Section 45(2) of Income Tax Act

Section 45 (2) of the Income Tax Act, 1961 contains the provisions which deal with the taxability of the conversion of capital assets into stock in trade. In this article, we explain the provisions relating to taxability on the conversion of stock in trade into capital assets.

2018 Amendment to Section 45(2)

Section 28 (via) has been inserted in the Act through the 2018 budget and the amendment provides that the Fair Market Value of inventory as on the date of conversion should be determined in the prescribed manner. The fair market value of inventory referred to in above section 28(via) has been included in the definition of income by insertion of clause (xiia) to section 2(24).

Amendment Affecting Capital Gains

Section 49 of the

Income Tax Act has been amended by inserting sub-section (9) which states that for the purpose of computing capital gain, at the time of transfer of such capital asset, fair market value as on the date of conversion shall be considered as the cost of acquisition for calculating capital gain. A new sub-clause (ba) in clause (i) in Explanation 1 has been inserted to section 2(42A) which states that the date of conversion of stock in trade to capital assets will be considered as the period of holding.

Impact Analysis

Understanding all the above amendments would conclude that, at the time of conversion of stock in trade into capital asset, income would be chargeable to tax under business income in the year when the conversion has taken place and income would be charged to tax under capital gain in the year of final transfer. The amendments are effective from Assessment year 2019-2020.

Objective of Section 45(2)

Section 45(2) encourages people to bring their capital assets to invest in a business without incurring excessive taxes. Capital assets are covered under Section 2 (14) of Income Tax Act, 1961.

Features

Investments in capital gain returns by the assessee will be utilized for computation in the year wherein such converted capital asset is sold.
The complete value will be determined as fair market value as on the date of conversion.
Cost indexation will be computed until the year of conversion.

Capital Assets

The following capital assets can be included under this section, once the prescribed conditions are satisfied:

The capital asset must be held under section 2(14) of the Income Tax Act.
Property of any kind must be possessed by an assessee, whether or not connected with his profession or business; further, the property should be capable of being put to use both for business and personal purposes.
Securities held by a Foreign Institutional Investor under the Securities and Exchange Board of India Act, 1992, especially stock-in-trade consumable stores or raw materials held for the purpose of profession or business.
Personal effects such as movable property possessed for personal use by the assessee or any member of his family dependent on him, with certain exclusions.
Motor cars and furniture are not capital assets.
Conversion of the asset should be in the form of stock in trade.
Business fixed assets are not covered under section 45(2).
Capital gains will be assumed based on the fair market value as on the date of the asset conversions.
Six months of time will be given if the assessee claims capital gain under the sections of 54EA, 54EB, and 54EC.

Computation of Business Profit

The assessee needs to convert the Jewellery that was purchased on 1 May 1980 for Rs 3,00,000. The fair market value as on 15.09.2016 was Rs. 40,00,000. On 3rd June 2017, the Jewellery is sold for Rs. 41,00,000.

Computation of business profit will be performed in the manner as tabulated:

Business Profit	1,00,000
Assessment Year	2018-2019
Fair Market Value on Conversion	40,00,000
Sales Consideration	41,00,000

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Frequently Asked Questions

Common questions about Section 45(2) Income Tax Act: Capital Asset Conversion.

Section 45(2) of the Income Tax Act encourages individuals to convert their capital assets into stock-in-trade for business purposes without incurring excessive taxes. It provides a tax-efficient way to utilize capital assets for business investments.

According to the article, capital assets covered under Section 45(2) include any property held by the assessee under Section 2(14) of the Income Tax Act, such as securities, personal effects (excluding motor cars and furniture), and foreign institutional investor holdings under the SEBI Act, 1992.

The fair market value of the capital asset on the date of conversion to stock-in-trade is determined in the prescribed manner. This fair market value is considered the cost of acquisition for calculating capital gains when the converted asset is eventually transferred or sold.

The fair market value of the capital asset on the date of conversion is taxed as business income in the year of conversion. When the converted asset (now stock-in-trade) is eventually sold or transferred, the capital gains are calculated based on the fair market value as the cost of acquisition, and taxed accordingly.

No, the article specifically mentions that business fixed assets are not covered under Section 45(2). The provision applies only to capital assets held by the assessee.

Yes, the article states that if the assessee claims capital gains exemptions under Sections 54EA, 54EB, or 54EC after converting capital assets to stock-in-trade, they will have a six-month time limit to do so.

The cost indexation for calculating capital gains is computed until the year of conversion of the capital asset to stock-in-trade. The fair market value on the date of conversion is considered the cost of acquisition for further capital gains calculations.

No, the article specifically excludes motor cars and furniture from the definition of personal effects that can be considered capital assets under Section 45(2).

The amendment to Section 45(2), which introduces the concept of determining the fair market value of inventory on the date of conversion, is effective from the Assessment Year 2019-2020, as per the article.

The objective of Section 45(2) is to encourage individuals to bring their capital assets into business investments without incurring excessive taxes. It provides a tax-efficient avenue for utilizing capital assets for business purposes.