Court rules against sham share transfer for tax evasion, disallowing capital loss and interest deduction.

Commissioner Of Income-Tax Versus LN. Dalmia

Commissioner Of Income-Tax Versus LN. Dalmia - [1994] 207 ITR 89 Issues Involved:
1. Validity of the transaction of sale of shares to Laxminiwas and Co. (Export) Pvt. Ltd. before its incorporation.
2. Whether the transfer of shares was sham or unreal.
3. Determination of the market price of the shares at the time of sale.
4. Capitalization of interest paid on borrowed funds for acquisition of shares.
5. Allowability of short-term capital loss on the sale of shares.

Summary:

Issue 1: Validity of the Transaction of Sale of Shares
The Tribunal held that the transaction of sale of shares to Laxminiwas and Co. (Export) Pvt. Ltd. was valid as it was ratified by the company after its incorporation on June 7, 1969. However, the Court found that pre-incorporation contracts generally have no legal effect unless specific conditions are met, which were not fully detailed in this case. Therefore, the Court refrained from answering this question.

Issue 2: Whether the Transfer of Shares was Sham or Unreal
The Tribunal concluded that the transfer of shares was not sham or unreal, holding that the transaction was between competent parties at the prevailing market price. However, the Court found that the transfer was a mere paper transaction with no real change in control or ownership. The Court emphasized the need to look beyond the form to the substance of the transaction, concluding that it was a sham designed to create a paper loss for tax purposes. This issue was answered in the affirmative and in favor of the Revenue.

Issue 3: Determination of the Market Price of the Shares
The Tribunal held that the market price of the shares was Rs. 25 based on evidence of other transactions. The Court disagreed, noting that the Income-tax Officer had rightly ascertained the break-up value of the unquoted shares, which was more than Rs. 25. This issue was also answered in the affirmative and in favor of the Revenue.

Issue 4: Capitalization of Interest Paid on Borrowed Funds
The Appellate Assistant Commissioner and the Tribunal allowed the interest paid on borrowed funds for the acquisition of shares to be capitalized and added to the cost of acquisition. The Court, however, held that the interest should be allowed as a deduction u/s "Other sources" and not be capitalized. This issue was answered in the affirmative and in favor of the Revenue.

Issue 5: Allowability of Short-term Capital Loss
The Tribunal upheld the short-term capital loss on the sale of shares. The Court, however, found that the loss was a paper loss created through a sham transaction. This issue was answered in the affirmative and against the assessee.

Conclusion:
Questions Nos. 2, 3, and 4 were answered in the affirmative and in favor of the Revenue. Question No. 5 was answered in the affirmative and against the assessee. The Court refrained from answering Question No. 1. There was no order as to costs.