the Income Tax Act, 1961 w.e.f 1 st
April, 2003 i.e. for Assessment Year 2003-2004 regarding value of consideration to be
adopted in case of transfer of capital asset being land or building or both. Sub section 1
of the above section states :-

“ Where the consideration received or accruing as a result of the transfer by any assessee
of a capital asset being land or building or both, is less than the value adopted or assessed
by any authority of a State government ( hereinafter in this section referred to as the
“stamp valuation authority”) for the purpose of payment of stamp duty in respect of such
transfer, the value so adopted or assessed shall, for the purposes of section 48, be deemed
to be the full value of consideration received or accruing as a result of such transfer.”

So it is clear from the plain reading of the above section that actual consideration
received by transferor or value adopted by stamp valuation authority which ever is
higher will be deemed to be the full value of consideration for the purposes of section 48.

Sub section 2 of the above section further states that subject to certain conditions value
adopted by stamp value authority may be disputed by the assessee before the assessing
officer who may refer the matter to the Valuation officer under the Wealth Tax.

However we will restrict our discussion in the following paras to the questions:-

1) whether the assessing officer can make a reference to the value adopted by the
stamp valuation authority even if there is no dispute by assessing officer
regarding the fact that transfer of property by the assessee is a perfectly honest &
bonafide transaction or,

2) whether in case the assessing officer disputes the bonafide or honesty of the
transaction, the onus is on assessing officer to prove that assessee has received
more consideration than what is disclosed by him.

3) Whether the provision of Section 50C(1) would be constitutionally valid.

The Honourable Supreme Court had decided identical issues in the case of K.P. Varghese
vs. I.T.O., Ernakulam and others. (1981) 4 SCC 173 , while construing almost similar
provision then existing in Section 52(2) of the Income Tax Act, which was omitted by
Finance Act, 1987 w.e.f 1.4.1988. Here we shall discuss the ratio of the Judgement of the
Honourable Supreme Court in K P Varghese case. Section 52(2) as it existed before
being omitted is reproduced below for reference :-

52. (2) Without prejudice to the provisions of sub section (1), if in the
opinion of the Income Tax Officer the fair market value of a capital
asset transferred by an assessee as on the date of the transfer exceeds
the full value of the consideration declared by the assessee in respect
of the transfer of such capital asset by an amount of not less than 15%
of the value declared, the full value of consideration for such capital
 asset shall, with the previous approval of the Inspecting Assistant
Commissioner, be taken to be its fair market value on the date of
transfer.

Now on these provisions the question arose as to what is the true interpretation of
Section 52(2) ? The argument of the Revenue was – and this argument found favour with
the majority judges of the Full Bench of Kerela High Court – that on plain natural
construction of the language of Section 52(2), the only condition for attracting the
applicability of that provision is that the fair market value of the capital asset transferred
by the assessee as on the date of the transfer exceeds the full value of the consideration
declared by the assessee in respect of the transfer by an amount of not less than 15% of
the value so declared. Once the ITO is satisfied that this condition exists, he can proceed
to invoke the provision in section 52(2) and take the fair market value of the capital asset
transferred by the assessee as on the date of transfer as representing the full value of the
consideration for the transfer of the capital asset and compute the capital gains on that
basis. No further evidence is necessary to be proved. To introduce any further condition
such as understatement of consideration in respect of transfer would be to read into the
statutory provision something, which is not there. This argument was based on strict
literal reading of section 52(2). This view of the High Court was not accepted by the
Supreme Court.

It was held in K P Varghese case that a strict literal interpretation of Section 52(2) should
not be adopted. The language of the section must be construed having regard to the
object and purpose, which the legislature had in view in enacting that provision.

The primary objection against the literal construction of section 52(2) is that it leads to
manifestly unreasonable and absurd consequences. It is true that the consequences of a
suggested construction cannot alter the meaning of a statutory provision but it can
certainly help to fix its meaning. It is a well- recognized rule of construction that a
statutory provision must be so construed, if possible, that absurdity and mischief may be
avoided. There are many situations where the construction suggested on behalf of the
Revenue would lead to a wholly unreasonable result, which could never have been
intended by the legislature. Take, for example, a case where A agrees to sell his property
to B for a certain price and before the sale is completed pursuant to the agreement – and
it is quite well known that sometimes the completion of sale may take place even a
couple of years after the date of agreement – the market price shoots up with the result
that the market price prevailing on the date of the sale exceeds the agreed price at which
property is sold by more than 15% of such agreed price. This is quite a common case in a
economy of rising prices and in fact we would find in a large number of cases where the
sale is completed more than a year or two after the date of agreement and that the market
price prevailing on the date of sale is more than the price at which the property is sold
under the agreement. It would be most harsh and inequitable to tax the assessee on the
income, which has neither arisen to him nor is received by him, merely because he has
carried out the contractual obligation undertaken by him.

It is difficult to conceive of any rational reason why the legislature should have thought
fit to impose liability to tax on an assessee who is bound by law to carry out his
contractual obligation to sell the property at the agreed price and honestly carries out
such contractual obligation. It would indeed be strange if obedience of the law should
attract the levy of tax on income, which has neither arisen to the assessee nor has been
received by him.

If we take another illustration whereby A sells his property to B with a stipulation that
after some time which may be a couple of years or more, he shall resell the property to A
for the same price. Could it be contended in such a case that when B transfers the
property to A for the same price at which he originally purchased it, he should be liable
to pay tax on the basis as if he has received the market value of the property as on the
date of re-sale, if , in the meantime the market price has shot up and exceeds the agreed
price by more than 15%.

Many other similar situations can be contemplated where it would be absurd and
unreasonable to apply section 52(2) according to its strict literal interpretation. We must
therefore eschew literalness in the interpretation of Section 52(2) and try to arrive at an
interpretation, which avoids the mischief and absurdity and makes the provision rational
and sensible. The court may also in such cases read into statutory provision a condition
which, though not expressed, is implicit as constituting the basic assumption underlying
the statutory provision. Having regard to this well recognized rule of interpretation, a fair
and reasonable construction of Section 52(2) would be read into it a condition that it
would apply only where the consideration for the transfer is understated or in other
words, the assessee has actually received a larger consideration for the transfer than what
is declared in the instrument of transfer and it would have no application to a bonafide
transaction where the full value of the consideration for the transfer is correctly declared
by the assessee.

Regarding the question of onus of establishing that there was understatement or no

understatement of consideration by the assessee, it was further held that it is a well
established rule of law that the onus of establishing that the conditions of taxability are
fulfilled is always on the Revenue. So the burden lies on the Revenue to show that there
is understatement of the consideration. Moreover, to throw the burden of showing that
there is no understatement of the consideration, on the assessee would be to cast an
almost impossible burden upon him to establish the negative, namely, that he did not
receive any consideration beyond that declared by him.

However once it is established by the Revenue that the consideration for the transfer has
been understated then the Revenue is no more required to show what is the precise extent
of the understatement. That would in most cases be difficult, if not impossible, to show
and hence fair market value of the property will be deemed to be the full value of
consideration. This relieves the Revenue of all burdens of proof regarding the extent of
understatement or concealment and provides a statutory measure of the consideration
received in respect of transfer. It does not deem as receipt something, which is not in fact
received. It merely provided a statutory best judgement assessment of the consideration
actually received by the assessee. This approach in construction of sub section 2 of
section 52 falls in line with the scheme of provisions relating to tax on capital gains. It
may be noted that section 52 is not a charging section but a computation section. It has to
be read along with Section 48, which provides the mode of computation and under which
the starting point of computation is “ the full value of the consideration received or
accruing”. What in fact never accrued or was never received cannot be computed as
capital gains under section 48 therefore 52(2) cannot be construed as bringing within the
computation of capital gains an amount which, by no stretch of imagination, can be said
to have accrued to the assessee or been received by him.

Moreover even if the literal interpretation of section 52(2) is accepted it would result in
an amount being taxed which has neither accrued to the assessee nor been received by
him and which from no viewpoint can be rationally considered as capital gains or any
other type of income. Under Entry 82 in List I of the Seventh Schedule to the
Constitution which deals with “ Taxes on income” and under which the Income Tax Act
has been enacted, Parliament cannot “choose to tax as income an item which in no
rational sense can be regarded as a citizen’s income or even receipt”. Section 52(2)
would therefore on construction of Revenue, go outside legislative power of Parliament
and it would not be possible to justify it even as an incidental or ancillary provision or a
provision intended to prevent evasion of tax. Section 52(2) would also be violative of the
fundamental right of the assessee under Article 19(1)(f) – which fundamental right was
in existence at the time when section 52(2) came to be enacted – since on the
construction canvassed on behalf of the Revenue, the effect of Section 52(2) would be to
penalize the assessee for transferring his capital asset for a consideration lesser by 15%
or more than the fair market value and that would constitute unreasonable restriction on
the fundamental right of the assessee to dispose of his capital asset at the price of his
choice. The court must obviously prefer a construction which renders the statutory
provision constitutionally valid rather than that, which makes it, void.

Conclusion

Now the question arises as to whether the rationale of Supreme Court judgement in K P
Varghese case while construing Section 52(2) of the Income Tax Act which existed prior
to 01.04.1988 can be made applicable to new Section 50C also which is intended to be
inserted in the Income Tax Act, 1961 w.e.f 1st April, 2003 i.e. for Assessment Year 2003-
2004.

To understand the above it is essential to understand the similarity of both the provisions.

1) if we refer to the literal construction of Section 50C, which is proposed to be

inserted from 1st April, 2003, & Section 52(2), as it existed till 1st April, 1988 it
appears that the literal construction of both the sections are virtually the same.
From literal interpretation of both the Sections it is clear that both of the Sections
intend to tax an income, which has neither accrued to the assessee nor has been
received by him.

2) The old section 52(2) and new section 50C are not charging sections but
computation sections and they have to be read along with Section 48, which
provide the mode of computation.

We do not find any reason/justification why the principal laid down by Supreme Court in
K P Varghese case, while construing section 52(2) of Income Tax Act as existed prior to
01.04.1998, cannot be applied to the new section 50C intended to be inserted by 1TA
1961 w.e.f 01.04.2003, for assessment year 2003-2004. It would be absurd and irrational
to give literal interpretation to provisions of Section 50C and ignore the principal laid
down in K P Varghese case. The revenue cannot escape its responsibilities, to establish
the value actually received by assessee and burden of proving such
concealment/understatement shall continue to be on the revenue and the revenue simply
cannot rely on assessment made by Stamp Assessing Authority under the State, while
valuing the market value on the date of transfer of the capital assets.

It has to be seen how the department interprets provision of Section 50C intended to be
inserted in ITA 1961 w.e.f. 01.04.2003 and unless the revenue interprets section 50C in
the manner laid down by the Supreme Court in K P Varghese case the issue is likely to be
debated in Court.