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Quantifying the unquantified Cost of acquisition – Budget 2023

2.
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

3.
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.

4.
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 Hon’ble 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.

5.
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.

6.
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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