Income Tax Act embeds various tax saving options for the taxpayers to minimize the tax impact. It is true even with respect to capital gain tax arising on transfer of depreciable assets. Most of the taxpayer believes that the tax saving option cannot be stretched to the capital gain arising from transfer of depreciable assets. Depreciable assets could be any commercial / business assets of the taxpayers like machinery, office block, clinic, sheds, car, shop, computer, furniture etc. for which taxpayers claims deduction by way of depreciation against their business income. Subject to the concept of block of assets u/s 32, profit arising on sale of depreciable assets is taxable not as “Income from Business & Profession” but is taxable as “Income from Capital Gain”.

Income Tax Act – 1961 provides special mechanism for computation of capital gain arising on transfer of Depreciable Assets. Even if such assets is held for a period of more than 2 years or 3 years, any capital gain arising on sale of such depreciable assets is always taxable as Short Term Capital Gain (STCG) as a result of specific provision u/s 50 of the Income Tax Act-1961.  For ease of understanding, relevant part of section 50 in a simplified form reads as under:
“If any capital gain arises from the transfer of the depreciable assets then such excess shall be deemed to be short-term capital gain”

Availability of Exemption from Capital Gain:

Whether income on transfer of depreciable assets with holding period of 3 years (2 years for immoveable properties) will be eligible for capital gain exemption u/s 54EC (by investing in REC/NHAI Bonds) or 54F (by investing in another house property)? It is an interesting issue as assets after a holding period of 2 years/3 years is reckoned as Long Term Capital Assets.

Department argues that the object of section 50 is to deny second benefit to the owners of depreciable assets, first obviously by way of depreciation. However, the restriction is limited to the computation of capital gains and not to the exemption provisions. The key words used in the section are “shall be deemed to be the short term capital gain “. It is only the Income that is recognized as STCG. Section 50 nowhere says the assets will be treated as short-term capital assets.

Section 54EC/54F allows an exemption on capital gain arising from the transfer of long-term capital assets if the amount is invested in the prescribed mode.

Section 54EC & 54F simply talk about capital gain arising from long-term capital assets. Depreciable assets if hold for a period of more than 3 years (2 years for immoveable property) remains a long-term capital asset. Section 54EC, 54F are an independent sections & don’t make any distinction between Depreciable assets vis a vis Non Depreciable Assets.

Further, Section 50 does not have an overriding effect over exemption provisions.

The legal fiction created by the statute is to deem the capital gain as short-term capital gain and not to deem the asset as short-term capital asset.

In short, it cannot be said that section 50 converts a long-term capital asset into a short-term capital asset. Section 54EC & 54F have an application where long-term capital asset is transferred. Therefore, capital gain is earned by taxpayer on transfer of a long term depreciable asset (if all other necessary conditions mentioned u/s 54EC & 54F are complied to) is eligible for the benefit under this relevant section.

Various Courts have held that section 50 of the Act is a deemed provision. Deeming fiction of section 50 is to be restricted only for limited purpose of modification of provisions of sections 48 and 49 as there is nothing in section 50 suggesting that deeming fiction is to be extended further. So, denial of exemption is not justified in such cases.

Even Supreme Court in the case of CIT v. Amarchand N. Shroff (1963) 48 ITR 59 held that deeming provision is a fiction of law, it cannot be extended beyond the object for which it was enacted. Fiction created by the legislature has to be confined to the purpose for which it is created.

Reliance can be placed on ITAT’s Mumbai Bench in DCIT v. Hrishikesh D. Pai [IT Appeal No. 2766 (Mum.) of 2017, Shrawankumar G. Jain v. ITO [IT Appeal No. 695 (Ahd.) of 2016, ITAT “D” Bench, Ahemdabad in DCIT Vs.   Aditya Medisales Limited [I.T.A. No.2544/Ahd/2012, AY: 2007-08, Bombay High Court in ACE Builders (P) Ltd. (2005) 144 Taxman 855 (Bom), Gauhati High Court in CIT v. Assam Petroleum Industries (P.) Ltd. [2003] 262 ITR 587.