TaxTMI 
TaxTMI 
2010 (11) TMI 718
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....loan. The resolution further provides that three of RCILs directors and the Dy. Company secretary of RCIL are authorized to negotiate, finalise and settle the terms and conditions of the borrowing including offering of security of the equity shares held by RCIL in RIC and to sign all documents/agreements/writing/papers as may be necessary with regard to the above loan. The Assessee did not participate in the said meeting as he was a person concerned and/or interested in the resolution. 4. On 13.3.2004, RCIL addressed a letter to the Assessee requesting for a loan of Rs.50 crores. On 15.3.2004, the Assessee expressed his willingness to provide interest free loan of Rs.50 crores for a temporary period. 5. On 17.3.2004, RCIL informed the Assessee that it was willing to pledge 50 crores equity shares of Re.1/-each of RIC owned by it as security for the loan to be advanced by the Assesee. 6. On 23.3.2004 and 24.3.2004, the Assessee disbursed a sum of Rs.50 crores to RCIL. 7. RCIL held shares of RIC in physical form. On 25.3.2004, RCIL dematerialized the shares held by it in physical form through a depository participant Reliance Capital Ltd. The c....
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....4, RCIL by its letter proposed to repay the aforesaid loan on 14.5.2004. On 12.5.2004, the Assessee gave a delivery instruction slip to its depository participant HDFC Bank Ltd. for transferring 50 crores equity shares of RIC to RCIL. Accordingly on 12.5.2004, the shares in question were retransferred to the account of RCIL with its depository participant Reliance Capital Ltd. The loan was also discharged by RCIL. 12. The fact that the Assessee gave loan to RCIL on the security of pledge of shares of RIC and the fact that the said loan was discharged by payment was duly recorded in the books of accounts/Annual Accounts of RCIL. 13. According to the AO there was a transfer by way of sale of 50 crores shares of RIC of the face value of Re.1/- by RCIL to the Assessee on 31.3.2004 when the Demat Account of the Assessee held with the Depository Participant, HDFC Bank Ltd., the Client's ID of the Assessee being 42646206 and Depository IDNo. being IN300476 was credited with 50 Crores shares of face value of Re.1/- of RIC from the Demat account of RCIL bearing ID No.10011366 with the Depository Participant Reliance Capital Ltd. According to the AO there was a necessity ....
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....way of sale of 50 Crores shares of RIC to the Assessee at a price of Re.1/- per share although their market value was Rs.53.71 per share on the date of transfer to enable the Assessee to increase his equity share holding in RIC. 14. In the course of assessment proceedings the AO called upon the Assessee to show cause as to why the difference between the value of the shares and the value at the which the Assessee purchased the shares of RIC should not be assessed as deemed income u/s.2(24)(iv) of the Act. The Assessee put forth a plea before the AO that the transaction in question was a pledge of shares by RCIL to the Assessee as security for a loan of Rs.50 crores that the Assessee had given to RCIL. The Assessee narrated the above sequence of events which we have set forth in the earlier paras 2 to 12 of this order. 15. The Assessing Officer called for information u/s.133(6) of the Act, from Reliance Capital Ltd., the depository participant with whom RCIL held shares of RIC in demat form, prior to the Assessee being recognized as the beneficial owner of 50 crores shares of RIC as to whether RCIL had applied for creation of pledge of 50 crores shares, whether it....
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....the pledge. 3. The purported transaction of loan of Rs.50 crores is not supported by any contemporaneous third party evidence nor is it grounded on commercial reality. In this regard the AO pointed out that the Registrar of Companies was informed only on 28.12.2004 about the fact that RCIL was the beneficial owner of 50 crores shares of RIC though the Assessee was shown as the beneficial owner in the register of Depository Participant. RIC had to file such a return within 30 days from 31.3.2004 the date of the pledge but had filed the return only on 28.12.2004. 4. It was unusual for a borrower to offer shares worth Rs.2685 crores as security for a paltry loan of Rs.50 crores. 18. The Assessee by its reply dated 20.12.2006 pointed out that 1. The order of performance of a contract is not relevant as long as the same is performed by both the parties to be transaction. The Assessee pointed out that there was nothing wrong in first giving the loan and then taking security for the loan. The Assessee also pointed out that when the loan was given, the shares were in physical form and had to be dematerialized and hence after dematerialization the sam....
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.... If a beneficial owner intends to create a pledge on a security owned by him, he shall make an application to the depository through the participant who has his account in respect of such securities. (2) The participant after satisfaction that the securities are available for pledge shall make a note in its records of the notice of pledge and forward the application to the depository. (3) The depository after confirmation from the pledgee that the securities are available for pledge with the pledgor shall within fifteen days of the receipt of the application create and record the pledge and send an intimation of the same to the participants of the pledgor and the pledgees. (4) On receipt of the intimation under sub-regulation (3) the participants of both the pledgor and the pledgee shall inform the pledgor and the pledgee respectively of the entry of creation of the pledge. 20. The above regulations are framed pursuant to Sec.30 of the Securities and Exchange Board of India Act, 1992 (Act 15 of 1992) read with Sec.25 of the Depositories Act, 1996 (DPA). Sec.12 of the Depositories Act, 1996 (DPA) provides as follows: 12. Pledge or hy....
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....price of Rs.53.71Ps. per share. There was therefore a benefit or perquisite to the extent of difference between the market price and the price at which shares were allotted to the Assessee viz., Rs.2635 crores (2685 crores Less 50 crores) and the same was brought to tax as income of Assessee u/s.2(24(iv) of the Act. The AO relied on the decision of the Hon'ble Bombay High Court in the case of D.M.Neterwalla vs. CIT 122 ITR 880 (Bom) wherein it was held benefit or perquisite received by a director from the company has to be taxed as income in the hands of the director. 25. On appeal by the Assessee, the CIT(A) held that the transaction in question was a pledge and not sale of shares. In coming to the above conclusion, the CIT(A) was of the view that the compliance by the Assessee under the Companies Act, 1956 and the return of the shares by the Assessee to RCIL on discharge of the loan, could not be ignored by the AO. On the applicability of the bye-laws of NSDL and regulations of SEBI referred by the AO in the order of Assessment, the CIT(A) held that the regulations referred to by the AO were not mandatory. He held that parties are at liberty to enter into transaction of....
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.... Officer be restored." 27. We have heard the submissions of the learned Additional Solicitor General Mr.Bishwajit Bhattacharyya,(ASG) who appeared on behalf of the department and Mr.Arvind Sonde, who appeared on behalf of the Assessee. 28. The learned ASG submitted that there was a transfer of 50 crores shares of RIC of the face value of Re.1/- by RCIL to the Assessee on 31.3.2004 when the Demat Account of the Assessee held with the Depository Participant, HDFC Bank Ltd., the Client's ID of the Assessee being 42646206 and Depository IDNo. being IN300476 was credited with 50 Crores shares of face value of Re.1/- of RIC from the Demat account of RCIL bearing ID No.10011366 with the Depository Participant Reliance Capital Ltd. Since there was a transfer of ownership in shares by way of sale, the Assessee was recognized as beneficial owner by the Depository participant. The legal consequence of the Assessee being recognized as the beneficial owner of 50 crores shares of RIC by the depository participant was that he was to be considered as owner for all purposes. In this regard he submitted that the letter of Reliance Capital Ltd., the depository participant, with wh....
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.... later legislation DPA and to the extent the later law prescribes a particular mode of creation of pledge, the same should prevail. In this regard he referred to the provisions of Sec.172 of the Contract Act, 1879, which defines Pledge to mean, a bailment of goods as security for payment of debt or performance of a promise. The bailor being the pawnor and the bailee being the pawnee. Under 148 of the Contract Act, 1872, a bailment is delivery of goods by one person to another for some purpose, upon a contract that they shall, when the purpose is accomplished, be returned or otherwise disposed of according to the directions of the person delivering them. The person delivering the goods is called the "bailor". The person to whom they are delivered is called the "bailee". The delivery of possession could be actual or constructive. It was submitted by him that in the case of shares which are held in dematerialized form actual delivery is not possible because the shares do not exist physically and therefore the only mode of delivery in such cases will be constructive delivery as laid down in the SEBI procedures referred to in the order of the AO. 29. The learned counsel for th....
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....rship in goods will take place when parties intend that transfer should take place. He submitted that in ascertaining the intention of the parties regard should be had to the terms of the contract, the conduct of the parties and the circumstances of the case. He pointed out that those provisions will apply only when there is a contract of sale. According to him there was no contract for sale of shares and therefore those provisions will not apply. Without prejudice it was submitted that the terms of the contract viz., loan of Rs.50 crores on the promise of pledge of shares as security, conduct of parties in declaring that the Assessee though recognized as beneficial owner of shares, is in fact not beneficial owner and other circumstances of the case, viz., the shares were retransferred on repayment of the loan, clearly show that there was no transfer of ownership in goods. 32. It was further submitted that the veracity of the documents filed by the Assessee has been doubted as a façade to create a situation as if there was a loan and the shares were given as security for the loan. The conclusions arrived at by the AO for coming to such conclusions are purely on sur....
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.... the further allegation that the parties to the transaction were group companies whose control was management was in the hands of the Assessee. The only third party evidence of filing the return u/s.187C of the Companies Act, 1956 with the ROC which was filed late by about 8 months. d) To create a pledge of shares is it still possible to have physical delivery of shares after the introduction of the concept of dematerialization of shares and whether to this extent do the provisions of Sec.172 of the Contract Act, 1872 stand modified? If yes, what is the effect of the provisions of Sec.28 of DPA? I) Mode of creating Pledge of shares prior to DPA and Mode of making a sale of shares prior to DPA: 34. Sec.2(46) of Companies Act, 1956 defines "Share" as a share in the share capital of the company. Sec.82 of the Companies Act, 1956 lays down that shares or other interest of any member in a company shall be movable property, transferrable in the manner provided by the Articles of the company. Sec.2 (7) of the Sale of Goods Act, 1930 defines "Goods" to mean every kind of movable property other than actionable claims and money and includes stock and shares, gro....
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....which the property in the goods is to pass to the buyer. 36. Generally a sale of shares would be complete when the seller delivers the original share certificate together with the instrument of transfer duly signed by the seller in favour of the purchaser or in blank, to the purchaser and the consideration for the transfer is paid by the purchaser to the seller. This will be the position where the intention of the parties was to enter into a contract of sale/sale. 37. A Pledge is defined in Sec.172 of the Contract Act, 1872, as follows: 172: The Bailment of goods as secutiry for payment of debt or performance of a promise is called "pledge". The bailor is in this case called the "pawnor". The Bailee is called the 'pawnee'. Sec.148 of the Contract Act, defines "Bailment" "bailor", and "bailee". A "bailment" is the delivery of goods by one person to another for some purpose, upon a contract that they shall, when the purpose is accomplished, be returned or otherwise disposed of according to the directions of the person delivering them. The person delivering the goods is called the "bailor". The person to whom they are delivered is call....
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....ating a bank account where shares, instead of money, are kept. A depository should be a company formed under the Company Act, 1956 and should have been granted a certificate of registration under the Securities and Exchange Board of India Act, 1992. Presently, there are two depositories registered with SEBI, namely: National Securities Depository Limited (NSDL), and Central Depository Service Limited (CDSL) 40. The depositories can provide their services to investors through their agents called depository participants. These agents are appointed subject to the conditions prescribed under Securities and Exchange Board of India (Depositories and Participants) Regulations, 1996 and other applicable conditions. Thus the Participant is the intermediary between the depository and the owner of the security/share. A holder of shares can surrender his certificate in physical form to the depository through the Participant. On receipt of such a request the issuer (the company whose shares are sought to be held in dematerialized form), will cancel the certificate and substitute in its records the name of the depository as a registered owner in respect of that security and i....
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....of such pledge or hypothecation to the depository and such depository shall thereupon make entries in its records accordingly. (3) Any entry in the records of a depository under sub-section (2) shall be evidence of a pledge or hypothecation. 43. We have already seen the regulations framed regarding procedure to be followed in case of pledge of shares and how security is enforced by the creditor and how the security is discharged on due repayment and incidental matters. Hence, the same is not being repeated. III. Whether after the introduction of dematerialization of shares, whether a pledge of shares can take place only in the manner laid down in those regulations. 44. With the introduction of the system of holding shares in dematerialized form, corresponding changes were made in the Companies Act, 1956. Some of those changes which may be material for a decision in the present case are: "Sec. 41. Definition of "member" (1) The subscribers of the memorandum of a company shall be deemed to have agreed to become members of a company, and on its registration, shall be entered as members in its register of members. (2....
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....se may be, for the purposes of the Companies Act, 1956. 45. Sec. 28 of the DPA provides that the provisions of the DPA shall be in addition to, and not in derogation of, any other law for the time being in force relating to the holding and transfer of securities. Therefore, application of all other laws dealt with by the DPA which were in force as on the date on which the DPA came into force are not affected. In view of the provisions of Sec.28 of the DPA can it be said that a pledge of shares has to be created only in the manner contemplated by Sec.12 of the DPA. The Provisions of Sec.12 of the DPA or any other provision of DPA do not provide that a pledge created otherwise than in the manner contemplated by DPA is null and void. Thus the provisions of Sec.12 of the DPA are directory and not mandatory. In our view it cannot be said to be the only manner in which a pledge of shares has to be created is as laid down by Sec.12 of the DPA. It may the most desirable way of creating a pledge so that a third party who deals with securities on the basis of entry in the records of a depository without knowledge of any underlying pledge of those securities are put on notice about ....
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....ld shares as beneficial owner and not as a pawnee. There is no material brought on record to show that the claim of the Assessee in this regard is not true. The revenue has further relied on the fact that the transaction of pledge is not grounded on commercial reality because the pledge was taken after disbursement of the alleged loan and the value of security were disproportionate to the amount of loan. These are matters lying with the realm of consent of parties to an agreement and cannot be the basis to conclude that there was in fact sale of shares by RCIL to the Assessee. In this regard, the fact that RCIL was again recognized as beneficial owner of the shares after due repayment of the loan cannot be ignored. In this regard we are also of the view that the AO in the order of assessment has made a vague reference to queries regarding transfer of shares at a grossly undervalued rate and consequent inquiries conducted by the Department into the transaction in dispute in this appeal. There is also a reference to the fact that the Assessee needed to buy shares to have control over RIC and the transaction in question was in fact a sale and not a pledge. There is also an allegation ....
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....in respect of securities held by it. (3) The beneficial owner shall be entitled to all the rights and benefits and be subjected to all the liabilities in respect of his securities held by a depository. 49. A perusal of Sec.10(1) shows that it begins with a non obstante clause. Sec.10(3) which is relevant to the present case, does not have any non-obstante clause. Thus entry as a beneficial owner confers only all rights and benefits to such person in respect of those shares. It is similar to the presumption of prima facie evidence of title to the shares as contained in Sec.84 of the Companies Act, 1956 regarding certificate of shares and name of the person found on such certificate. It can by no stretch of imagination be said that entry as a beneficial owner is conclusive proof of title to the shares of the person whose name is found as beneficial owner in the register of a depository. It is at best prima facie evidence of title to the shares of the person whose name is recorded as beneficial owner of the shares. Such entry is only for the purpose of adjustment of rights and obligations as between the company and share holder. When a question arises as to who is ....
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.... to operate as a pledge. It can still be shown that no property was intended to pass and that the transaction was really a pledge/bailment. In this regard, we find that there is a statutory recognition of such right found in Sec.66(3) of the SG Act, 1930 which provides that the Provisions of the SG Act, 1930 relating to contract of sale do not apply to any transaction in the form a contract of sale which is intended to operate by way of mortgage, pledge, charge or other security. 51. In the light of the above discussion, we would revert back to the question raised in para-33 of this order and answer them in the following manner: a) What is the mode of creating pledge of shares prior to the DPA? How sale of shares is effected? This has been answered in para-34 to 38 of this order. b) With the introduction of the concept of dematerialization of share certificate and holding them in dematerialized form, whether the only mode in which a pledge can be created is in accordance with the provisions of Sec.12 of the DPA and the rules and regulations made under the DPA? How sale of goods Act, 1930 would apply in the light of the DPA to shares held in d....