The provisions of Section 45 (2) of the Income Tax Act of 1961 deal with the taxability of the conversion of capital assets into stock in trade. The regulations relating to taxability on the conversion of stock in trade into capital assets.

The word ‘capital gains’ is defined in section 45(2) of the Income Tax Act as ‘earnings arising from the transfer of any capital property.’  In other words, when a permanent or temporary item is sold for more than its cost price, the difference is referred to as capital gains.

Moreover, capital assets refer to any assets held by an income tax assessee, whether or not they are related to a business or profession.

Section 45(2) Was Amended In 2018

The Fair Market Value of inventory as of the date of conversion should be assessed in the prescribed method, according to Section 28 (via) of the Act, which was included in the Act through the 2018 budget. By inserting clause (xiia) to section 2(24), the fair market value of inventory referred to in section 28(via) has been included in the definition of income. 

Amendments To Capital Gains Taxes

Subsection (9) of Section 49 of the Income Tax Act has been added, which specifies that, for calculating capital gain, fair market value as of the date of conversion must be considered as the cost of acquisition at the time of transfer of such capital asset. Section 2(42A) contains a new sub-paragraph in clause (i) of Explanation 1 that indicates that the date of conversion of stock in trade to capital assets shall be considered the term of holding.

Section 45(2) Of Income Tax Act

Analysis Of The Effects

Considering all of the foregoing modifications leads to the conclusion that when stock in trade is converted into a capital asset, income is taxed under business income in the year the conversion occurs, and income is taxed under capital gain in the year of ultimate transfer. The changes will take effect in the 2019-2020 assessment year.

The Objective Of Section 45(2)

Section 45(2) encourages people to invest in a firm with their capital assets without paying excessive taxes. Section 2 (14) of the Income Tax Act of 1961 applies to capital assets.

Section 45(2) Of Income Tax Act

Investing In Capital Assets

Once the requirements are met, the following capital assets can be included in this section:-

  • Section 2(14) of the Income Tax Act requires that the capital asset be kept.
  • An assessee must own property of any kind, whether or not it is related to his profession or business; additionally, the property must be usable for both business and personal purposes.
  • Securities held by a Foreign Institutional Investor under the Securities and Exchange Board of India Act, 1992, in particular stock-in-trade consumable stores or raw materials held for professional or commercial purposes.
  • With some exceptions, personal effects include movable property owned for personal use by the assessee or any member of his family who is dependent on him.
  • Automobiles and furniture are not considered capital assets.
  • The asset should be converted into the form of stock in trading.
  • Section 45(2) does not apply to business fixed assets.  
  • The fair market value on the date of the asset conversions will be used to calculate capital gains.
  • If the assessee claims capital gain under sections 54EA, 54EB, and 54EC, he or she will be given six months.

Profit Calculation In A Business

The assessee must convert the Jewellery that he paid Rs 3,00,000 for on May 1, 1980. As of September 15, 2016, the fair market value was Rs. 40,00,000. The Jewellery was sold for Rs. 41,00,000. on June 3rd, 2017.

The following method of calculating business profit will be used:-

Business Profit1,00,000
Year of Assessment2018-2019
On conversion, the fair market value is40,00,000
In sales consideration41,00,000