Conversion of equity into preference shares treated as a deemed gift, with valuation to follow the prescribed rule.

Conversion of equity shares into preference shares was held to constitute a transfer of property and a deemed gift under the Gift-tax Act because the shareholder gave up the wider rights attached to equity and received shares carrying lesser rights, thereby diminishing one property interest and enhancing another. The court also held that Rule 10(2) of the Gift-tax Rules governed valuation of shares in the relevant assessment period, as the shares were not freely saleable in the open market and the later Schedule II could not apply retrospectively. The valuation therefore had to be redetermined under the prescribed statutory method taking all relevant factors into account.

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Issues: (i) Whether conversion of equity shares into preference shares amounted to a transfer of property and a deemed gift under the Gift-tax Act, 1958. (ii) Whether Rule 10(2) of the Gift-tax Rules, 1958 governed valuation of the shares and whether the valuation adopted by the Revenue could be sustained.

Issue (i): Whether conversion of equity shares into preference shares amounted to a transfer of property and a deemed gift under the Gift-tax Act, 1958.

Analysis: A share represents a bundle of rights and interests in the company, and equity shares and preference shares carry materially different rights, particularly in management, voting, dividend participation, and distribution on liquidation. On conversion, the shareholders gave up the incidents attached to equity shares and received a different species of shareholding with lesser rights. A transaction that directly or indirectly diminishes the value of one person's property and increases the value of another's property falls within the statutory definition of transfer, and the concept of gift under the Act is wider than the ordinary law of transfer. The conversion was therefore not a mere unilateral internal act without legal consequence; it constituted a transfer of property for the purposes of the Act.

Conclusion: The conversion of equity shares into preference shares amounted to a transfer of property and a deemed gift. This issue is decided in favour of the Revenue and against the assessee.

Issue (ii): Whether Rule 10(2) of the Gift-tax Rules, 1958 governed valuation of the shares and whether the valuation adopted by the Revenue could be sustained.

Analysis: The shares were not freely saleable in the open market, and the prescribed valuation machinery had to be applied. Rule 10(2) was the relevant mode for valuing shares in a private company with restrictive transfer provisions. The Tribunal was also justified in noticing that the Revenue valuation had ignored relevant encumbrances and incidents affecting value, but its further view that the rule had no application was erroneous. The later introduced Schedule II could not govern the present assessment year. The proper course was to determine value in accordance with the prescribed rule after taking all relevant factors into account.

Conclusion: Rule 10(2) applied, and the matter required fresh redetermination of value on the prescribed basis. This issue is also decided in favour of the Revenue.

Final Conclusion: The reference was answered against the assessee on both the existence of a taxable gift and the applicability of the statutory valuation method, and the Tribunal was directed to redetermine the value accordingly.

Ratio Decidendi: A conversion of equity shares into preference shares, where the rights attached to the former are reduced and replaced by inferior rights, constitutes a transfer of property and a deemed gift if the transaction diminishes the value of the transferor's property and increases the value of another's property; valuation must then be made under the prescribed statutory method applicable to the relevant assessment period.

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