Leasehold Land Value Essential for Share Valuation in Capital Gains Calculation: J&K&L High Court

Jammu : The High Court of Jammu & Kashmir and Ladakh recently upheld the principle that the value of a company's leasehold interest in land must be included when determining the fair market value of its shares for the purpose of calculating capital gains under the Income Tax Act, 1961. The court dismissed an appeal filed by the Principal Commissioner of Income Tax, affirming the decisions of the Commissioner of Income Tax (Appeals) and the Income Tax Appellate Tribunal.

The judgment, delivered by Justices Tashi Rabstan and Puneet Gupta , arose from an income tax appeal (ITA No.1/2022) challenging the computation of capital gains arising from the sale of shares by Dr. Karan Singh (the assessee-respondent) in M/s. Jyoti Pvt. Ltd.

Background of the Case

The dispute pertained to the financial year 1997-98. Dr. Karan Singh , a shareholder in M/s. Jyoti Pvt. Ltd. , sold 7150 shares of the company to M/s. Bharat Hotels Ltd. for a consideration of Rs. 10 crores. In his tax return, the assessee declared a capital loss, having calculated the indexed cost of acquisition as on 01.04.1981 at a significantly higher figure (Rs. 14,48,59,000/- for 7150 shares) based on a valuation report of the company's assets, which included both building and land value.

The Assessing Officer (AO), however, disputed this calculation. The AO's primary contention was that the value of the land (measuring 225.85 kanals) on which the company's hotel building stood should be excluded from the valuation of shares because the land was not owned by Jyoti Pvt. Ltd. but was held under a lease deed from Shri Vikramaditya Singh . Adopting a "break-up method" based mainly on the building's value, the AO determined the indexed cost of 7150 shares to be Rs. 2,33,23,300/-, resulting in a calculated capital gain of Rs. 7,66,76,700/-.

Appeals and Tribunal Decision

Aggrieved by the assessment order, the assessee appealed to the Commissioner of Income Tax (Appeals) [CIT(A)]. The CIT(A) sided with the assessee, deleting the addition. The CIT(A) reasoned that M/s. Jyoti Pvt. Ltd. held the land under a long-term lease with more than 20 years remaining as of the sale date. This effectively made the company the 'de facto owner' for practical purposes, rendering the land value in the hands of the lessor (Shri Vikramaditya Singh ) practically nil or negligible. Therefore, the value of the leasehold land could not be excluded from the company's asset valuation for determining the fair market value of its shares. The CIT(A) directed the AO to adopt the assessee's valuation, which resulted in no capital gain.

The revenue challenged the CIT(A)'s order before the Income Tax Appellate Tribunal (ITAT). The Tribunal dismissed the revenue's appeal, upholding the CIT(A)'s decision. The ITAT further held that the reopening of the assessment was not in accordance with law and also allowed the cross-objections filed by the assessee. The Tribunal emphasized that the Assessing Officer had himself applied the Fair Market Value of assets (specifically buildings) in the assessment, validating the use of FMV over book value or valuation methods under the Wealth Tax Rules (like Rule 1D), which the revenue had suggested. The ITAT reiterated that the fair market value, as defined under Section 2(22B) and relevant for computing cost of acquisition under Section 55(2)(b)(ii), is the price an asset would fetch in the open market on 01.04.1981.

High Court's Affirmation

The Principal Commissioner of Income Tax then filed the present appeal before the High Court of Jammu & Kashmir and Ladakh. The core issue before the High Court remained the method of valuing unquoted shares in a private company and whether the leasehold interest in the land should be included in the company's assets for determining the fair market value as on 01.04.1981.

The High Court, after hearing arguments from both sides, found itself in agreement with the CIT(A) and the ITAT. The court noted that M/s. Jyoti Pvt. Ltd. held a 40-year lease on the land since 1973, along with the ownership of the building. The restrictions prevailing in J&K at the time prevented the company (being a non-state subject) from owning land outright.

The bench found the AO's action of excluding the land value from the company's asset valuation for share valuation purposes to be "apparently erroneous and unsustainable in law." A significant point highlighted by the court was the inconsistency in the revenue's approach – the AO had excluded the land value from Jyoti Pvt. Ltd. 's assessment but had not included it in the assessment of the lessor, Shri Vikramaditya Singh .

The judgment emphasized:

> "We are also in agreement with the learned Tribunal that the lease hold interest in the land is an asset of the company and is capable of valuation; as such the same is to be included in the value of asset of M/s. Jyoti Private Limited so as to determine the fair market value of shares held by the assessee as well as other shareholders."

The court further affirmed that for capital gains computation under Section 45, the relevant value is the fair market value of the asset (shares, determined by the underlying assets' FMV as per Section 55(2)(b)(ii) read with Section 2(22B)), not the book value or valuation under Wealth Tax Rules, especially when the AO had already applied the FMV concept for other assets. The long unexpired lease period supported the view that the leasehold interest held significant value that could not be ignored.

Concluding that the impugned order of the Tribunal was "well defined and reasoned," the High Court found "no substantial question of law" arising for its consideration.

Consequently, the appeal filed by the Principal Commissioner of Income Tax was dismissed. This ruling reinforces the principle that the economic reality of control and value derived from long-term leasehold interests must be considered when valuing the shares of a private company for capital gains tax purposes.

Bench: Hon’ble Mr. Justice Tashi Rabstan , Judge and Hon’ble Mr. Justice Puneet Gupta , Judge Case: ITA No.1/2022 Pronounced: 02.03.2024