J.B Devadhar, J.:— Although several questions of law are raised by the Revenue in this appeal, counsel for the Revenue presses only the last question. The said question (as reframed) reads thus:
“While computing the capital gains arising on transfer of a capital asset acquired by the assessee under a gift, whether the indexed cost of acquisition has to be computed with reference to the year in which the previous owner first held the asset or the year in which the assessee became the owner of the asset?”
2. The appeal is admitted on the above substantial question of law and taken up for final hearing by consent of both the parties. The assessment year involved herein is the assessment year 2004-05.
3. The relevant facts are that the assessee is an individual who derived income from business, house property, capital gains and other sources.
4. In the assessment year in question, the assessee had declared total income of Rs. 20,92,400. The said return of income included long-term capital gains arising from the sale of a residential flat bearing No. 1202-A (“capital asset” for short) at Chaitanya Towers, Prabhadevi, Mumbai. The said flat was originally purchased by the daughter of the assessee (“previous owner” for easy reference) on January 29, 1993, at a cost of Rs. 50,48,350. By a gift deed dated February 1, 2003, the previous owner gifted the said capital asset to the assessee. On June 30, 2003, the assessee sold the said capital asset for a total consideration of Rs. 1,10,00,000 and offered the long-term capital gains to tax.
5. During the assessment proceedings, the assessee contended that though the capital asset in question was acquired by the assessee under a gift deed dated February 1, 2003. and transferred on June 30, 2003, under section 48 read with section 49 and section 2(42A) of the Income-tax Act, 1961 (“the Act” for short), the gains arising therefrom were liable to be computed as long-term capital gains, by deducting from the total consideration received, inter alia, the amount of the indexed cost of acquisition. The assessee contended that the indexed cost of acquisition has to be determined with reference to the cost inflation index for the year in which the cost of acquisition was incurred. In the present case, the cost of acquisition was incurred on January 29, 1993, and, hence, the cost inflation index for 1993-94 would be applicable. The Assessing Officer was of the opinion that under Explanation (iii) to section 48 of the Act, the indexed cost of acquisition has to be determined with reference to the cost inflation index for the first year in which the asset was first held by the assessee. According to the Assessing Officer, the asset was held by the assessee from February 1, 2003, and, therefore, the cost inflation index for 2002-03 would be applicable in determining the indexed cost of acquisition.
6. On appeal filed by the assessee, the Commissioner of Income-tax (Appeals) allowed the claim of the assessee by holding that the long-term capital gains has to be determined by computing the indexed cost of acquisition with reference to the cost inflation index for 1993-94 instead of the cost inflation index for the assessment year 2002-03 as held by the Assessing Officer.
7. On further appeal filed by the Revenue, the Income-tax Appellate Tribunal concurred with the decision of Commissioner of Income-tax (Appeals) and dismissed the appeal filed by the Revenue. Challenging the aforesaid order, the present appeal is filed by the Revenue.
8. According to Mr. Chatterjee, learned counsel for the Revenue, Explanation (iii) to section 48 specifically provides that the indexed cost of acquisition has to be determined with reference to the first year in which the capital asset was held by the assessee. In the present case, admittedly, the capital asset was acquired by the assessee under a gift on February 1, 2003 and, therefore, the first year of holding the capital asset by the assessee is the financial year 2002-03. Therefore, the indexed cost of acquisition in the present case has to be computed with reference to the cost inflation index for 2002-03. Mr. Chatterjee further submits that the deeming fiction contained in Explanation 1(i)(b) to section 2(42A) of the Act cannot be applied in determining the indexed cost of acquisition, in view of the specific words used in clause (iii) of the Explanation to section 48 of the Act, The submission is that the deeming fiction under Explanation 1(i)(b) to section 2(42A) of the Act to include the period for which the asset was held by the previous owner in the period for which the asset was held by the assessee under a gift or will, is for the limited purpose of determining as to whether the asset was held as a short-term capital asset or long-term capital asset and that the said fiction cannot be applied in determining the indexed cost of acquisition in view of the express language used in Explanation (iii) to section 48 of the Act. It is contended that to determine the “indexed cost of acquisition” what is relevant under Explanation (iii) to section 48 of the Act is the cost inflation index for the first year in which the capital asset was held by the assessee and not the first year in which the capital asset was held by the previous owner. Accordingly, it is contended that when the words used in Explanation (iii) to section 48 of the Act are clear and unambiguous, it would not be proper to interpret section 48(iii) of the Act by importing the meaning given in Explanation 1(i)(b) to section 2(42A) of the Act.
9. In support of the above contention, Mr. Chatterjee relied upon a decision of the Mumbai Bench of the Income-tax Appellate Tribunal in the case of Deputy CIT v. Kishore Kanungo reported in [2006] 102 ITD 437 (Mum); [2007] 290 ITR (AT) 298 (Mumbai), wherein it has been held that under Explanation (iii) to section 48, the indexed cost of acquisition has to be determined with reference to the cost inflation index for the first year in which the asset was held by the assessee and not with reference to the cost inflation index for the first year in which the asset was held by the previous owner. Relying upon a decision of the apex court in the case of CIT v. Anjum M.H Ghaswala, [2001] 252 ITR 1 (SC), Mr. Chatterjee submitted that where the language of a statute is clear and unambiguous, one has to apply the literal interpretation and not the purposive interpretation. Mr. Rai, learned counsel for the assessee, on the other hand, supported the order passed by the Income-tax Appellate Tribunal by detailed submissions which are dealt with in the subsequent paragraphs of this judgment.
10. Before dealing with the rival contentions, we may refer to the relevant provisions of the Act relating to the taxability of the gains arising on transfer of the capital assets under the head “Capital gains”. Section 45 of the Act provides that any profits or gains arising from the transfer of a capital in the previous year shall be chargeable to income-tax under the head “Capital gains”. Where the gains arise on transfer of a short-term capital asset as defined under section 2(42A) of the Act, the gains are taxed as short-term capital gains. Where the gains arise on transfer of long-term capital asset, as defined under section 2(29A) of the Act, the said gains are taxed as long-term capital gains. Section 47(iii) of the Act provides that where a capital asset is transferred under a gift or will, then, such transaction shall not be regarded as transfer and in such a case the liability to pay capital gains tax would not arise. Liability to pay capital gains tax, however, would arise when the assessee transfers the capital asset acquired under a gift or will for valuable consideration.
11. The mode and the manner of computing the capital gains is provided under section 48 of the Act. As per section 48, the income chargeable under the head “Capital gains” is liable to be computed by deducting from the full value of the consideration received on transfer of the capital asset, the amount of expenditure incurred wholly and exclusively in connection with such transfer and the cost of acquisition of the asset and the cost of any improvement thereto. Where the assessee acquires any capital asset under a gift or will without incurring any cost of acquisition, there would be no capital gains liability. However, section 49(1)(ii) of the Act provides that in the case of an assessee acquiring an asset under a gift or will, the cost of acquisition of the asset shall be deemed to be the cost for which the previous owner of the property acquired it, as increased by the cost of any improvement of the asset incurred or borne by the previous owner or the assessee, as the case may be. Thus, on account of the deeming fiction con tained in section 49(1)(ii) of the Act, gains arising on transfer of a capital asset acquired by the assessee under a gift or will would arise. In such a case, the capital gains under section 48 of the Act would have to be determined by deducting from the total consideration received by the assessee, inter alia the deemed cost of acquisition.
12. Where the gains are long-term capital gains (other than long-term capital gains arising to a non-resident from the transfer of shares in, debentures of an Indian company), then, as per the second proviso to section 48 of the Act, the capital gains have to be computed by deducting from the full value of consideration the “indexed cost of acquisition” and the “indexed cost of any improvement” instead of deducting the “cost of acquisition” and “cost of improvement”.
13. In the present case, the capital asset in question (Flat No. 1202-A) was originally acquired by the previous owner (daughter) on January 29, 1993 and the same was acquired by the assessee under a gift deed dated January 2, 2003 without incurring any cost. The assessee sold the said capital asset on June 30, 2003 for Rs. 1,10,00,000. Since the assessee held the capital asset for less than thirty six months January 2, 2003, to June 30, 2003) in the ordinary course, as per section 2(42A) of the Act the assessee would have held the asset as a short-term capital asset and, accordingly, liable for short-term capital gains tax. However, in view of Explanation 1(i)(b) to section 2(42A) of the Act which provides that in determining the period for which any asset is held by an assessee under a gift, the period for which the said asset was held by the previous owner shall be included, the assessee is deemed to have held the asset as a long-term capital asset and, accordingly, liable for long-term capital gains tax. Thus, by applying the deeming provision contained in Explanation 1(i)(b) to section 2(42A) of the Act, the assessee is deemed to have held the asset from January 29, 1993, to June 30, 2003 (by including the period for which the said asset was held by the previous owner) and, accordingly, held liable for long-term capital gains tax.
14. It is not disputed by the Revenue that the assessee must be deemed to have held the capital asset from January 29, 1993 (though actually held from February 1, 2003) by applying Explanation 1(i)(b) to section 2(42A) of the Act and, hence, liable for long-term capital gains tax. However, the Revenue disputes the applicability of the deemed date of holding the asset from January 29, 1993, while determining the indexed cost of acquisition under clause (iii) of Explanation to section 48 of the Act.
15. For better appreciation of the dispute, we quote the relevant part of section 48 herein:
“48. Mode of computation.— The income chargeable under the head ‘Capital gains’ shall be computed, by deducting from the full value of the consideration received or accruing as a result of the result of the transfer of the capital asset the following amounts, namely:—
(i) expenditure incurred wholly and exclusively in connection with such transfer;
(ii) the cost of acquisition of the asset and the cost of any improvement thereto:…
Provided further that where long-term capital gain arises from the transfer of a long-term capital asset, other than capital gain arising to a non-resident from the transfer of shares in, or debentures of, an Indian company referred to in the first proviso, the provisions of clause (ii) shall have effect as if for the words ‘cost of acquisition’ and ‘cost of any improvement’, the words ‘indexed cost of acquisition’ and ‘indexed cost of any improvement’ had respectively been substituted:…
Explanation.— For the purposes of this section, —….
(iii) ‘indexed cost of acquisition’ means an amount which bears to the cost of acquisition the same proportion as cost inflation index for the year in which the asset is transferred bears to the cost inflation index for the first year in which the asset was held by the assessee or for the year beginning on the 1st day of April, 1981, whichever is later;
(iv) ‘indexed cost of any improvement’ means an amount which bears to the cost of improvement the same proportion as cost inflation index for the year in which the asset is transferred bears to the cost inflation index for the year in which the improvement to the asset took place;
(v) ‘cost inflation index, in relation to a previous year, means such Index as the Central Government may, having regard to seventy-five per cent, of average rise in the consumer price index for urban non-manual employees for the immediately preceding previous year to such previous year, by notification in the Official Gazette, specify, in this behalf.”
16. It is the contention of the Revenue that since the indexed cost of acquisition as per clause (iii) of the Explanation to section 48 of the Act has to be determined with reference to the cost inflation index for the first year in which the asset was held by the assessee and, in the present case, as the assessee held the asset with effect from February 1, 2003, the first year of holding the asset would be the financial year 2002-03 and, accordingly, the cost inflation index for 2002-03 would be applicable in determining the indexed cost of acquisition.
17. We see no merit in the above contention. As rightly contended by Mr. Rai, learned counsel for the assessee, the indexed cost of acquisition has to be determined with reference to the cost inflation index for the first year in which the capital asset was “held by the assessee”. Since the expression “held by the assessee” is not defined under section 48 of the Act, that expression has to be understood as defined under section 2 of the Act. Explanation 1(i)(b) to section 2(42A) of the Act provides that in determining the period for which an asset is held by an assessee under a gift, the period for which the said asset was held by the previous owner shall be included. As the previous owner held the capital asset from January 29, 1993, as per Explanation 1(i)(b) to section 2(42A) of the Act, the assessee is deemed to have held the capital asset from January 29, 1993. By reason of the deemed holding of the asset from January 29, 1993, the assessee is deemed to have held the asset as a long-term capital asset. If the long-term capital gains liability has to be computed under section 48 of the Act by treating that the assessee held the capital asset from January 29, 1993, then, naturally in determining the indexed cost of acquisition under section 48 of the Act, the assessee must be treated to have held the asset from January 29, 1993, and, accordingly the cost inflation index for 1992-93 would be applicable in determining the indexed cost of acquisition.
18. If the argument of the Revenue that the deeming fiction contained in Explanation 1(i)(b) to section 2(42A) of the Act cannot be applied in computing the capital gains under section 48 of the Act is accepted, then, the assessee would not be liable for long-term capital gains tax because it is only by applying the deemed fiction contained in Explanation 1(i)(b) to section 2(42A) and section 49(1)(ii) of the Act, the assessee is deemed to have held the asset from January 29, 1993, and deemed to have incurred the cost of acquisition and, accordingly, made liable for the long-term capital gains tax. Therefore, when the Legislature by introducing the deeming fiction seeks to tax the gains arising on transfer of a capital asset acquired under a gift or will and the capital gains under section 48 of the Act has to be computed by applying the deemed fiction, it is not possible to accept the contention of Revenue that the fiction contained in Explanation 1(i)(b) to section 2(42A) of the Act cannot be applied in determining the indexed cost of acquisition under section 48 of the Act.
19. It is true that the words of a statute are to be understood in their natural and ordinary sense unless the object of the statute suggests to the contrary. Thus, in construing the words “asset was held by the assessee” in clause (iii) of Explanation to section 48 of the Act, one has to see the object with which the said words are used in the statute. If one reads Explanation 1(i)(b) to section 2(42A) together with sections 48 and 49 of the Act, it becomes absolutely clear that the object of the statute is not merely to tax the capital gains arising on transfer of a capital asset acquired by an assessee by incurring the cost of acquisition, but also to tax the gains arising on transfer of a capital asset, inter alia, acquired by an assessee under a gift or will as provided under section 49 of the Act where the assessee is deemed to have incurred the cost of acquisition. Therefore, if the object of the Legislature is to tax the gains arising on transfer of a capital acquired under a gift or will by including the period for which the said asset was held by the previous owner in determining the period for which the said asset was held by the assessee, then that object cannot be defeated by excluding the period for which the said asset was held by the previous owner while determining the indexed cost of acquisition of that asset to the assessee. In other words, in the absence of any indication in clause (iii) of the Explanation to section 48 of the Act that the words “asset was held by the assessee” has to be construed differently, the said words should be construed in accordance with the object of the statute, that is, in the manner set out in Explanation 1(i)(b) to section 2(42A) of the Act.
20. To accept the contention of the Revenue that the words used in clause (iii) of the Explanation to section 48 of the Act has to be read by ignoring the provisions contained in section 2 of the Act runs counter to the entire scheme of the Act. Section 2 of the Act expressly provides that unless the context otherwise requires, the provisions of the Act have to be construed as provided under section 2 of the Act. In section 48 of the Act, the expression “asset held by the assessee” is not defined and, therefore, in the absence of any intention to the contrary the expression “asset held by the assessee” in clause (iii) of the Explanation to section 48 of the Act has to be construed in consonance with the meaning given in section 2(42A) of the Act. If the meaning given in section 2(42A) is not adopted in construing the words used in section 48 of the Act, then the gains arising on transfer of a capital asset acquired under a gift or will be outside the purview of the capital gains tax which is not intended by the Legislature. Therefore, the argument of the Revenue which runs counter to the legislative intent cannot be accepted.
21. Apart from the above, section 55(1)(b)(2)(ii) of the Act provides that where the capital asset became the property of the assessee by any of the modes specified under section 49(1) of the Act, not only the cost of improvement incurred by the assessee but also the cost of improvement incurred by the previous owner shall be deducted from the total consideration received by the assessee while computing the capital gains under section 48 of the Act. The question of deducting the cost of improvement incurred by the previous owner in the case of an assessee covered under section 49(1) of the Act would arise only if the period for which the asset was held by the previous owner is included in determining the period for which the asset was held by the assessee. Therefore, it is reasonable to hold that in the case of an assessee covered under section 49(1) of the Act, the capital gains liability has to be computed by considering that the assessee held the said asset from the date it was held by the previous owner and the same analogy has also to be applied in determining the indexed cost of acquisition.
22. The object of giving relief to an assessee by allowing indexation is with a view to offset the effect of inflation. As per CBDT Circular No. 636, dated August 31, 1992 (see [1992] 198 ITR (St.) 1) a fair method of allowing relief by way of indexation is to link it to the period of holding the asset. The said circular further provides that the cost of acquisition and the cost of improvement have to be inflated to arrive at the indexed cost of acquisition and the indexed cost of improvement and then deduct the same from the sale consideration to arrive at the long-term capital gains. If indexation is linked to the period of holding the asset and in the case of an assessee covered under section 49(1) of the Act, the period of holding the asset has to be determined by including the period for which the said asset was held by the previous owner, then obviously in arriving at the indexation, the first year in which the said asset was held by the previous owner would be the first year for which the said asset was held by the assessee.
23. Since the assessee, in the present case, is held liable for long-term capital gains tax by treating the period for which the capital asset in question was held by the previous owner as the period for which the said asset was held by the assessee, the indexed cost of acquisition has also to be determined on the very same basis. In the result, we hold that the Income-tax Appellate Tribunal was justified in holding that while computing the Capital gains arising on transfer of a capital asset acquired by the assessee under a gift, the indexed cost of acquisition has to be computed with reference to the year in which the previous owner first held the asset and not the year in which the assessee became the owner of the asset.
24. Accordingly, we dispose of the appeal by answering the question in the affirmative, i.e, in favour of the assessee and against the Revenue with no order as to costs.