TaxTMI 
TaxTMI 
2015 (11) TMI 1219
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....pect of renunciation of rights to subscribe to partly convertible debentures (hereafter 'PCD') of M/s Jindal Iron & Steel Co. Ltd. (hereafter 'JISCO'). The Assessee was entitled to these rights by virtue of holding shares of JISCO which were acquired by the Assessee at an approximate average cost of Rs. 6.86 per share (The documents filed by the Assessee indicate that the Assessee had acquired 1,04,150 nos. of shares at the aggregate consideration of Rs. 7,14,900/-). As against the aforesaid cost actually paid, the Assessee had claimed a cost of acquisition of rights entitlement to subscribe to PCDs at the rate of Rs. 200 per share of JISCO on the basis of which such rights were acquired. 3. According to the Revenue, the transaction was entered into solely for the purpose of contriving a loss by unjustifiably relying on a decision of the Supreme Court in Dhun Dadabhoy Kapadia vs. CIT: (1967) 63 ITR 657 (SC). 4. The present appeal was admitted by this Court on 12th October, 2004 and the following questions of law were framed for determination:- "1. Whether the Income Tax Appellate Tribunal was right in holding that the sale consideration received by the assessee by tr....
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....l assessment year i.e. AY 1984-85, the Assessee company made investments in shares of the following companies:- (i) JSL, 79,800 equity shares. (ii) Nalwa Steels Ltd., 50,000 equity shares (iii) JISCO 3,50,000 equity shares At the material time, the shares of the aforesaid companies were not quoted at the stock exchange. 6.4 The AO noted that in the previous year relevant to AY 1988-89, the shares of JSL were quoted at the Delhi Stock Exchange. The Assessee had further purchased 7500 shares of JISCO during the said year at Rs. 1,35,000/- and the same were reflected in the closing stock at a value of Rs. 97,500/-. The Assessee company further made a purchase of 40,000 shares of JISCO on 31st July, 1992 at a consideration of Rs. 1,20,00,000/- i.e. Rs. 300/- per share and sold 1,40,000 shares on 9th March, 1993 at a total price of Rs. 3.92 crores i.e. Rs. 280/- per share to JSL. 6.5 On 4th April, 1991 the Directors of the Assessee company passed a resolution to the effect that the shares and debentures held in various companies which were shown as stock-in-trade were to be now reflected as investment as the said securities were intended to be retained on a long term b....
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....Jindal Equipment and Leasing Co. Ltd., Sun Investment Ltd., Mansarovar Investment Ltd. and Stainless Investment Ltd. All the aforesaid companies sold shares of JISCO, JSL or Saw Pipes Ltd. and had earned substantial income. In order to reduce the taxable profits, these companies had renounced rights to subscribe to securities in favour of other companies belonging to the same group at a price much below the market value and, further, on the basis of the notional cost of acquisition, claimed a loss which was sought to be set off from the profits earned from the sale of shares of JSL, JISCO and/or Saw Pipes Ltd. The AO noted that the Assessee could not provide any reason for selling the rights to subscribe to PCDs at below the market price. He also observed that the transactions entered into with JSL had effectively ensured that the shares of JISCO resulting from subscription to the PCDs remained within the Group. The AO also observed that, in fact, the Assessee had practically funded the purchase of the PCDs by JSL by advancing the funds received by the Assessee from sale of the shares of JSL, to JSL. On the basis of the above facts observed by the AO, he concluded that the transfer....
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....ights issue floated by JISCO, the facts indicated quite to the contrary. He submitted that admittedly the Assessee had not subscribed to the rights issue but on the contrary had sold the rights entitlement at a fraction of its market value to JSL. He further submitted that prior to this transaction the Assessee had also advanced the funds received by it from sale of shares of JSL to JSL. He argued that the ITAT had grossly erred in not considering the factual position. 8. Mr Madan further argued that the Assessee had passed a resolution for transferring the shares in question from stock-in-trade to investments in the balance sheet as on 31st March, 1992 solely for the purpose of taking benefit of the decision of the Supreme Court in Dhun Dadabhoy Kapadia (supra). He contended that the shares in question had been held by the Assessee as stock-in-trade and the resolution to transfer them to investments was taken only once the Assessee contemplated sale of the said shares. He contended that this was apparent from the fact that the shares in JSL were sold within the same financial year - FY 1991-92. He argued that the resolution was part of a device to avoid tax. 9. Countering th....
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.... of acquisition. He submitted that if the transaction was held to be a sham transaction, then the consideration received by the Assessee also ought to have been reduced from the profits declared by the Assessee. Mr Vohra conceded that this argument had not been urged by the Assessee in the alternative at any stage - neither before the AO nor at any later stage - as the Assessee was consistently canvassing that the transaction in question was a genuine transaction. Reasoning and Conclusion Question No.(i) 12. The first question relates to the issue as to whether the income from sale of shares of JSL and the rights entitlement of the PCDs is chargeable as Capital Gains or Income from Business and Profession. 13. The Assessee, in its submissions filed before the CIT(A), had explained that up to the AY 1991-92, the Assessee had two types of holdings: one as current assets held as 'stock-in-trade' and the second as 'investments'. Admittedly, as on 31st March, 1991, the Assessee held shares of the value of Rs. 18.59 lacs as investments and Rs. 82.55 lacs as stock-in-trade. According to the Assessee, the Board of Directors had on 4th April, 1991 decided to retain the investmen....
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....as an investment. The shares of JSL were also reflected as stock-intrade in the balance sheet as on 31st March, 1991. The AO had observed that even during the assessment year in question, the Assessee had continued to reflect the dividends as being received from trading assets. In any event, since the Assessee had, admittedly, held the shares in question as stock-in-trade, it would not be open for the Assessee to contend to the contrary. 16. The ITAT proceeded on the basis that it was always the intention of the Assessee to hold the shares in question as investments and not to trade in them. In our view, this is unsustainable because the Assessee had itself reflected the shares in question as stock-in-trade. The Assessee had also further valued the closing stock at cost or market value, whichever was lower; undisputedly, this treatment could only be accorded to shares held as stock-in-trade and not as investment. It appears that the Assessee had also booked losses in its books on account of reduction in the market value of shares of JISCO as it is not disputed that the 7,500 shares purchased by the Assessee in AY 1988-89 at a consideration of Rs. 1,35,000/- were reflected as a p....
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....s rightly skeptical as to the resolution dated 4th April, 1991 and found it necessary to examine the actions of the Assessee. It was at once apparent that the actions of the Assessee were not in conformity with the purported resolution dated 4th April, 1991. Whilst the resolution indicated that the Board of Directors had decided to retain the shares and debentures held by it as investments on a long term basis, substantial shares of JSL were sold within four months thereafter. To ascertain the bonafides of the sale, a Director of the Assessee was asked the reason for the sale of shares. He responded by stating that "so far as I remember the company sold the shares for want of liquidity for repayment of loans and for meeting other liabilities of the company". This was not true. The sale proceeds of shares of JSL were not used to liquidate the liabilities but substantial amounts were advanced to JSL. The AO also noted that sale transactions entered during the year in question involved the maximum amount since the incorporation of the Assessee. 20. It is also relevant to note that the Assessee further acquired 40,000 shares of JISCO in July 1992, that is, within a few months of sel....
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....d in AY 1992-93 sought to treat them as investments to avoid tax on the gains. None of the Assessee's actions in the previous year 1991-92 indicated any change in the Assessee's intention regarding its holding in shares and debentures. The ITAT observed that there were hardly any transactions in the past and on that basis concluded that the Assessee was in substance an investment company. However, the ITAT failed to appreciate that the Assessee had consciously held itself out as a company engaged in sale and purchase of shares; it was also assessed on the income earned from business and also claimed deduction on account of business expenses incurred by the Assessee. The shares in question were, concededly, held as stock-in-trade. All that happened in the year in question is that the Assessee sold substantial shares and renounced rights to subscribe to PCDs contrary to its stated intention of holding the same on a long term basis. 24. In view of the above, the income received by the Assessee from sale of shares of JSL and the renunciation of rights to subscribe to the PCDs of JISCO was rightly held by the AO as business income and not income under the head capital gains. As discu....
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....sold, the income or loss resulting therefrom would subsume within it the business income/loss at the time of conversion from stock-in-trade to capital asset. Thus, in the year in which the asset is sold, the income/loss attributable to the period for which the asset was held as stock-in-trade may have to be ascertained and taxed as such. In other words, the difference between the value at which the asset was held as stock-in-trade and the market value on the date of its conversion as investment would have to be treated as business income/loss and the difference between the market value of the asset as on the date of conversion and the value at which it is sold would be in the nature of capital gains. However, we must add that none of the counsel addressed any arguments on this issue. In the circumstances we do not consider it appropriate to finally decide the same and leave the question open to be decided in an appropriate case. Question No. (ii) 30. The second question relates to whether the Assessee could claim that it has incurred a loss on the sale of its right to subscribe to the PCDs of JISCO and further set off the said loss against the other income from capital gains.....
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....iation of its rights to subscribe to 1,29,688 PCDs. The question whether such loss could be claimed by the Assessee is a separate matter; but, in our view, it cannot be disputed that such loss could at best be described as notional. 35. The transaction of renunciation of rights in favour of JSL ensured that the right to subscribe remained within the group. Thus, looking at the transaction at a group level, it is apparent that the right to subscribe to the PCDs and consequently acquire further shares of JISCO was not alienated and remained within the Jindal Group. 36. It is also necessary to note that several companies of the group entered into similar transactions, thus, ensuring that the Rights Issue remained within the Jindal Group and funds for subscription of those rights were also made available from the entities within the Group. Plainly, the only purpose for executing transactions of renunciation of rights was to contrive a loss; there was no other purpose for entering into the transactions in question and none has been canvassed before us. 37. It has been argued on behalf of the Assessee that it was open for the Assessee to enter into such transactions to mitigate ....
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.... that every action or inaction on the part of the taxpayer which results in reduction of tax liability to which he may be subjected in future, is to be viewed with suspicion and be treated as a device for avoidance of tax irrespective of legitimacy or genuineness of the act ; an inference which unfortunately, in our opinion, the Tribunal apparently appears to have drawn from the enunciation made in McDowell's case [1958] 154 ITR 148 (SC). The ratio of any decision has to be understood in the context it has been made. The facts and circumstances which lead to McDowell's decision leave us in no doubt that the principle enunciated in the above case has not affected the freedom of the citizen to act in a manner according to his requirements, his wishes in the manner of doing any trade, activity or planning his affairs with circumspection, within the framework of law, unless the same fall in the category of colourable device which may properly be called a device or a dubious method or a subterfuge clothed with apparent dignity." 41. Indisputably, the Assessee is at liberty to arrange its affairs in a manner so as to mitigate its tax liability. Every action of the Assessee aimed at re....
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....e was not created for avoidance of tax but for other genuine business purposes. 45. It follows from the aforesaid decision that in order to examine whether a transaction is a device or a subterfuge the answer to the question whether the transaction has any reasonable business purpose would be a vital consideration. Clearly, the use of corporate form to evade tax would be impermissible and it is, thus, necessary in the facts of the present case to look at the transactions entered into by the Assessee and other companies of the Jindal Group. It is at once clear that shares of listed corporate entities of the Group were sold and funds were raised. The sale of these shares had resulted in substantial capital gains in the hands of the investment companies of the Jindal Group including the Assessee and the investment companies were liable to pay tax on the gains so made. In order to avoid paying the tax, the investment companies including the Assessee entered into transactions for renunciation of rights with related companies of the same group. These incestuous transactions were for no other business purpose but to contrive a loss in the hands of the companies such as the Assessee who....
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....indal and Anand Prakash Garg (who was an employee of JSL). Such transactions which are for the sole purpose of contriving a loss cannot in our view be described other than a colourable device. 47. In our view, the AO had rightly found the transaction of sale of rights as a transaction for purchasing taxable losses for the purposes of evading tax. It has been argued that the Assessee had in fact relinquished its rights to subscribe to PCDs and the transaction had been implemented by JSL subscribing to the PCDs and in the circumstances, it could not be disputed that the transaction was genuine. It was contended that such transaction were permissible in law and, therefore, the tax effect of such transactions would necessarily follow. It was further contended on behalf of the Assessee that it is permissible for an Assessee to part with its asset with a view to book a loss. In our view, it cannot be disputed that in a case where an Assessee transfers its income producing asset, there could be no objection by the Revenue on the ground that the same had resulted in reducing the tax liability of an Assessee. However, this would not hold good if it is found that the Assessee alongwith it....
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....Ds of JISCO by claiming the cost of acquisition of the rights entitlement as the difference in cum-right price and an ex-right price of shares of JISCO. It has also been contended that the method of computation of cost of acquisition as approved by the Supreme Court in Dhun Dadabhoy Kapadia (supra) would also be applicable for computing business profits/losses. In that case the Assessee had inherited 710 shares of Tata Iron Steel and Co. Ltd. (TISCO) in the year 1954. In the financial year 1956-57 - the previous year relevant to the concerned Assessment Year - TISCO floated a rights issue in terms of which its existing shareholders were entitled to purchase one new ordinary share for every ordinary share held by them as on 26th April, 1956 at a price of Rs. 105 per share (face value of Rs. 75 and a premium of Rs. 30). Thus, the Assessee - who was not a dealer in the shares - became entitled to subscribe to 710 ordinary shares of TISCO. She did not subscribe to her entitlement but sold her entitlement to subscribe 710 shares of TISCO for a consideration of Rs. 45,262.50/-. It is important to note that there was no dispute between the Assessee and the Revenue that the amount received....
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....to claim that its cost of acquisition be computed on the basis of what could reasonably be perceived as cost of acquisition. However, for a trader, the costs incurred by him are subsumed in his trading account, which is mandatorily required to be drawn up. It is neither necessary nor an accounting practice to determine profit and loss on each piece of trading asset that is sold. Therefore, there is no necessity or occasion for trader to separately determine the cost of acquisition of each item of goods sold by him; he is only required to prepare a trading account while reflecting the aggregate sales and purchases. Thus, in a case of a trader, the principle of ascertaining notional cost attributable to the rights entitlement is neither necessary nor apposite. 53. Secondly, the trading account maintained by a trader is drawn up to present a true and fair picture of his trading activities. The account includes an inbuilt mechanism for capturing the revenue and the real cost incurred by the trader. Both the revenue and costs are recognized by following the accounting standards - which are mandatorily required to be adhered to in case of companies - or accepted accounting practices. ....