ITAT Upholds FIFO Method for Computing Capital Gains on Shares

The Mumbai Bench of the Income Tax Appellate Tribunal (ITAT) has upheld the adoption of the First-In-First-Out (FIFO) method for computing capital gains on the sale of shares held in physical form and rejected the assessee’s attempt to determine gains based on selective identification of share lots. The Tribunal held that physical share certificates do not alter the fungible nature of equity shares and cannot be used to artificially reduce tax liability.

A Bench comprising Judicial Member Narender Kumar Choudhry and Accountant Member Prabhash Shankar dismissed the assessee’s challenge to an addition of Rs 10.76 crore made towards short-term capital gains in the case of Megasolis Renewable Private Limited.

The assessee had sold Rs 46.66 lakh shares of its subsidiary, Brightsolar Renewable Energy Private Limited (BREPL), during AY 2016-17. While computing capital gains for tax purposes, it adopted the “specific identification method” and claimed that the shares sold consisted primarily of shares acquired at a higher cost, resulting in taxable short-term capital gains of only Rs 43.54 lakh.

The Assessing Officer rejected the computation and applied the FIFO method, holding that all equity shares carried identical rights and obligations and were therefore indistinguishable. On that basis, the capital gains were recomputed at Rs 11.20 crore, leading to an addition of Rs 10.76 crore.

The Tribunal observed that the assessee had itself computed profits of Rs.5.92 crore in its books by applying Accounting Standard-13, but claimed a substantially lower figure of Rs.43.54 lakh in its tax computation by selectively identifying high-cost shares as having been sold.

Before the Tribunal, the assessee argued that Section 45(2A), which incorporates the FIFO principle, applies only to dematerialised securities and not to shares held in physical form. It contended that physical shares are capable of specific identification through distinctive numbers and share certificates, making FIFO inapplicable.

The Tribunal, however, found no merit in the contention. It held that the assessee had neither consistently followed the accounting treatment adopted in its books nor any recognised valuation method. According to the Tribunal, merely because shares were held in physical form did not change their character as identical equity shares carrying equal rights and liabilities.

Relying, among others, on the decision of the Calcutta High Court in Nawal Kishore Kejriwal v. Commissioner of Income Tax, the Tribunal concluded that the FIFO principle could validly be applied even in relation to shares held in physical form.

On the issue of disallowance under Section 14A, however, the Tribunal granted partial relief to the assessee. It held that only those investments which had actually yielded exempt income during the relevant year could be considered for the purpose of Rule 8D computation and reiterated that the disallowance cannot exceed the amount of exempt income earned.

The matter was remanded to the Assessing Officer for recomputation of the Section 14A disallowance in accordance with these principles. Consequently, the appeal was partly allowed.

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