Share sale to subsidiary not a transfer under IT Act - Capital loss claim denied

The ITAT held that the transaction of selling shares to a second step-down 100% subsidiary does not qualify as a transfer under section 47(iv) of the Income Tax Act. Consequently, the assessee's claim of capital loss was denied, and the AO's computation of capital gain based on fair market value was deemed irrelevant. The appeal of the assessee was partially allowed, dismissing the capital loss claim and acknowledging the nature of the transfer. The decision was pronounced on 28-02-2018.

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Issues Involved:
1. Whether the CIT-A was justified in confirming the AO's determination of long-term capital gain at Rs. 29,05,83,769/- against the assessee's claim of long-term capital loss of Rs. 25,05,20,775/-.
2. Whether the transaction in question qualifies as a transfer under section 47(iv) of the Income Tax Act.
3. Whether the AO can substitute the sale consideration of shares with the fair market value (FMV) as computed by him.

Issue-wise Detailed Analysis:

1. Determination of Long-Term Capital Gain vs. Long-Term Capital Loss:
The assessee, a company, filed its return of income for the A.Y. 2010-11 declaring a total income of Rs. 88,79,544/-. The AO determined the total income at Rs. 29,99,30,657/- after examining the sale of 2,86,329 equity shares of Zandu Realty Ltd. The assessee claimed a long-term capital loss of Rs. 25,05,20,775/- based on the sale consideration of Rs. 60,12,90,900/- and the cost of acquisition Rs. 85,05,20,775/-. The AO found discrepancies in the sale price and determined the long-term capital gain at Rs. 29,05,83,769/- by considering the average market price of Rs. 3989.80 per share as on 31-03-2010. The AO rejected the assessee's valuation based on a report by SSKM Corporate Advisory Pvt. Ltd. and concluded that the sale price was not at arm's length due to the related party transaction.

2. Applicability of Section 47(iv) of the Income Tax Act:
The assessee argued that the transaction should not be regarded as a transfer under section 47(iv) of the Act, as it involved a transfer to a 100% subsidiary. The CIT-A rejected this claim, stating that the benefit of section 47(iv) is not available for transfers to a subsidiary of the subsidiary company, referencing the Gujarat High Court decision in Kalindi Investments Pvt. Ltd. The ITAT, however, preferred the Bombay High Court's decision in Petrosil Oil Co. Ltd., which considered a second step-down subsidiary as a subsidiary under the Companies Act. Thus, the ITAT concluded that the transaction is not regarded as a transfer under section 47(iv) of the Act.

3. Substitution of Sale Consideration with Fair Market Value:
The AO substituted the sale consideration with the FMV of Rs. 3989.80 per share, arguing that the market price on the stock exchange is the fair value. The CIT-A upheld this view, citing that the shares were sold at a significantly lower price to a related party, and the provisions of section 45(2A) were not applicable as the shares were acquired on demerger. However, since the ITAT concluded that the transaction is not regarded as a transfer under section 47(iv), the issue of substituting the sale consideration with FMV became academic and was not adjudicated.

Conclusion:
The ITAT held that the transaction of sale of shares to the second step-down 100% subsidiary is not regarded as a transfer under section 47(iv) of the Act. Consequently, the assessee's claim of capital loss cannot be allowed, and the AO's computation of capital gain based on FMV is rendered academic. The appeal of the assessee is allowed in part, dismissing the ground related to capital loss and allowing the ground related to the nature of the transfer.

Order Pronounced:
The appeal of the assessee is allowed in part, with the decision delivered on 28-02-2018.

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