The Finance Bill, 1999, now seeks to tax this amount as capital gains. In 1997, the Expert Group set up by the government had recommended in its final report (see 224 ITR (St) 169, 207) as follows:

"Where any capital asset is destroyed due to fire, earthquake or for any other reasons, eg, sinking of a ship, etc, such destruction of asset will be included in the extended meaning of the word `transfer'. Section 2(47) of the Act which defines `transfer' does not include destruction of an asset.The group feels that in the event of destruction of the capital asset, capital gains should be chargeable on compensation, if received, in excess of the cost of acquisition. Hence, it is proposed to amend section 2(47) and include destruction of an asset in thedefinition of `transfer'."

Before going into the provisions of the Finance Bill, 1999, it is necessary to refer to the judgment of the Supreme Court of India on this important point. In Vania Silk Mills Pvt Ltd vs CIT (191 ITR 647), the apex court reversed the high court's decision and also overruled the decision of the Allahabad High Court in CIT vs JK Cotton Spinning & Weaving Mills Co Ltd (164 ITR 18).

The facts before the Supreme Court were that the company in 1957 purchased machinery worth Rs 281,741 and gave it on hire to Jasmine Mills at an annual rent of Rs 39,000. Jasmine Mills insured the machinery, along with its own machinery, against fire and the policy contained a clause requiring the insurer to pay the cost of the machinery as on the date of fire, in case of destruction or loss. On August 11, 1966, a fire broke out in Jasmine Mills causing extensive damage to the machinery including that hired from the appellant. The appellant's machinery became uselessly damaged. On the claim'ssettlement Jasmine Mills received a certain amount and paid Rs 632,533 to the appellant for the destroyed machinery.

The income tax officer imposed a tax on Rs 350,792, the difference between the claim amount received by the appellant for its machinery and the original cost, as capital gains. The Appellate Tribunal, however, held that the amount was not received on transfer of a capital asset but on account of damage to machinery and that section 45 of the Income Tax Act, 1961, was not attracted. On a reference, the high court reversed the tribunal's decision.

On appeal to the Supreme Court, it was held, reversing the high court's decision, that capital gains tax was attracted under section 45 by transfer and not merely by extinguishment of rights howsoever brought about. Whatever the mode by which the transfer was brought about, the existence of the asset during the process of transfer was a precondition unless the asset existed in fact, there could not be a transfer of it. The extinguishment of a rightshould in any case be on account of its transfer to attract provisions of section 45. If it was not, and was on account of destruction or loss of the asset, it was not a transfer and did not attract provisions of section 45 which related to transfer and not to mere extinguishment of a right. Hence, an extinguishment of right not brought about by transfer was outside the purview of section 45.

The court also held that in case of damage, or loss of property, there was no transfer of it in favour of a third party. The money received under insurance policy in such cases was by way of indemnity or compensation for the damage, loss or destruction of the property. It was not in consideration of the transfer of the property or any right in it in favour of the insurance company. It was because of the insurance contract or of indemnity, and in terms of contract conditions. The court also held that it was not necessary to inquire whether the amount received by the appellant was spent in replacement of the machineryor not. Therefore, the court concluded that the difference of Rs 3,50,792 was not capital gains and was not chargeable to tax under section 45.

In coming to this conclusion, the court observed that since associated words and expression like "sale", "exchange", etc, used in the definition of "transfer" in section 2(47), imply the existence of the asset and of the transferee, according to the rule of noscitur a sociis, the expression "extinguishment of any rights" would take colour from those associated words and expression and will have to be restricted to the sense analogous to them.If the legislature had intended to extend the definition to any extinguishment of right, it would not have included the obvious instances of transfer, viz, sale, exchange, etc. Hence, the expression "extinguishment of any rights therein" will have to be confined to the extinguishment of rights on account of transfer and cannot be extended to mean any extinguishment of right independent of or otherwise than on account oftransfer.

According to the Supreme Court, when an asset is destroyed, there is no question of transferring it to others. The destruction or loss of the asset, no doubt, brings about the destruction of the right of the owner or possessor of the asset in it. However, it is not on account of transfer. It is on account of the disappearance of the asset.

The extinguishment of right in the asset on account of extinguishment of the asset itself is not a transfer of the right, but its destruction. By no stretch of imagination can the destruction of the right on account of the destruction of the asset be equated with the extinguishment of right on account of its transfer. In an insurance policy with a reinstatement clause, the insurer is bound to pay the cost of the insured property as on the date of destruction or loss, and it matters very little if the amount so paid by the insurance company is invested for replacing the destroyed asset or for any other purpose. The money received under an insurance policy insuch cases is by way of indemnity or compensation for the damage, loss or destruction of the property. There being no transfer of any property, section 45 of the Income Tax Act is not attracted and the question of assessment of capital gains does not arise.

Unless an asset is transferred, the question of taxability of capital gains under section 45 does not arise.

With a view to supersede the decision of the Supreme Court and high court on this point, clause 342 of the Finance Bill, 1999 proposes to insert sub-section (1A) in section 45 of the Income Tax Act, 1961 to provide that where any person receives any money or other assets under any insurance from an insurer on account of damage to or destruction of any capital asset, as a result of flood, typhoon, hurricane, cyclone, earthquake or other convulsion of nature, riot or civil disturbance, accidental fire or explosion or because of action by an enemy or action taken in combating an enemy (whether with or without a declaration of war), any profits orgains arising from receipt of such money or other assets shall be chargeable to income-tax under the head "capital gains" and shall be deemed to be the income of such person for the previous year in which such money or other asset was received.

It is also proposed that for the purposes of section 48, value of any money or the fair market value of other assets on the date of such receipt shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of such capital assets.

This amendment will take effect from April 1, 2000 and will, accordingly, apply in relation to the assessment year 2000-2001 and subsequent years.In view of the aforesaid new sub-section being effective from the assessment year 2000-2001, the decision of the Supreme Court in Vania Silk Mills' case will apply in respect of amounts received on settlement of claims from insurance companies up to the financial year 1998-99, relevant to the assessment year 1999-2000. In other words, all claimssettled by insurance companies up to March 31, 1999, will be governed by the law as laid down by the Supreme Court and high court as discussed in this article.The proposed new law amending section 45 will only govern cases of settlement of insurance claims sin respect of capital assets made on or after April 1, 1999.

The author is a Supreme Court advocate