The Income Tax Appellate Tribunal (ITAT), Chennai, has held that the previous owner’s holding period must be included when determining whether gifted shares are long-term capital assets, even where the recipient has paid tax on the gift under Section 56(2)(x) of the Income-tax Act, 1961. However, where the value already subjected to tax becomes the deemed acquisition cost under Section 49(4), indexation on that value is available only from the year of the gift.
The Bench of George George K (Vice President) and Padmavathy S. (Accountant Member) directed the Assessing Officer to recompute the capital gains by treating the disputed shares as long-term capital assets and allowing indexation from financial year 2020-21.
Buy Now: Direct tax (Income Tax) E-Magazine September 2026
The dispute concerned assessment year 2022-23, for which the assessee filed a return declaring total income of ₹8,89,37,300.
During the relevant year, he sold 2,833 shares of SPI Music Private Limited. Of these, 1,722 shares had been received as a gift from Kiran Reddy through a gift deed dated March 24, 2021. The value of the gifted shares, amounting to ₹4,13,87,047, had been offered to tax under Section 56(2)(x).
While computing capital gains, the assessee treated the shares as long-term capital assets and claimed an indexed acquisition cost of ₹7,85,51,042.
The Assessing Officer rejected this treatment, reasoning that the assessee had acquired the gifted shares only on March 24, 2021, and had therefore held them for less than the prescribed period. The officer treated the resulting gains as short-term capital gains, denied indexation and made an addition of ₹3,71,73,995.
The Commissioner of Income Tax (Appeals) referred favourably to the extended holding period arising from the donor’s ownership, but upheld the denial of indexation. The assessee consequently approached the Tribunal.
The Tribunal examined whether taxation of the gifted shares under Section 56(2)(x), coupled with the substitution of acquisition cost under Section 49(4), prevented the assessee from including the donor’s holding period.
The assessee argued that Explanation 1(i)(b) to Section 2(42A) expressly requires the previous owner’s holding period to be included where an asset is acquired in the circumstances specified in Section 49(1), including a gift.
He maintained that Section 49(4) concerns only the determination of acquisition cost. It does not change the character of the transaction or displace the statutory rule governing the holding period.
The Revenue’s submissions before the Tribunal focused principally on indexation. It argued that once the value taxed under Section 56(2)(x) became the acquisition cost, that newly recognised value could not receive inflation adjustment for the earlier years during which the donor held the shares.
Accepting the assessee’s position on the holding period, the Tribunal explained that the application of Section 49(1) depends on the mode of acquisition. An asset received through a gift continues to satisfy that condition even if its receipt separately attracts tax under Section 56(2)(x).
The Bench held that Section 56(2)(x) imposes a tax consequence on the transaction without converting it into something other than a gift.
It further observed that Section 49(4) substitutes the acquisition cost but contains no language altering the holding period under Section 2(42A). Had Parliament intended the provision to affect both cost and holding period, it could have expressly provided for that consequence.
The Tribunal also noted that neither the Assessing Officer nor the Commissioner (Appeals) had disputed the genuineness or character of the transaction as a gift.
Accordingly, it held that the donor’s holding period had to be included and that the disputed shares qualified as long-term capital assets.
The Tribunal nevertheless rejected the assessee’s claim for indexation on the substituted acquisition cost from the year in which the donor first held the shares.
The assessee had relied on the Bombay High Court’s decision in CIT v. Manjula J. Shah, reported in 355 ITR 474, and other decisions supporting indexation with reference to the previous owner’s holding period.
Distinguishing that line of authority, the Bench explained that, in the ordinary carry-over situation under Section 49(1), the previous owner’s acquisition cost and holding period operate together.
The present case involved a different cost mechanism. Since the gift value had already been subjected to tax under Section 56(2)(x), Section 49(4) substituted that taxed value as the assessee’s acquisition cost.
The Tribunal reasoned that this statutory cost arose only on March 24, 2021. Applying an inflation index from an earlier year to that later value would provide an adjustment for a period during which the substituted cost did not exist.
It held that the purpose of Section 49(4) was to recognise a value already subjected to tax, rather than provide additional inflation relief on that value for the donor’s earlier ownership period.
The Bench also declined to uphold the complete denial of indexation.
Having classified the shares as long-term capital assets, it held that the assessee was entitled to indexation on the deemed acquisition cost under Section 49(4), but with reference to the cost inflation index for financial year 2020-21, corresponding to the gift dated March 24, 2021.
The Assessing Officer was therefore directed to recompute the capital gains by treating the disputed shares as long-term capital assets and applying indexation from that year to the value already subjected to tax under Section 56(2)(x).
The order did not quantify the revised capital gains or the final tax relief.
The Tribunal partly allowed the appeal. Since the substantive appeal had been decided, the accompanying stay application was dismissed as infructuous.
Membership Required to Access Case Details & Order Copy
To view the complete Case Details and Download Order Copy, you must have an active membership. Please subscribe to continue.
Read More: Unexplained Cash Transactions Can’t Be Taxed At Ad Hoc 8% Without Legal Basis: Delhi HC
