Court rules against tax avoidance scheme involving share conversion and sale to evade capital gains tax obligations.

The court held that the conversion of shares into stock-in-trade and subsequent sale to a private limited company was a colorable device to evade capital gains tax. Despite the assessees' argument that no capital gain arose due to the market value of shares being higher than the sale price, the court found the steps taken were artificial and solely aimed at tax avoidance. The court upheld the decision that the capital gains were taxable, emphasizing the need to look beyond superficial transactions aimed at evading tax obligations.

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Issues:
Whether a sum should be brought to tax as capital gains in the hands of the assessee for a transaction that took place prior to the introduction of section 45(2) of the Income-tax Act, 1961.

Analysis:
The judgment pertains to an assessment year of 1984-85 involving two assessees, a father, and his minor son, who held shares in four companies. An affidavit was filed declaring the conversion of these shares into stock-in-trade and subsequent sale to a newly incorporated private limited company. The assessees argued that the sale resulted in a loss, not a capital gain, due to the market value of shares being higher than the sale price. However, the Assessing Officer rejected this claim, viewing the transaction as a device to evade capital gains tax. The Commissioner initially sided with the assessees, but the Tribunal restored the Assessing Officer's order, considering the transaction a colorable device to avoid tax, following the precedent set in McDowell and Co. Ltd. v. CTO [1985] 154 ITR 148 (SC).

The assessees contended that the law in that assessment year did not prohibit the conversion of shares to stock-in-trade, and thus, no capital gain was earned upon the subsequent sale to the private limited company. However, the court found that the series of steps taken by the assessees were pre-conceived solely to evade capital gains tax. The declaration of conversion into stock-in-trade was deemed artificial and introduced only to avoid tax liability. The court emphasized that the shares were not genuinely utilized as stock-in-trade but were immediately transferred to a company controlled by the assessees, indicating a clear intent to evade capital gains tax.

The court concluded that the conversion of individual holdings into stock-in-trade was a mere attempt to avoid capital gains tax, as the shares were never intended to be used as stock-in-trade and were promptly sold to a company owned by the assessees. The artificial steps taken to evade tax were disregarded, and the capital gains were deemed liable for taxation. The court upheld the Tribunal's decision, ruling in favor of the Revenue and against the assessee. The judgment highlights the importance of examining the true nature of transactions and disregarding artificial steps introduced solely to evade tax obligations.

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