Previous Year Question
Under which of the following circumstances may ‘capital gains’ arise?
When there is an increase in the sales of a product
When there is a natural increase in the value of the property owned
When you purchase a painting and there is a growth in its value due to an increase in its popularity
Select the correct answer using the codes given below:
Only 1
2 and 3
Only 2
1, 2 and 3
Correct Answer: B
Detailed Solution
A capital gain is associated with an increase in the value of a capital asset. For income-tax purposes, it is generally chargeable when the capital asset is transferred and the consideration received exceeds its cost calculated according to the applicable statutory provisions.
Statement 1 is incorrect. An increase in the sales of a product may increase business revenue or trading profit. A product or stock-in-trade held for ordinary business transactions is generally not treated as a capital asset.
For example, profit earned by a vehicle manufacturer through increased car sales is business income, not a capital gain. However, profit arising from the transfer of the manufacturer’s capital asset, such as land or a building, may constitute a capital gain.
Statement 2 is correct. The value of land, a building or another property may appreciate over time, creating a potential capital gain.
A distinction is necessary between economic appreciation and a taxable capital gain. An increase in market value represents an unrealised or potential gain; under the Income-tax Act, capital gains are generally charged to tax when the capital asset is transferred.
Statement 3 is correct. A painting can be a capital asset. Although many movable properties held for personal use may be excluded as personal effects, paintings, sculptures, drawings, archaeological collections and other works of art are not covered by that general exclusion.
If the popularity of a painting causes its value to appreciate, its transfer may generate a capital gain.
Thus:
Increase in product sales → ordinarily business income
Appreciation in property value → potential capital gain
Appreciation in the value of a painting → potential capital gain