Direct Taxes Code too doesn’t solve the indexation tangle of inherited assets

Direct Taxes Code too doesn’t solve the indexation tangle of inherited assets

Our tax laws contain various ambiguities on account of poor drafting—a provision can often be interpreted to give diametrically opposite results. The manner in which our tax law is administered causes harassment of the taxpayer as tax officers invariably take the alternative view resulting in higher tax collection with scant regard to considerations of whether such an interpretation is fair to the taxpayer or not. A classic example of such bad drafting and unfair interpretation is in respect of the provisions relating to indexation of cost for computation of capital gains on sale of assets inherited or received as gift.

Cost indexation is a simple concept. To neutralize the effect of inflation on the value of a capital asset, for computation of capital gains, the cost of the asset is to be adjusted by 75% of the rise in the Consumer Price Index through the mechanism of a Cost Inflation Index notified for each year by the tax authorities. The index starts in 1981-82 at 100; the index for 2010-11 is 711. The indexed cost is to be computed by multiplying the cost by a factor of index in the year of sale divided by the index in the year in which you acquired the asset. So if you bought a property in 1981-82 for 5 lakh and sell it today for 1 crore, your indexed cost would be 35,55,000 (5,00,000 x 711/100), and your taxable capital gains would be 64,45,000.

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When you inherit an asset or receive it as a gift, the law provides that you take the date of acquisition of the asset by the previous owner as your date of acquisition, and his cost of that asset as the cost to you. Effectively, the law deems the same ownership to continue, though with a different person. Logically, you would assume that you would be entitled to get the benefit of cost indexation from that date on which the asset had been acquired by the previous owner. But that doesn’t happen.

Over the past few years, tax officers have been denying the benefit of cost indexation for the pre-inheritance or pre-gift period on the ground that the law requires cost indexation to be computed with reference to the first year in which the asset was held by the taxpayer which, according to them, is the year of receipt of the inheritance or gift. So, if you have inherited a property in 2010-11 from your father, who had acquired it in 1981-82 for 5 lakh and you sell it within the same fiscal, the tax officers treat it as a long-term capital gain (entitled to concessional tax rate), but deny you the cost indexation benefit as the year of inheritance is the same as the year of sale.

This leads to an absurd interpretation that the asset is treated as being held from 1981 for one aspect of capital gains computation, but regarded as recently acquired for another aspect of the same capital gains computation.

The matter was aggravated by a decision of the Income-tax Appellate Tribunal, which agreed with the tax officers, though a few other tribunal decisions rejected this absurd interpretation. This confusion was reduced when the matter was decided in favour of the taxpayer by a special bench of the Mumbai tribunal and that view is now being followed by most appellate authorities. The matter will probably finally be resolved only by the Supreme Court.

Given the fact that every year at least 100 amendments are carried out to the tax law through the annual budget, it would have been extremely easy for the government to amend the tax law and clarify that it did not intend such an absurd interpretation. This would have put an end to the litigation and harassment. It, however, chose not to make any amendment, leaving one with the feeling that the government prefers to collect taxes at any cost, even if it is on account of unfair treatment of taxpayers. Also, one wonders whether the government really wants to reduce litigation (as it often proclaims) or to encourage it, by permitting such absurd interpretation on account of bad drafting to continue by its inaction.

One would have thought that this inconsistent drafting would be addressed at least in the Direct Taxes Code Bill, intended to be a “world-class law", and supposed to simplify and rationalize the existing law. No prizes for guessing whether this has been done—the position remains the same even under the Direct Taxes Code Bill. So one can look forward to continued litigation.

Gautam Nayak is a chartered accountant. Your comments are welcome at