AI Drafter 
TaxTMI 
TaxTMI 
2000 (5) TMI 173
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....ts completed on the appellant-companies, for the assessment year 1995-96. The assessments have been completed by the Asstt. Commissioner of I.T., Company Circle-4(5), Hyderabad, vide her separate proceedings under section 143(3) of the Income-tax Act, 1961, dated 27-3-1998. M/s. KNB Investments (P.) Ltd. has returned an income of Rs. 15,73,540 and M/s. KAR Investments (P.) Ltd. has returned an income of Rs. 23,63,720. The Assessing Officer made additions of Rs. 32,85,00,000 in the case of the former and Rs. 29,70,73,500 in the case of the latter and determined a total and taxable income of Rs. 33,00,73,540 and Rs. 29,94,37,220 respectively. It is against the above additions that the appellant-companies have preferred these second appeals before the Tribunal, as the first appeals were dismissed, and the additions confirmed by the learned CIT(A). 3. Dr. Reddy's Laboratories Ltd. is a company in which the appellant-companies have substantial investments as shares in the capital. The said company had made a preferential allotment of equity shares to the appellant-companies in the previous year relevant to the assessment year under appeal. M/s. KNB Investments (P.) Ltd. was allotted ....
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....tandard Equity Fund Ltd., Globe Organics Ltd., Diana Hotels, etc. 6. Dr. Reddy's Laboratories Ltd. convened an Extraordinary General meeting on 16-3-1994 to consider and pass certain important resolutions regarding matters like increasing the authorised share capital of that company, issue of bonus shares, issue of shares in international market for tapping NRI sources and named as Euro-issue for a sum not exceeding 75-million US Dollars and also among other things to offer shares of the company to its promoters. And in the matter of offering shares to its promoters, a special resolution was passed to offer and allot 22,50,000 Equity Shares of Rs. 10 each at a premium of Rs. 80 per share to the 'promoters group' consisting of Dr. Anji Reddy, Shri M.P. Chary, their family members and relatives, companies, trusts, AOPs formed or controlled by them. 7. On the basis of the above decision, the Board of Directors of Dr. Reddy's Laboratories Ltd., offered allotment of equity shares to the appellant-companies through their letters dated 25-4-1994. M/s. KNB Investments (P.) Ltd. made an application for 9,00,000 equity shares on 7-5-1994 and paid Rs. 90 lakhs as application money @ Rs.....
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....ition of shares through the above preferential allotment has been reflected in the Balance-Sheets of the two appellant-companies as on 31-3-1995 as investments in the shares of Dr. Reddy's Laboratories Ltd. We are concerned with the assessment year 1995-96 for which the relevant previous year is 1994-95. While examining the accounts of the appellant-companies in the course of assessments under section 143(3) of the Income-tax Act, 1961, the acquisition of shares on preferential allotment caught the special attention of the Assessing Officer. She found that the shares of Dr. Reddy's Laboratories Ltd. were quoted in Hyderabad Stock Exchange at Rs. 455 per share at the time of share applications made by the appellant-companies, whereas the preferential allotment of shares were made to the appellant-companies at Rs. 90 per share. She found that there is a difference of Rs. 365 between the quoted market price and preferential allotment price of a share. On a detailed examination of the facts and circumstances of the case, she came to a finding that the appellant-companies have derived benefits of Rs. 365 per share in the deal of preferential allotment; and that those benefits arose from....
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....t become income. Reliance, placed on CIT v. Bhavnagar Bone & Fertiliser Co. Ltd [1987] 166 ITR 316 (Guj.) and CIT v. General Electrodes & Equipments Ltd [1985] 155 ITR 78 (Bom.) 6. The profit on acquisition of shares made not for the purposes of dealing in them, would be on capital account and therefore, could not be treated as income. Reliance placed on Ramnarain Sons (P.) Ltd v. CIT [1961] 41 ITR 534 (SC), Kishan Prasad. & Co. Ltd v. CIT [1955] 27 ITR 49 (SC) and CIT v. National Finance Ltd [1962] 44 ITR 788 (SC). 7. Every benefit is not taxable Mere relief in expenses is not income. The reduction in the capital cost cannot be treated as income. Reliance placed on Acharya D.V. Pande v. CIT [1965] 56 ITR 152 (Guj.). 8. If the proposition of the Assessing Officer is to be accepted then the benefits arising to Shareholders and directors in the, Rights issue of shares by a company would be treated as income and brought to tax which is against the legislative intention discussed in CBDT Circular No., 710, dated 24-7-1995. 11. The Assessing Officer considered all the above objections in detail, but declined to accept them for the following reasons: 1. In Abbot's case cit....
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....tments when compared to others. 4. In all returns filed by the appellant-companies for the earlier years, the income of dividend and interest were declared under the head 'Profits and gains of business or profession'. They have been consistently showing NIL 'income from other sources'. Against the Dividends and interest income credited in the Profit and Loss Account, the appellant companies have been debiting all their expenses of business. Thr loss determined in the assessments has been claimed for the benefit of carry forward and set off. Auditors Report dated 23-12-1994 in para 3 sub-para (ix) observes that the companies have been dealing in shares. In the letter dated 6-10-1997, it has been stated that the principal business of the assessee-company is to deal in shares and securities of listed companies mainly in the nature of investment activity. Therefore, the contention by the appellant-companies that their only income is from 'other sources' and not from 'business' is clearly unfounded. 5. The main objects of the appellant-companies as set out in their Memorandum of Association are to carry on the business of investment, to acquire stocks and shares and to deal in the....
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....lenged in first appeals before the CIT(Appeals), the appellant-companies urged the following further grounds of objections in addition to the grounds already raised at the time of assessments- 1. The appellant companies were not in existence at the time of assessments as they ceased to exist with effect from 1-10-1994, when they merged into Dr. Reddy's Holdings Ltd. as a result of amalgamation. Therefore, the impugned assessments are void ab initio and liable to be quashed. Reliance placed on CIT v. Express Newspapers Ltd. [1960] 40 ITR 38 (Mad.). 13. The learned CIT(Appeals) examined this ground in detail and held that the assessments are valid in view of the provisions contained in section 292B, read with section 170(2) of the Income-tax Act, 1961. 14. On the other grounds, invariably raised before the Assessing Officer also, the learned CIT Appeals made the following findings- 1. As per the Memorandum and Articles of Association, the main objects of the a appellant-companies were (a) to carry on the business of investment, (b) to assist or aid in promoting companies; and (c) to buy and sell moveable assets of all kinds. 2. In the merger petition filed before the H....
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....panies, who are non-existing and therefore, the assessments are void ab initio and bad in law. The third ground relates to the contention that the CIT (Appeals) has erred in confirming the assessment treating the benefit as taxable in the impugned assessment year 1995-96 instead of the assessment year 1994-95. Any how, at the time of hearing Shri S.E. Dastur, the learned Senior Counsel, informed the Court that these two grounds are not pressed any more. In the circumstances, ground Nos. 1 and 3 relating to the legal objection and the assessment year respectively are dismissed as not pressed. 17. The remaining effective grounds to be considered in these appeals are concerning- (i) The real issue of applicability of section 28(iv) of the Income-tax Act, 1961; (ii) Alternatively the question of valuation of the benefit; and (iii) Chargeability of interest under sections 234B and 234C. These issues are contained in Ground Nos. II, IV and V respectively stated in the grounds of appeals filed before us. 18. The principal ground No. II reads as follows- "Ground II 1. The CIT(Appeals) erred In confirming the action of the Asstt. Commissioner of Income-tax Company Ci....
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....g of investments' specifically used in section 23A of Indian Income-tax Act, 1922 and confers companies whose primary or principal source of income is house property or capital gains as well; (j) mere fact that the company was incorporated to carry on business of investments did not show that it was carrying on business; (k) the mere holding of shares as, investment could not amount to business within the meaning of the term business used in the Income-tax Act, (l) the Appellant was not the promoter of DRL and they had never rendered any services in connection with the formation or promotion of the company and that it had never aided in promoting DRL; (m) the onus to prove that the transaction was an adventure in trade or business was on the department and that the ACIT had failed to prove the same; (n) it is a settled law that the Memorandum is not conclusive proof for or against the activity carried by the assessee; (o) the issue of the said equity shares in, DRL on preferential basis to the Appellant was on capital account and not on revenue account; (p) there was no benefit or perquisite arising on account of issue of preferential equity shares in DRL; (....
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....ns 234B and 234C of the Act. 3. The Appellant prays that the levy of interest of Rs. 10,88,10,331 under section 234B and Rs. 4,649 under section 234C be deleted." 21. Let us first examine the ground whether section 28(iv) of the Income-tax Act, 1961 is applicable in these case or not. Shri S.E. Dastur, the learned Senior Counsel for the companies dealt with the issue in an extensive manner. He explained the legal situation that the appellant-companies would be caught in the web of section 28(iv) only if all the following circumstances are satisfied with reference to the appellant-companies and their acquisition of shares through preferential allotment. While explaining the circumstances, the learned Senior Counsel first took us to the provisions of section 28 of the Act with special reference to clauses (i) and (iv) thereof. They read as follows: "28. The following income shall be chargeable to income-tax under the head 'profits and gains of business or profession'- (i) the profits and gains of any business or profession which was carried on by the assessee at any time during the previous year; (iv) the value of any benefit or perquisite, whether convertible into mon....
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....even after the Euro-issue. But for the preferential allotment, this would not have been possible. As the only intent and purpose of preferential allotment was to retain the group control in the share-holding of Dr. Reddy's Laboratories Ltd., the allotments were made to the appellant-companies, M/s. KNB Investments (P.) Ltd. and M/s. KAR Investments (P.) Ltd. It could not have been allotted to the public at large through market as argued by the Revenue, as that would defeat the very purpose of preferential issue itself. The appellant-company, also had no intention to procure the shares of Dr. Reddy's Laboratories Ltd. from the market. Therefore, the preferential allotment of shares does not partake the character of a business transaction. As the event was not a business transaction, the provisions of section 28(iv) would not apply. The appellant-companies have not been carrying on any business. They were only holding the shares of group companies. They had not dealt in the purchase and sale of shares and securities. The entire income of the appellant-companies during the previous year comprised only of dividends and interest. They have not invested in the shares of any outside compa....
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....ture of business, the learned Senior Counsel further argued that no benefit has arisen to the appellant-companies by way of preferential allotment of shares. The shares allotted to appellant-companies could not be sold for a lock-in period of three years. That was a mandatory condition of preferential issue. The share issue has been made observing all the provisions of the Companies Act, 1956 and the SEBI Regulations. It has been done in accordance with all the existing laws and regulations. The preferential allotment of shares was not a manipulative scheme. There was no secret agenda. Everything was transparent. The allotted shares were not quoted in the stock exchange. It cannot be sold for three years. As such, it is very absurd to presume that the shares are comparable to the market value of shares quoted in the stock exchange. The so-called benefit presumed by the Department could be crystallised only if the shares could be sold on the date of allotment. If those shares could not be sold in the market, there is no market value for those shares issued through preferential allotment. Therefore, there is no meaning in comparing the issue price of Rs. 90 per share to the market pr....
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....th the Valuation Report. Therefore, there could not be any benefit for the appellant-companies in acquiring shares at Rs. 90 per share. 26. Without prejudice to contentions noted above, the learned Senior Counsel further submitted that if at all there was any benefit arising to the appellant-companies, that was not in the nature of income contemplated in section 28 of the Income-tax Act as the benefit would be capital in nature and not revenue. He contended that the acquisition of shares was made for the purpose of Management Control and not for the purpose of any trading or business. Therefore, those shares are in the nature of capital and not stock-in-trade. Therefore, any benefit arising out of such capital asset would only be capital in nature. Therefore, the same could not be a subject-matter of discussion under section 28(iv) of the Income-tax Act, 1961. 27. He also submitted that cash payments are outside the purview of section 28(iv) of the Income-tax Act. He contended that none of the circumstances necessary to invoke section 28(iv) existed in the present case, and therefore, the whole exercise of the Assessing Officer was quite uncalled for. He stated that the manda....
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....ation of the appellant-companies. 5. The option sale agreement with Margadarsi was a loan transaction coupled with security and concluded as a loan transaction with interest at a rate 12.5%. 6. Facilitating the obtaining of a loan by Dr. Reddy's Laboratories Ltd. in the past by pledging shares of Dr. Reddy's Laboratories held by the appellant-companies was not a business transaction as no fee was charged. 7. Admittedly the shares even as per the Assessing Officer are capital assets at all points in time. Thus any 'benefit' if any could only be on capital account which would be taxed when the shares were transferred. The shares of Dr. Reddy's Laboratories Ltd. were never purchased from the open market but acquired by way of subscription, rights, bonus etc. 8. Where assets are purchased with a view to obtaining control whether with borrowed funds or not, the profit from the sale of those assets would be on capital account and it would not amount to a business activity. Reliance is placed on the following decisions- (a) Bengal & Assam Investors Ltd. v. CIT [1966] 59 ITR 547 (SC); (b) Rameshwar Prasad Bagla v. CIT [1973] 87 ITR 421 (SC); and (c) CIT v. H. Holck Lar....
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....cannot be assessed under section 28(iv). Reliance is placed in this behalf on the following decisions- (a) Comfund Financial Services (I) Ltd v. Dy. CIT [1998] 67 ITD 304 (Bang.) (b) Smt. Chetanaben B. Sheth 's case. 15. The decision of the Hon'ble Rajasthan High Court cited by the learned Departmental Representative in CIT v. R.L Kasliwal [1994] 207 ITR 208 is clearly distinguishable as in that case, the appellant had himself returned an amount of Rs. 4,000, under section 28(iv). The only question was whether in view of the expenditure expended by the firm on renovation of the premises it would be enhanced to Rs. 9,000. It was primarily a case of valuation of the benefit. Also, it was a case where a tangible benefit was received by an assessee, and not a case where assets are purchased at a lesser price. 16. The issue of shares at a lesser price would have normally resulted in a liability to gift-tax in the hands of Dr. Reddy's Laboratories and just because the provisions of the Gift Tax Act was not applicable (see section 45 of the Gift Tax Act) to Dr. Reddy's Laboratories Ltd., being a company the shares of which are quoted on the stock market cannot mean that a liab....
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....inute books reflecting the proceedings in Annual General Meetings, where the business carried on and the business prospects might have been discussed by the members of the companies were fabricated to suit the convenience of the appellant-companies. The appellant-companies stated before the Hon'ble High Court of Andhra Pradesh through various petitions and affidavits and statements made in the context of amalgamation proceedings that the appellant-companies have been carrying on business in investment. The appellant-companies have been filing their returns of income for an the assessment years under the head 'profits and gains of business or profession', and at no point of time, the appellant-companies had raised any contention that they were not carrying on business. The learned Departmental Representative submitted that the Assessing Officer has extensively dealt with this matter and has clearly established that the appellant-companies have been carrying on business as investment companies. The learned Departmental Representative also pointed out the benefit enjoyed by the appellant-companies, by availing the facility of preferential allotment of shares. He submitted that the sha....
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.... learned Departmental Representative submitted that the present cases coming under the circumstances explained by the learned senior counsel for the assessee, are clearly caught in the web of section 28(iv) of the Income-tax Act, 1961. The appellant companies, according to him have derived benefit coming under section 28(iv) of the Act. He submitted that the conditions necessary for attracting clause (iv) of section 28 have been satisfied in these cases, in the following manner- (i) That the appellant-companies had carried on business of dealing in investments during the previous year; (ii) That the appellant-companies have derived benefit out of the transactions in question; (iii) That the benefits derived by the appellant-companies have arisen from the business carried on by them; (iv) That the benefits have arisen to the appellant-companies in the business transaction which the appellants had with M/s. Dr. Reddy's Laboratories Ltd. (iv) That there is no legal compulsion to examine the question whether the benefit derived by the appellant-companies is of capital or revenue nature. 30. The learned Senior Departmental Representative has filed a synopsis of the Dep....
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....es. This benefit, it is stated is analogous to the benefit construed in section 17(2)(iii) of the Income-tax Act, 1961. As per the CBDT Circular No. 710 dated 21-1-1995, where an employee is allotted shares in the company at less than the market value, the difference between the market value and issue price is assessable as benefit under that section. This has now been incorporated as section 17(2)(iiia) with effect from 1-4-2000. The benefit under section 28(iv) is analogous. The lock-in period prescribed in the share issue in the present cases does not take away the benefit enjoyed by the appellants in these cases. There is thus, accretion to the net worth of the appellant-companies and such accretion has come at a cheaper rate compared to the cost of acquisition of shares at the market rates. The credit rating agencies generally treat such benefit as secret reserve. 4. On the aspect of the Department's contention that the benefit in question has arisen from a business transaction, it is pointed out that the purchase of the preferential shares was just one other investment transaction of the appellant-companies in the business of holding investments, and therefore, the benefit....
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....otment made by Dr. Reddy's Laboratories Ltd. The prevailing market price at that time was Rs. 455 per share. The differential price is Rs. 365 per share. Whether this price differential availed by the appellant-companies amounts to benefit arising from business or not, is the issue to be decided in these appeals. 33. The shares on the basis of preferential allotment were made over to the appellant-companies on 10-5-1994. The issue price was Rs. 90 per share; the face value of the share was Rs. 10; and the premium of Rs. 80 per share. An examination of certain contemporaneous facts relating to the share value of Dr. Reddy's Laboratories would be interesting at this stage. M/s. Dr. Reddy's Laboratories Ltd. had obtained a share valuation report, prepared by M/s. C.C. Chokshi & Co., Mumbai. The said Report dated 19-9-1994 was prepared on the basis of the State of affairs of M/s. Dr. Reddy's Laboratories as on 31-3-1994. The valuation report was obtained in the context of the amalgamation scheme of M/s. Standard Equity Fund Ltd. and Dr. Reddy's Laboratories Ltd. with effect from 1-4-1994. -The report is available from pages 60 to 101 of appellants' paper-book Vol. I. The shares have....
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....hare on a comparison of issue price of Rs. 90 per share with the market price of Rs. 455 per share. There is no such benefit where the comparison is between the issue price and the net worth value. The case of 'benefit' is attempted on a comparison of the issue price and market price. The contemplated benefit is a price saver in a context when the issue price is compared to the then prevailing market rate. Or the contemplated benefit is relative in nature; relative to the prevailing market price. Even in circumstances where the issue price is compared to the market price, there need not be such a relative benefit in all cases. In paragraph 33 above, we have seen the market price fluctuation in the case of Dr. Reddy's Laboratories Ltd. shares. The share value was Rs. 62.50 per share in the market in the third quarter of 1992. If the present issue price of Rs. 90 per share is compared to the then prevailing market price of Rs. 62.50 per share, it is obvious that there could be no benefit or advantage. Therefore, the advantage or benefit on the basis of a comparative price saver is subject to the market price prevailing on a particular day. 36. Where the benefit is related to the p....
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.... was holding a percentage of more than 25 in the equity of Dr. Reddy's Laboratories Ltd., and they could retain or maintain the same level of holding only because of the preferential issue of shares. If there was no such preferential allotment, the group's holding would have come down to less than 25%, to be precise at 22.77%. As pointed out by the learned CIT(A), the promoters' group never had a 51% shareholding in Dr. Reddy's Laboratories Ltd. so as to claim a majority and to stall any possible take over bid. But, as rightly argued by Shri S.E. Dastur, the learned Senior Counsel for the appellants, the minimum holding of at least 25% always helped the promoters' group to block the passing of any special resolution proposed by any hostile group at any point of time, as passing of Special Resolution needed a minimum of 75% of voting power. It means, the promoters could retain their control over the management of the company even after the Euro-issue. There should not be a misconception regarding the majority shareholding and the effective group control in the management of Dr. Reddy's Laboratories Ltd. An absolute majority in the shareholding having more than 50% of voting power is....
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....o contemplation of any immediate sale of shares. This is the factual aspect. Legally also, the appellant-companies could not sell those shares before the expiry of a lock-in-period of three years. One of the mandatory conditions of preferential issue of shares was a compulsory lock-in period of three years, and as a matter of fact, that lot of shares allotted through preferential issue was not quoted in the stock-market, as it could not be. 39. As seen in the above paragraphs, one of the main objects of preferential issue of shares was to retain the group control in Dr. Reddy's Laboratories Ltd. Therefore, Dr. Reddy's Laboratories Ltd. could not have offered the shares to public at large. That would defeat the purpose itself. The shares cannot be quoted in the market because of the compulsory lock-in-period of three years. Therefore, those shares were not quoted in the market. In the circumstances, those shares that could not be quoted in the market, cannot be a subject matter of comparison with the existing shares already quoted and traded in the stock market. There is no basis or justification in making a comparison between unequals. Such a comparison is hypothetical. 40. T....
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....it that he might have, but had not made. If Mason's case was decided in this country, the decision would be the same as that of Court of Appeals, for the principle of leaving out of assessment any potential advantage, benefit or gain was firstly established by the Hon'ble Supreme Court in Smt. Kikabhai Premchand's case. 42. The above principle is in no way overlooked in the provisions contained in section 28 of the Income-tax Act, 1961. For the purpose of our discussion, the relevant portion of section 28 is quoted below: "28. The following income shall be chargeable to income-tax under the head "profits and gains of business or profession"-- (iv) the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession......... The statute has listed about six items of income chargeable to tax under section 28. The opening words are "The following income shall be...'. The words are not "The following items shall be...'. The word 'income, is very important and purposeful. All the six different items should satisfy the character of 'income' so as to be taxed under section 28. Those six items as such are not suffi....
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....templated in section 28(iv) of the Income-tax Act, 1961. 44. On the basis of our discussion of the issue in paras 33 to 45 above, we have come to the following findings- (i) That the alleged benefit is a 'comparative benefit'. It is an advantage, relative in nature.--Paras 33 to 35. (ii) That there is no justification or sustainable basis for a comparison between issue price and market price. Such a comparison would only be hypothetical. - Paras 34 to 40. (iii) That the benefit the appellant-companies might derive would be an eventual capital gain on the sale of shares after the lock-in period of three years. That prospective benefit is again uncertain.--Para 41. (iv) That the benefit should be in the nature of income arising in the relevant previous year; it should be real income in the present and not a prospective income of future.--Paras 42 to 45. (v) In fact the market price is applicable only to those shares quoted and traded in the market. It is not applicable to those shares that could not be quoted and traded in the market. For such shares, the correct method of valuation is break-up value method. In the present case, the break-up value and the preferenti....