As per Income Tax Act, conversion of a Capital asset into Stock in trade is treated as a transfer in the previous year in which such conversion is made. However the Capital Gains Tax is chargeable on such transfer only in the previous year such Stock in Trade is either sold or transferred.

The Taxation of such transaction has two facets defined below: 

1. Chargeability as Capital gains

• Full Value of Consideration shall be taken as the fair market value on the date of conversion..

• Cost of Acquisition will be taken as the cost incurred by the assessee at first instance on purchase of such asset along with indexation applicable on the asset, being recognized as long term.

• Cost of Improvements (if any) made before conversion shall be considered along with indexation applicable if the asset was a long term capital asset on the date of conversion.

• Expenses on transfer shall be allowable to the extent specifically related to such conversion.

• Capital gains shall be calculated as per the taxing provisions as explained in the topic of Tax Rates for Short term/ Long Term Capital Assets.

2. Chargeability as Business Income: 

• The Sale Price less market value as on the date of such conversion shall be taxed under the head Profits and Gains from Business and Profession. 

PLEASE NOTE: 

• Indexation of cost in the above case shall be done till the year of conversion of the capital asset into Stock in trade although the Capital gains will be computed in the year of sale or transfer of such converted capital asset; Let’s consider this example for better clarity:

• C converted Gold Jewellery purchased by him on 4^th April’ 2001 for Rs. 50,000/- as an Investment, into Stock in Trade on 2^nd January’ 2007 for starting his business as jewelers. The said jewellery was sold on 22^nd May’ 2007.

1. Cost inflation index for FY 2001-02: 426

2. Cost inflation index for FY 2006-07: 519 

In this case indexed cost of acquisition will be calculated as: 

Rs. 50,000 × (Cost inflation index of Financial Year 2006-07 ÷ Cost inflation index of Financial Year 2001-02) i.e., Rs 50,000× (519 ÷ 426) = Rs. 60,915/- 

• If the asset converted into Stock in Trade by the assessee is not a Capital Asset, then there shall be no Capital Gains (Refer Exclusions stated from the definition of Capital Asset)

• Capital Gains shall be calculated as per the applicable provisions in the previous year in which such conversion / transfer is made. In no case it shall have any relevance with provisions of the previous year in which such asset is sold.