Briefly stated, the assessee, a private limited company, engaged in the business of borrowing and lending funds reflected stock-in-trade of Rs.8,30,95,223.15 in its P&L account as on 31.03.2002 and converted its stock-in trade of shares to investment with effect from 1.4.2002. Accordingly, the assessee reflected its stock of shares in its balance sheet as ‘investment’ as on 31.03.2003. During the year under consideration (A.Y 2004-05) the assessee sold shares out of the shares converted into investment and has claimed long term capital gain on sale of such shares amounting to Rs.7,13,29,191/-. In the assessment framed u/s 143(3) of the Income Tax Act (‘Act’) , the AO assessed the same as business income on the reason that the act of the assessee shifting the value of stock-in-trade to the head investment clearly indicated the colourable mind of the assessee and thus intentionally avoided the payment of tax @ 35%.
On appeal, the Ld.CIT(A) allowed the claim of the assessee holding that there was no specific ban on conversion of stock-in-trade into capital asset or vice versa and observed that the assessee had later on discontinued the activity of trading in shares and converted its stocks in investment. The Ld.CIT(A) also relied on the decision of the Hon’ble Supreme Court in the case of Sir Kilabhani Premchand (24 ITR 506 SC). Aggrieved by the impugned order, the revenue is in appeal before us.
Ld. DR has vehemently argued that it is a case of rarest of rare cases in which the assessee has adopted reverse engineering of converting the stock in trade to investment as a device formulated with the sole intention of avoiding tax liability. In support of this argument the Ld.DR relied on the decision of the decision of the jurisdictional High Court in the case of Twin star Holdings Ltd Vs Anand Kedia (260 ITR 6 Bom). In the written submission filed by the then Ld.DR, it has been stated that stock-in trade cannot be converted into capital asset as long as such stock remains in the business of the assessee. The definition of capital asset provided u/s 2(14) of the Act clearly shows that any stock-in trade is excluded from capital asset. Section 45 (2) of the Act gives legal sanctity only for the conversion of the capital asset into stock-in-trade and there is no provision in the Act which allows conversion of stock-in-trade to capital asset. In support of the proposition that stock-in trade cannot be converted into capital asset as long as such stock remains in the business of the assessee, several decisions are quoted in the written submission.
Ld.AR has argued that the conversion is necessitated due to shift in the business model of the assessee from share trading to financing business. The assessee in the earlier years has shown business income on account of trading in shares, both delivery based and speculative i.e non-delivery based. However, on 01.04.2002 it has discontinued the trading activity i.e delivery based trading and consequently converted its entire share held as stock-in-trade into investments. Due to market scenario, the assessee has taken such a conscious business decision to discontinue delivery based trading in shares. Accordingly, the assessee has passed entries in its books on 01.04.2002 and the same has been consistently shown as investments in its books and also the profits on sale thereof is shown in accounts as capital.
While preparing the balance sheet as on 31.03.2003 relevant to the AY 2003- 04, the unsold shares so converted has been shown under the head ‘investments’ with suitable clarificatory note given in the Notes to Accounts for that year and when the return of income submitted on the basis of such change and profits on sale of investment declaring as capital gains, the said written has been accepted u/s 143(1) of the Act without calling for scrutiny.
In support of the contention that such conversion of stock in trade into capital asset/investment is legally permissible, the Ld.AR relied on the decision of the Hon’ble Supreme Court in the case of Sir Kikabhai Premchand (24 ITR 506) (SC).
ITAT heard the parties and perused the material on record. It is relevant to state that the Ld.CIT(A), for the purpose of deciding the case has elaborately discussed three main issues, namely (i) whether the assessee can legally convert its stock-in trade into investments, (ii) if yes, whether the conversion is motivated by tax avoidance and (iii) if not, whether the assessee can claim to be an investor in some shares while doing speculation in other shares.
ITAT Further observed that As regards the legality of conversion of stock-in trade into investments, the Ld.CIT has correctly held that there is no specific bar for the said conversion and vice versa in view of the decision of the Hon’ble Supreme Court in the case of Sir Kikabhai Premchand (24 ITR 506) (SC) wherein it has been held that such conversion is not something not known to the commercial world and there is no legal bar on the same.
On the second issue as to whether the conversion is motivated by tax avoidance, shorn off extracting the entire discussion, reading of paras 14.3 to 14.7 of the order of the Ld.CIT(A) clearly establishes that the Ld.CIT(A) has well appreciated the facts and thereby arrived at a correct conclusion that it is not the case that the assessee has entered into any sham transactions for avoiding tax and the conversion of stock into investment is transparent from the audited accounts of the assessee with clarificatory note appended in the Notes to Accounts for the FY 2002-03. As regards the argument the Ld.DR that such conversion is to be treated as a sham transaction based on the decision of the jurisdictional High Court in the case of Twin star Holdings Ltd Vs Anand Kedia (260 ITR 6 Bom), we are of the view that the ratio of the said decision is not applicable to the facts in the present case as the former relates to such conversion by three investment companies and transmission of shares thereon.
Regarding the third issue whether the assessee can be an investor as well as a speculator in shares simultaneously, the Ld.CIT(A) has relied on the decision of the Tribunal in the case of Vesta Investments & Trading Co.(P) Ltd (70 ITD 200)(Chd) wherein it has been held that in the case of assessee holding both shares as well as investments for which separate accounts are kept and if the Department in the past has accepted the sale of shares held as investments would give rise to capital gains and not business. Since the said decision is squarely applicable in the case of the assessee in the present case, we are of the view that the Ld.CIT(A) has rightly answered this issue affirmatively.
In view of that matter, we do not find any justifiable reason to interfere with the order of the Ld.CIT(A) directing the AO to assess the profits on sale of share under the head ‘Capital Gains’ and not as business income. Thus, the order of the Ld.CIT is hereby upheld.