2008 (11) TMI 16 - SC - Income Tax

Allotment of rights shares is creation of shares, not a transfer; no gift under Section 2(xii); renouncers liable

SC held that allotment of rights shares constitutes creation of shares, not a transfer, so no gift arose under Section 2(xii) on allotment; liability for ... Gift Arising from Rights Issue Allotment - Element of 'gift' as defined u/s 2(xii) in issuing Bonus shares - evasion of tax - difference between 'allotment' and 'renunciation' - Whether any 'gift' arose in terms of Section 2(xii) of the Gift-tax Act on the allotment of rights issue by the company to its shareholders - HELD THAT:- In our view, the judgment of this Court in Sri Gopal Jalan & Company [1963 (5) TMI 30 - SUPREME COURT] squarely applies to the present case. There is a vital difference between 'creation' and 'transfer' of shares. As stated, the words 'allotment of shares' have been used to indicate the creation of shares by appropriation out of the unappropriated share capital to a particular person. A share is a chose in action. A chose in action implies existence of some person entitled to the rights in action incontradistinction from rights in possession. There is a difference between issue of a share to a subscriber and the purchase of a share from an existing shareholder. The first case is that of creation whereas the second case is that of transfer of chose in action. In this case, when twenty shareholders did not subscribe to the rights issue, the appellant allotted them to the seven investment companies, such allotment was not transfer. In the circumstances, Section 4 (1)(a) was not applicable as held by the Tribunal. As stated above, in this case, even according to CIT(A), the right shares were allotted to the seven investment companies because the other existing shareholders did not subscribe for the shares. According to CIT(A), the gift tax proceedings ought to have been initiated against the existing shareholders, who had renounced their rights. We are surprised that despite the orders passed by CIT(A), the Department did not initiate proceedings under the Gift-tax Act against the shareholders who had renounced their rights, particularly when the CIT(A) has specifically said so in her order. For the aforestated reasons, we hold that the word 'allotment' indicates creation of shares by appropriation out of the unappropriated share capital to a particular person and that such creation did not amount to transfer. That, in any event, liability to pay gift tax would be on the donor (shareholder) who exercises the option to renounce and not on the appellant-company. Accordingly, question no. 1 is answered in favour of the appellant and against the Department. Element of 'gift' - HELD THAT:- According to the Department, the market value of the said shares and the yield from the said shares were totally disproportionate to the investments made by the seven investment companies. Therefore, according to the Department, the modus operandi adopted by the appellant was an exercise in tax evasion. As stated, we do not know the reason why the Department had not proceeded under the Income-tax Act, 1961 if, according to the Department, the case was of tax evasion. According to the CIT(A), the appellant had undertaken an exercise to avoid wealth tax whereas according to the A.O. the exercise undertaken by the appellant was to evade Gift Tax and in the same breadth the A.O. states that the entire exercise was to evade tax by allotting shares to the Directors which attracted the deeming provisions of Section 2(22) of the 1961 Act. There is utter confusion on this aspect. Therefore, in our view, on the question of evasion of tax, the contention of the Department is conflicting. In fact, as stated above, the Department has messed up the entire case. The Department has not kept in mind the difference between 'allotment' and 'renunciation'. The Department has not invoked the provisions of the Gift-tax Act against the renouncer shareholder despite the observation of the CIT(A) in that regard. The impugned judgment of the High Court is set aside and the civil appeal filed by the assessee stands allowed Issues: (i) Whether allotment of rights issue amounted to a 'gift' within Section 2(xii)/Section 4(1)(a) of the Gift-tax Act, 1958; (ii) Whether issuance of bonus shares (ratio 1:23) involved an element of 'gift' under Section 2(xii) of the Gift-tax Act, 1958.Issue (i): Whether the allotment of right shares to existing shareholders/investment companies constituted a transfer or a creation attracting gift-tax under Section 4(1)(a) of the Gift-tax Act, 1958.Analysis: The concept of 'allotment' denotes appropriation out of unappropriated capital and results in creation of shares which did not exist prior to allotment. A distinction exists between issuing new shares (creation) and transferring existing shares (transfer of chose in action). Renunciation by a shareholder may, in certain factual settings, create a transferable existing right; liability under the Gift-tax Act normally lies on the donor (renouncer) rather than on the company effecting allotment. Prior authority establishes that initial allotment creates shares and is not a transfer of existing property; therefore Section 4(1)(a) is not attracted on allotment to the company as donee in these facts.Conclusion: Allotment of right shares in the facts before the Tribunal did not amount to a 'gift' under Section 4(1)(a) and Section 2(xii) of the Gift-tax Act, 1958; conclusion is in favour of the assessee and against the Revenue.Issue (ii): Whether issuance of fully paid bonus shares (capitalisation of reserves) to shareholders constituted a gift under Section 2(xii) of the Gift-tax Act, 1958.Analysis: Bonus shares represent capitalization of undistributed profits and are a redistribution within the companys capital structure rather than a distribution of assets to shareholders. The issuance increases share certificates but does not release company assets to shareholders; the proportional interest remains the same and the market/intrinsic value of holdings is adjusted. Authorities recognize bonus shares as capitalization and not a distribution yielding taxable gift.Conclusion: Issuance of bonus shares in the stated ratio did not constitute a 'gift' under Section 2(xii) of the Gift-tax Act, 1958; conclusion is in favour of the assessee and against the Revenue.Final Conclusion: The impugned decision taxing the company for allotment of right shares and for issuance of bonus shares is set aside; the legal effect is that neither the allotment of rights nor the bonus issue, on the facts before the adjudicating authorities, gives rise to gift-tax liability on the company.Ratio Decidendi: Allotment of shares from unappropriated capital constitutes creation (not transfer) of shares and bonus shares are capitalization of reserves; consequently neither allotment nor bonus issue, in the described facts, attracts gift-tax under the Gift-tax Act, 1958.