2007 (10) TMI 288 - HC - Income Tax

Court rules bonus shares not funds invested by trust. Specific entity shares impact substantial interest calculation. Trust not exempt under Income-tax Act.

The court ruled in favor of the assessee-trust regarding the issue of bonus shares not being considered as funds invested by the trust. However, the court ... Bonus shares are not 'funds of the trust' for the purposes of section 13(4) - substantial interest in a company determined by aggregate holding of persons described in section 13(3) - application of section 13(2)(h) where trust funds are invested in a concern in which prohibited persons have substantial interest - status of Hindu Undivided Family (HUF) shareholding vis-a -vis persons prohibited under section 13(3) - beneficiaries (including unborn beneficiaries) specified in a trust deed constitute identifiable persons for section 13(3)Bonus shares are not 'funds of the trust' for the purposes of section 13(4) - Bonus shares received by the trust do not represent funds of the trust invested in the concern for the purposes of section 13(4). - HELD THAT: - The court followed earlier decisions of this court holding that bonus shares received by a trust cannot be treated as funds invested by the trust within the meaning of section 13(4). On that authority the question whether bonus shares fall within the definition of invested funds was answered in the assessee's favour. [Paras 8]Answered in the affirmative for the assessee; bonus shares excluded from computation under section 13(4).Status of Hindu Undivided Family (HUF) shareholding vis-a -vis persons prohibited under section 13(3) - Shareholding by HUFs cannot be treated as shareholding by persons described in section 13(3) for computing substantial interest. - HELD THAT: - The court held that section 13(3) does not include an HUF as such within the prohibited categories. An HUF is a distinct taxable legal entity and the statute does not contemplate piercing that entity to treat the HUF's shares as attributable to individual members mentioned in section 13(3). Consequently the shares held by the six HUFs were not to be included when determining whether persons under section 13(3) had a substantial interest in MMBL. [Paras 12]HUF shareholdings excluded from computation of persons under section 13(3).Beneficiaries (including unborn beneficiaries) specified in a trust deed constitute identifiable persons for section 13(3) - application of section 13(2)(h) to shares held by trusts when trustees hold for named beneficiaries - Shares held by trusts (where trustees hold for specified beneficiaries, including unborn beneficiaries) are attributable to persons described in section 13(3). - HELD THAT: - Relying on this court's reasoning in Brig. Kapil Mohan, the court held that a valid trust identifying beneficiaries - even if the beneficiary is to be born in future - satisfies the requirement of certainty of beneficiaries. Trustees holding shares for such specified beneficiaries cannot be said to hold for no one; therefore the shares held by the trusts fall within the ambit of persons described in section 13(3) and must be counted for determining substantial interest under Explanation 3 to section 13. [Paras 14, 15, 16, 17]The three lakh shares held by the trusts are to be treated as held by persons within section 13(3) and included in the computation of substantial interest.Application of section 13(2)(h) where trust funds are invested in a concern in which prohibited persons have substantial interest - Shareholding of relatives (here, Bakshi Sampuran Singh and his sons) is attributable under section 13 and must be included in computing the aggregate to determine substantial interest. - HELD THAT: - The court rejected the Tribunal's reasoning that the spouse would cease to be a spouse on the death of her husband; the relationship of 'relative' as defined for section 13 persists and the shares held by Bakshi Sampuran Singh and his sons (being relatives) must be included. After adding these and the holdings attributable to trustees (and excluding HUF holdings as noted), the aggregate exceeds twenty per cent. of the paid-up share capital of MMBL, thereby establishing substantial interest of persons described in section 13(3). [Paras 18, 19]The relative's shareholding must be included; aggregate shareholding of persons under section 13(3) exceeds twenty per cent.Application of section 13(2)(h) where trust funds are invested in a concern in which prohibited persons have substantial interest - substantial interest in a company determined by aggregate holding of persons described in section 13(3) - Dividend income of the assessee-trust is not eligible for exemption under sections 11 and 12 because persons described in section 13(3) have a substantial interest in MMBL. - HELD THAT: - Taking the concluded positions together - bonus shares excluded for section 13(4), HUF holdings excluded, but shares held by the specified trusts and by relatives included - the court found that the prohibited categories of persons hold more than twenty per cent. of the paid-up capital of MMBL. Consequently the condition in section 13(2)(h) is satisfied and the trust's dividend income cannot be exempted under sections 11 and 12 for the assessment years in question. [Paras 19, 20, 21]For 1976-77 and 1977-78 the provisions of section 13(2)(h) apply and the dividend income is not exempt under sections 11 and 12.Final Conclusion: For AY 1976-77 and AY 1977-78 the references are disposed as follows: bonus shares are excluded from being treated as invested funds under section 13(4) (in favour of the assessee); however, on the facts the aggregate shareholding of persons described in section 13(3) (after including shares held by certain trusts and relatives but excluding HUF holdings) exceeds twenty per cent., so that section 13(2)(h) applies and the trust's dividend income is not entitled to exemption under sections 11 and 12. No order as to costs. Issues Involved:1. Whether bonus shares received by the assessee-trust represent funds of the trust invested in the concerned company for the purposes of section 13(4) of the Income-tax Act.2. Whether the prohibited category of persons mentioned in section 13(3) had substantial interest in the concerned company in which the funds of the assessee-trust were invested, thereby attracting the provisions of section 13(2)(h).3. Whether the assessee-trust was entitled to exemption as stipulated under sections 11 and 12 of the Income-tax Act.Issue-wise Detailed Analysis:1. Bonus Shares and Section 13(4):The court examined whether the bonus shares received by the assessee-trust represented funds invested by the trust in the concerned company for the purposes of section 13(4) of the Income-tax Act. It was noted that the decisions in CIT v. Sir Shri Ram Foundation and CIT v. Sir Sobha Singh Public Charitable Trust established that bonus shares received by a trust cannot be considered as funds invested by the trust. Consequently, the court answered this issue in the affirmative, favoring the assessee and against the Revenue for both assessment years 1976-77 and 1977-78.2. Substantial Interest and Section 13(2)(h):The court had to determine if the prohibited category of persons mentioned in section 13(3) had substantial interest in the concerned company (MMBL) in which the funds of the assessee-trust were invested, thus invoking section 13(2)(h). The relevant provisions of the Income-tax Act were examined, particularly the definitions and implications of substantial interest.For the assessment year 1976-77, the Tribunal concurred with the Commissioner of Income-tax (Appeals) that the bonus shares and shares received by way of donation should be excluded for the purposes of section 13(4). It was also agreed that the shares held by six HUFs and five trusts should be excluded when calculating substantial interest. The Tribunal concluded that the prohibited categories of persons did not possess substantial interest in MMBL, thereby not invoking section 13(2)(h).However, the court disagreed with the Tribunal's findings regarding the exclusion of shares held by HUFs and trusts. It was argued that the HUFs, being separate taxable entities, should not be considered as falling within the prohibited categories of persons. The court found this reasoning flawed and held that the shares held by HUFs should indeed be considered. Additionally, the court referenced CIT v. Brig. Kapil Mohan to argue that even if the beneficiaries of the trusts were unborn, the shares held by the trustees were still for the benefit of specific individuals, thus falling within the purview of section 13(2)(h).The court concluded that the shares held by the trusts and the shares held by Bakshi Sampuran Singh and his sons should be included in the calculation. This brought the total shareholding of prohibited persons to over 20% of MMBL's total paid-up capital, thus invoking section 13(2)(h).3. Entitlement to Exemption under Sections 11 and 12:Given the findings on the substantial interest issue, the court concluded that the dividend income of the assessee-trust could not be exempted from tax under sections 11 and 12 of the Act for the assessment year 1976-77. The court answered questions (2) and (3) in the negative, favoring the Revenue and against the assessee.For the assessment year 1977-78, the court followed a similar reasoning, answering question (i) in the affirmative (favoring the assessee) and question (2) in the negative (favoring the Revenue).Conclusion:The court disposed of the two references accordingly, with no order as to costs.