1. This appeal relates to the computation of capital gains. The assessee is a private limited company. The assessee had purchased land measuring to the extent of 56 grounds 295 sq. ft. for Rs. 11,80,765.57 being the consideration as well as stamp and registration charges by a deed dated 8-11-1972 from the Church of South India Trust Association.
The assessee had also incurred interest on money borrowed for the purchase of land amounting to Rs. 54,900 and legal fees of Rs. 3,000 paid to Mrs. Devadasan, Advocate, Madras for finalising the transaction. Apart from these expenses, the assessee had paid urban land taxes and corporation taxes totalling Rs. 33,165.18, the break up of which is as follows:Accounting year Particulars Amount paid1973-74 Urban land tax 6,721.341974-75 6-8-1974 Corporation taxes 254.061974-75 18-12-1974 Urban land tax - Fasli 1382 8,452.501974-75 29-1-1975 Urban land tax - Fasli 1383 8,452.501974-75 1-3-1975 Urban land tax - Fasli 1384 8,452.501974-75 3-3-1975 Corporation tax 254.061974-75 3-3-1975 Corporation tax 289.111974-75 3-3-1975 Corporation tax 289.11 33,165.18 Thus, in all the assessee had incurred total expenditure of Rs. 12,71,830 by capitalising the expenditure of Rs. 91,065 incurred for payment of taxes as well as interest on borrowed funds and adding it to the original cost of land at Rs. 11,80,765. The assessee then ascertained the cost per ground by dividing this total expenditure by the total extent of land determining it at Rs. 22,656 per ground. When the assessee sold 44 grounds 1578 sq. ft. of land to other parties for a total sum of Rs. 12,08,000 in the previous year ended 30-6-1975 relevant to the assessment year 1976-77, the assessee computed the capital gains arising from such transfer by taking the cost of such land at the rate of Rs. 22,656 per ground. The comoutation was worked out as follows:Sale proceeds 12,08,000Less: Commission paidRs. 22,656 per ground 10,11,760Net capital gains taxable 1,35,840 In the original assessment made on 22-10-1978, this computation was accepted bringing to tax short-term capital gains of Rs. 1,35,840.
Later acting under Section 263 of the Income-tax Act, 1961 ('the Act'), the Commissioner by order dated 16-10-1980 was of the opinion that the assessment order was erroneous and prejudicial to the revenue and accordingly set aside the assessment and restored the matter to the ITO for going to the question whether the expenses of Rs. 91,065 referred to above could be capitalised or not. Thereafter, the ITO passed a fresh assessment order dated 4-11-1980 by which he came to the conclusion that the sum of Rs. 91,065 could not be capitalised with the result that the proportionate cost of the land sold was only [Rs. 9,35,545 and the capital gains exigible to tax was Rs. 2,08,055. On appeal the Commissioner (Appeals) accepted the claim of the assessee that the interest paid on borrowed funds could be capitalised along with the advocate's fees, but the urban land tax and other taxes paid for maintaining the asset could not be capitalised. He, therefore, directed the ITO to recompute the capital gains accordingly. The assessee is in further appeal to reiterate its contention that even the taxes paid could be capitalised whereas the revenue has appealed against the capitalisation of the interest on borrowed funds.
2. On a consideration of the rival submissions, we are of the opinion that the assessee is entitled to succeed. Section 45 of the Act brings to charge any profits and gains arising from the transfer of a capital asset effected in the previous year. The Gujarat High Court has observed in the case of CIT v. Mohanbhai Pamabhai  91 ITR 393 at 408 that the object of the charging provision is to tax 'profits or gains' and this expression means real or net profits or gains and in order to arrive at real or net profits or gains, the cost which has been incurred by the assessee in acquiring the capital asset must be deducted from the full value of the consideration received by him. The Supreme Court has also observed in the case of Miss Dhun Dadabhoy Kapadia v. CIT  63 ITR 651 at 655 that in working out capital gain or loss, the principles that have to be applied are those which are a part of the commercial practice or which an ordinary man of business will resort to when making computation for his business purposes. Therefore, we have to find whether according to commercial principles the expenditure which the assessee capitalised and added to the original cost of the land purchased should be treated as forming part of the actual cost of the asset. The term 'actual cost' was considered by the Supreme Court in the case of Challapalli Sugars Ltd. v. CIT  98 ITR 167 and it was observed that as the expression 'actual cost' has not been defined, it should be construed in the sense which no commercial man would misunderstand. It was further laid down that for this purpose it would be necessary to ascertain the connotation of the expression in accordance with the normal rules of accountancy prevailing in commerce and industry. We may note in this connection that the audited balance sheet exhibited by the assessee-company presented a picture in which the expenditure listed above were capitalised obviously in conformity with the normal accountancy rules. Such capitalisation of interest on capital borrowed is also in conformity with the legal position enunciated by the Supreme Court in the case of Challapalli Sugars Ltd. (supra) as well as the Andhra Pradesh Hight Court in the case of Addl. CIT v. K.S. Gupta  119 ITR 372 and the Delhi High Court in the case of CIT v.Mithlesh Kumari  92 ITR 9. The fees paid to the advocate is also to be capitalised because it was incurred directly in connection with the purchase of the land and forms part of the cost of acquisition.
With regard to the urban land tax it is to be noted that under Section 10 of the Tamil Nadu Urban Land Tax Act, such tax is a first charge on the urban land and hence, that tax was also rightly capitalised in accordance with the accountancy principles since the asset is a capital asset in the hands of the assessee-company. It was argued on behalf of the revenue that since the taxes were paid for maintaining the asset and not for acquiring them, they may not be treated as part of the cost of acquisition. But we are unable to agree because as noted above, we are concerned with the real profits and gains and since the property could not be sold unless it was maintained and since the taxes beirg a first charge may even be recovered by sale of the property unless paid it is an expenditure which has to be taken into account in ascertaining the profits and gains arising from the purchase and sale of the land.
We are, therefore, of the considered opinion that all the expenditure listed above were rightly capitalised by the assessee and added to the cost of acquisition of the asset.
3. It was contended on behalf of the revenue by referring to Section 55(1)(b) of the Act, that the cost of improvement in relation to capital asset meant only expenditure of a capital nature and therefore, the expenditure incurred for payment of taxes could not be taken into account since they are of a revenue nature. We are of the opinion that this contention is irrelevant to the issue, because we have considered this expenditure in relation to the determination of cost of acquisition and not in relation to the determination of cost of improvement to the property. Section 48 of the Act requires that the income chargeable under the head 'Capital gains' shall be computed by deducting from the full value of consideration received: (7) the expenditure incurred wholly and exclusively in connection with the transfer, and (2) the cost of acquisition of the capital asset and the cost of any improvement thereto. The definition in Section 55(1)(b) refers only to the cost of improvement and cannot qualify expenditure which may rightly fall within the scope of cost of acquisition itself.
In the case of Smt. S. Valliammai v. CIT  127 ITR 713 (Mad.) (FB), relied on by the revenue the discussion was with reference to cost of improvement. In that case, the Tribunal had considered the payment of estate duty as not involving the acquisition of interest in the land and this was approved by the High Court. But whether expenditure incurred for payment of taxes could be capitalised and added to the cost of acquisition of itself on the basis of commercial principles of accountancy was not considered in that case. Moreover, that case was concerned with long-term capital gains and not with short-term capital gains where a different approach may be necessary as we shall presently see. Similarly, in the case of B.N. Pinto v. CIT  96 ITR 306 (Mys.), relied on by the revenue the claim for capitalising lawyer's fees and travelling expenses was rejected not because they could not be capitalised but because the claim was indefinite and vague and was not established to have any connection with the transfer of the property.
4. A little legislative history may not be out of place in rejecting the contention of the revenue. Originally capital gains was not taxable because obviously it did not amount to income. It is only by the provisions of Section 12B of the 1922 Act that capital gains was deemed to be income of the previous year in which the transfer took place. The rigour of this charge was compensated to an extent by providing for a large deduction in the computation of the capital gains. While presenting the Budget for the assessment year 1962-63, the Finance Minister observed (46 ITR Statutes): Capital gains are already taxable under our Income-tax Act. The incidence is, however, restricted in the case of non-company assessees to income-tax only, calculated in the prescribed manner.
In an equitable system of taxation, capital gains realised during a short period and those not so realised require to be treated differently. It is necessary to secure broad equity in the treatment of different categories of taxpayers. In a number of cases, it is not possible to establish certain incomes as arising out of business but they are nonetheless of a similar nature. Gains realised through purchase and sale of capital assets within a short period fall in this cateogory. I have proposed that gains which result from disposal of capital assets within a period of one year from the date of acquisition shall be made subject to income-tax and super tax like other ordinary incomes. Capital gains for assessees other than companies from assets held over a period longer than one year will be subject to income-tax at the rate of 25 per cent or at the rate applicable as if they were short term gains, whichever is less. Long term capital gains of companies will continue to be taxed at the rate of 30 per cent. This will yield a revenue of Rs. 50 lakhs, half of which is expected to be realised from companies. (p. 3) Thus, short-term capital gains was to be treated on a par with regular income. In the Budget speech for 1973-74 the Finance Minister stated (88 1TR Statutes): Capital gains tax can become a means of avoiding or reducing the burden of payment of income-tax. At present capital gains arising from the sale or transfer of capital assets held by a taxpayer for a period exceeding 24 months are entitled to concessional tax treatment. I propose to extend this period to 60 months. As a result, only capital assets held by a taxpayer for a period exceeding 60 months will qualify for concessional tax treatment applicable in relation to long-term capital assets. (p. 40) The concessional treatment was thus restricted to long-term capital gains. In this background, it will be clear that in the case of short-term capital gains the profit or gains arising from the transfer could not be computed at a figure larger than that which could be ascertained on the application of commercial principles. If such a computation were to be attempted by unnecessarily restricting the scope of cost of acquisition in Section 48, it would mean that short-term capital gains which is not to enjoy any concessional treatment would be computed at a figure greater than that ascertainable under commercial principles as an ordinary income and would thus be taxed more harshly than it would have been if it had been treated as ordinary income arising to the assessee from regular business of purchase and sale of asset concerned. We are, therefore, of the opinion that approaching the matter both from the point of legislative history as well as from commercial accountancy principles and in the light of the observations of the Supreme Court cited above, the computation of the short-term capital gains by the assessee was quite correct and did not require to be disturbed by the ITO. We have, therefore, no hesitation in annulling his order. The appeal of the assessee is allowed and the appeal of the revenue is dismissed.