Quantifying the unquantified Cost of acquisition – Budget 2023

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Quantifying the unquantified Cost of acquisition
Budget 2023
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• Intangibles have over the past couple of decades
  become an integral path for achieving accelerated
  business growth. A few decades ago, the valuation
  of a company was largely derived based on the
  tangible assets it owned, such as machinery,
  plant, raw material, etc. However, in recent
  times, intangibles such as software, data,
  intellectual property, etc. have also formed bulk
  of the enterprise value. There is no distinction
  as far as tax is concerned on the transfer of
  tangible and intangible assets as both fall
  within the definition of a capital asset. Given
  that they are also considered as capital assets,
  any gains on transfer of intangibles are also
  taxed as capital gains under the Income-tax Act,
  1961 (the Act), as discussed below. As per the
  provisions of the Act, any profits or gains
  arising from the transfer of a capital asset (as
  defined in section 2(47) of the Act) shall be
  chargeable to income-tax under the head Capital
  gains. Computation mechanism for capital gains
  has been provided under section 48 of the Act as
  follows
• Particulars
  Amount
• Full value of consideration
  XXX
• Less Cost of Acquisition (COA) (XX)
• Less Cost of Improvement (COI) (XX)
• Capital Gains (Either short-term or long-term)
  XXX

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• Cost of acquisition has been defined under the
  Act to mean any capital expenditure for
  acquisition of a capital asset on transfer, i.e.,
  purchase price, expenses incurred up to acquiring
  date in the form of registration, storage etc.
  and expenses incurred on completing the transfer.
  Cost of improvement includes capital expenditure
  towards addition or upgradation to the capital
  asset. The computation mechanism in regard to
  transfer of a capital asset visualises a clear
  cost of acquisition and cost of improvement for
  it to be taxed under the head Capital Gains. By
  implication, this means there is an issue of
  determining the cost of acquisition/cost of
  improvement where capital asset is self-generated
  asset, and the cost of acquisition or cost of
  improvement is indeterminate/ unquantifiable.
  

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• This controversy has been dealt by various
  judicial precedents over the years. The Courts in
  many of these cases have held that mechanism for
  computation of Capital Gains shall fail unless
  there is a quantifiable cost of acquisition or
  cost of improvement. Hence, for the assets where
  cost of acquisition or cost of improvement is
  unquantifiable, the taxability on transfer of
  such assets shall fall outside the purview of
  taxation under Capital Gains. The first in a
  line of rulings on self-generated assets where
  the cost of acquisition could not be determined
  was the decision of CIT vs. B. C. Srinivasa
  Setty, 128 ITR 294 wherein the Honble Supreme
  Court held that no capital gains tax shall be
  payable by the assessee where the capital gains
  u/s 48 of the Act cannot be computed. It was
  observed that if the cost of acquisition could
  not be conceived at all, the computation of
  capital gains may not be possible. Based on this
  judgement and certain other judicial precedence,
  it can be summarised that
• Determining cost of acquisition when the asset
  was acquired in any of the modes specified in
  section 49(1), is essential.
• If such cost cannot be determined, then there
  will be no liability to Capital Gains tax.
• No Capital Gains tax will arise if cost of
  acquisition is indeterminable.

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• On very similar reasoning, the High Court held
  that transfer of trademark would not be subjected
  to capital gains tax as the cost of improvement
  of trademark is not ascertainable and thus
  computation mechanism would fail. To overcome the
  legal effect of such rulings, section 55(2)(a) of
  the Act has been amended from time to time to
  provide that cost of acquisition of specified
  capital assets (refer table below), for which no
  consideration has been paid for acquisition,
  should be considered as NIL.
• Specified capital assets
  
  Amendment year
• Goodwill, tenancy rights, stage carriage permits,
  loom hours, right to manufacture, produce or
  process any article or thing 1998
• Trademark and brand name associated with a
  business
  2002
• Right to carry on any business or profession
  
  2003
• Similarly, section 55(1)(b) was also amended to
  provide that cost of improvement in case of
  goodwill of business, right to manufacture any
  article, right to carry on any business or
  profession, shall be considered NIL where there
  was no consideration paid for any improvement.
  However, section 55(1)(b) was silent on cost of
  improvement for intangibles such as trademark,
  brand name, tenancy rights, etc., which resulted
  in taxpayers arguing that the cost of improvement
  for such assets is unquantifiable. Thus, the
  amendments to overcome rulings were being made on
  a piece meal basis to deal with the individual
  intangible asset in question.

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• To finally put an end to such controversies the
  Finance Bill 2023 has proposed an amendment to
  section 55 of the Act, to provide that the cost
  of improvement or cost of acquisition of a
  capital asset being any intangible asset or any
  other right (other than those mentioned in the
  said sub-clause or clause, as the case may be)
  shall be NIL, where no consideration was paid
  for acquiring such assets or any self-generated
  intangible asset where the cost of acquisition or
  cost of improvement is indeterminable.
  Considering the above proposed amendment by
  Finance Act 2023, any intangible asset which was
  not covered by the erstwhile provisions of
  section 55, shall no longer escape the taxable
  net. It is to be noted that the words intangible
  asset is not defined under the Act. But, section
  32 of the Act provides that intangible asset
  includes know-how, patents, copyrights,
  trademarks, licenses, franchises, or any other
  business or commercial rights of similar nature.
  Accordingly, with this amendment, any other
  intangible asset shall include the ones covered
  by section 32 of the Act.
• This proposed amendment may put to rest the
  long-standing litigation on transfer of
  intangibles and other rights for which no
  consideration was paid for the purpose of
  acquisition. It may be noted that the intention
  to amend the law on such lines was evident in the
  Direct Tax Code amongst many other similar
  amendments aimed at ensuring that all rulings in
  favour of the taxpayer were overridden. It may be
  noted that these are all now being done every
  year to ensure that they go without too much of
  notice. (The Article is Co-authored by
  Zainab Bookwala (Senior Manager) and Risha Gandhi
  (Manager) from Deloitte Haskins Sells LLP)
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