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Capital Gains – An All New Classification
The provisions of the Direct Taxes Code Bill (DTC), 2010 propose a paradigm shift with regards to the scope of capital gains taxation. Under the DTC, capital gains / losses arise only on the transfer of "investment assets". Taxand India provides an overview of the DTC and debates some of the issues surrounding its introduction whilst specifically looking at the capital gains tax provisions in the DTC.
Under the Income-tax Act, 1961 ('Act'), capital gains / losses arise on a transfer of a "capital asset". A capital asset has been defined to mean any property of the taxpayer, whether or not such property is connected with the business of the taxpayer, but excludes stock in trade, consumables and raw materials held for the purpose of the business of the taxpayer.
What are investment assets?
It appears that the category of investment assets is significantly narrower as compared to the current category of capital assets under the Act. Capital assets connected with the business of the tax payer, which are currently covered under the capital gains provisions of the Act are specifically kept out of the scope of capital gains tax under the DTC. The term "business capital asset" has been defined under the DTC to mean any capital asset self generated in the course of business, any intangible asset related to the business (goodwill, trade mark/brand name, right to manufacture/carry on business, tenancy rights, licence, permits, etc), tangible assets like building, plant, machinery, furniture and any other capital asset, not being land, connected with or used for the purposes of any business of the taxpayer. This definition of business capital asset and particularly the residuary clause highlighted above is wide and can potentially have large ramifications.
Will all capital assets of a business concern be regarded as business capital assets under the DTC? One could argue that the aspect of proximity of the asset with the main business of the tax payer has to be checked before concluding on whether the asset is a business capital asset or otherwise. Conversely, one could also argue that the definition of business is very wide and all activities of a concern (barring probably one-off activities) could potentially be classified as a business and by implication all assets used or connected with such activities could be classified as business capital assets. Clearly, the classification of assets into business capital assets and investment assets is, potentially, going to be an area of significant dispute going forward.
The classification of income from the sale of assets into income from sale of business capital assets and income from sale of investment assets is important since under the DTC, as is the case of the Act, income is classified under different headings (such as capital gains, income from business, etc) and the computation machinery, exemptions available, etc are separately provided for each head of income. There are a number of consequences arising from the classification issue.
The classification issue seems to have the potential of creating a substantial shift in the treatment of gains/losses arising from the transfer of capital assets. While the legislative change in the asset classification seems to be a conscious decision, it is hoped that the fallout of such a change in classification, including on the tax neutrality of certain transactions and Treaty characterisation are carefully considered before the final draft of the DTC is released.
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