Capital gains arising from a transfer of capital assets will be taxed as “Income from Capital Gains”. However, there are certain exceptions available to the taxpayer in order to benefit from such gains and avoid paying higher capital gains taxes. In order to claim these exemptions, the taxpayer must comply with the relevant provisions of the Act. 

This article will discuss the treatment of gains from the transfer of a depreciable asset and the exemption available for the said gains. 

What Is Section 54EC?

Section 54EC of the Income Tax Act 1961 lays down conditions for claiming an exemption on capital gains if the amount is invested in specified government bonds such as NHAI, REC, and IRFC bonds within 6 months from the date of transfer. 

This exemption is available in the following cases:

• Transfer of Long-term capital assets being Land or Building
• Transfer of depreciable asset i.e., building in this case, held for more than 24 months. 

Tax Treatment Of Depreciable Assets

As per the Income Tax Act 1961, depreciable assets are treated as short-term capital assets even if they are held for a period of more than 24 months i.e., even if they qualify as a long-term capital asset. This is due to the fact that the value of such assets reduces over time and the WDV of the asset is considered while calculating capital gains and not the cost of acquisition. This treatment as a short-term asset disqualifies the taxpayer from claiming an exemption on the capital gains. 

However, in the case of CIT v. V.S. Dempo Company Ltd (2016) 387 ITR 354 (SC) it was held that section 50 only affects the capital gains computations and does not alter the nature of the asset. Therefore, extending the benefit of exemption to depreciable assets held for more than 24 months. 

Let’s understand this with the help of the case law.

Case Brief: V.S.Dempo Company Ltd. & Section 54E

Case

CIT v. V.S. Dempo Company Ltd (2016) 387 ITR 354 (SC)

Facts Of The Case

• During the Assessment Year 1989 - 1990, V. S. Dempo Company Ltd. sold a depreciable asset.
• The taxpayer claimed an exemption under Section 54E of the Income-tax Act, which permits capital gains to be exempt from taxes if the sale proceeds are reinvested in designated assets within six months from the date of transfer.
• The assessing officer disallowed the exemption referring to section 50, stating that depreciable assets are treated as short-term capital assets for the purposes of calculating capital gains.
• The decision was appealed by the assessee and the Commissioner of Income Tax ruled against the assessee, maintaining the assessing officer’s stance.
• The decision was appealed by the assessee with the Income Tax Appellate Tribunal. 
• The Income-tax Appellate Tribunal decided in favour of the assessee and this was upheld by the High Court.
• The decision was further appealed in the Supreme Court by the Tax Authority.

Arguments

Tax Department’s Argument:

• The Tax Department argued that the sale of depreciable assets should be treated as a short-term capital gain as per section 50.
• Since only long-term capital assets are exempt under Section 54E, the claim had to be rejected.

Taxpayer's Argument: 

• According to Section 2(29B), the asset is a long-term capital asset because it has been held since 1972.
• Section 50 does not alter the nature of the asset but it is solely used to calculate capital gains.
• This interpretation was supported by similar decisions in the cases of ACE Builders Pvt. Ltd. and Polestar Industries.

Judgment

The Supreme Court decided in favour of V. S. Dempo Company Ltd.,

• Stating that Section 50 does not categorize the asset as short-term and only affects the computation of capital gains.
• Despite the provisions of section 50, the taxpayer's asset was long-term.
• The Section 54E exemption was valid.
• The appeal filed by the tax department was denied.

Conclusion

This decision clarifies that even if depreciable assets are considered short-term for computation purposes under Section 50, they may still be eligible for the capital gains exemption under Section 54E based on the holding period of the asset.

Final Word

The Supreme Court in its judgment in the case of V.S.Dempo Company Ltd. clearly clarified that depreciable assets even though considered as short-term assets as per section 50, will still be treated as long-term capital assets if held for more than 24 months. Thus making it eligible for exemption under Section 54EC of the Income Tax Act 1961.