Effective date of transfer of shares for capital gains when agreement to transfer of shares is revocable

Recently ITAT Mumbai in the case of Mrs. Hami Aspi Balsara (Taxpayer) v ACIT. [2009-TIOL-789-ITAT-MUM] held that where a transfer of shares is made conditional upon fulfilment of certain covenants by the parties, the transfer can be regarded as complete only upon the fulfilment of such covenants. In the facts of the present case where the Taxpayer entered into an agreement to sell the shares that were held, the ITAT held that the transfer by way of extinguishment of rights did not arise on mere execution of the agreement to sell.

This was because the Taxpayer had the right to revoke the transaction on non- fulfilment of certain covenants by the buyer of the shares. The ITAT held that it was not relevant that the Taxpayer was restricted from exercising any rights over the shares, post the date of agreement to sell, and the transfer took place only when the sale became irrevocable from the Taxpayer’s perspective.

 Background and facts of the case

• Under the Indian Tax Law (ITL), profits or gains arising from transfer of a capital asset is chargeable to tax under the head ‘capital gains’. The term ‘transfer’ is defined to include, inter alia, sale, exchange or relinquishment of a capital asset or the extinguishment of any rights therein.

• The Taxpayer, being part of a Promoter Group, held shares in 3 companies (Target Companies). The Promoter Group entered into a share purchase agreement (SPA) on 27 January 2005 with Dabur India Ltd. (Buyer) to sell their shares in the Target Companies, on the terms and conditions as agreed in the SPA. The SPA contemplated that the transaction will be completed on 1 April 2005 after all the parties have fulfilled their obligations under the SPA.

• The Taxpayer did not offer capital gains on the transfer of shares in the return of income filed for tax year 2004-05 for the reason that since the transfer of shares was completed in April 2005, capital gains arose in the tax year 2005-06. The Tax Authority and the first appellate authority rejected the Taxpayer’s claim and held that the capital gains arose in the tax year 2004-05, on the date of signing of the SPA.

• Aggrieved by the first appellate authority’s order, the Taxpayer preferred an appeal before the ITAT.

Issue for consideration :-Whether the capital gains arose on the execution of the SPA on 27 January 2005 or on the completion of the transaction in April 2005.

Contentions of the Taxpayer

• The capital gains on transfer of shares in the Target Companies arose in April 2005 on the fulfilment of all the terms and conditions contemplated in the SPA.

• The transaction in the present case is a transaction of ‘sale’ of shares and not a case of ‘extinguishment of rights’ in such shares. The concepts of ‘sale’ and ‘extinguishment of rights’, occurring in the definition of ‘transfer’ under the ITL, are distinct and are mutually exclusive concepts since they are enumerated separately in the definition.

• Further, a ‘sale’ is different from an an agreement to sell’. According to the provisions of the Sale of Goods Act where, under a contract of sale, the property in the goods is transferred from the seller to the buyer, the contract is called a ‘sale’, but where the transfer of the property in the goods is to take place in future or subject to fulfilling certain conditions, the contract is called an ‘agreement to sell’. In the present case, the SPA was in the nature of an ‘agreement to sell’ and not a ‘sale’, since the SPA contemplated the following conditions to be fulfilled prior to transfer of ownership in the shares of the Target Companies:

-The resignation of the directors of the Promoter Group from the Target Companies, repayment of fixed deposits of the Promoter Group and release of personal guarantees of the Promoter Group, consents of the banks etc.

-The approval of the Board of Directors and shareholders of the Buyer, for the purchase of shares.

• In the present case, the sale took place in April 2005 upon fulfilment of the above conditions. Also, the shares were dematerialized and transferred to the Buyer’s name in April 2005. The transfer was registered in April 2005 in the statutory registers of the Target Companies, as per corporate law requirements. The Buyer informed the stock exchanges that the transfer was effective from April 2005 and also reflected the purchase in its financial statements for tax year 2005-06. This evidences that both the parties have understood the transfer to be complete only in April 2005 and not prior thereto.

• Reliance was placed on the Supreme Court’s (SC) decision in the case of Shellate VR v. P J Thakkar 45 Corn Cas 43 wherein the SC held that transfer of shares is completed when the share certificate, along with duly executed transfer deed, is handed over to the transferee. Reliance was also placed on Circular No. 704 (Circular) issued by the Central Board of Direct Taxes (CBDT) in which the CBDT has stated that, in case the transaction of sale of shares takes place directly between the parties and not through stock exchanges, the date of contract of sale, as declared by the parties, shall be treated as the date of transfer, provided it is followed up by the actual delivery of shares and the transfer deeds.

Contentions of the Tax Authority

• The capital gains on transfer of shares in the Target Companies arose on execution of the SPA.

• The SPA placed significant restrictions on the Taxpayer in relation to the shares, post the date of execution. The Taxpayer was deprived of the effective control over the shares by virtue of following restrictions, in terms of the SPA:

a. The Taxpayer had to deliver share certificates and signed blank transfer forms to the custodian appointed under the SPA. The Taxpayer was obliged to keep the blank transfer forms valid till April 2005.

b. The Taxpayer received substantial part of the consideration agreed for the transfer of shares. The sale consideration was not refundable.

c. The Taxpayer was prohibited from exercising any rights on the shares without the prior written approval of the Buyer.

d. In relation to the actual operations and conduct of business of the Target Companies, the Promoter Group was restrained from declaring any dividend, disposing or alienating or creating new encumbrance over any assets of the Target Companies, undertaking or varying any transaction with any related parties, causing liquidation or winding up of the Target Companies, issuing any new shares etc.

• For ‘transfer’ to take place in terms of the definition under the ITL, it is not necessary that all the rights in the capital asset be extinguished. The capital gains get triggered even if substantial rights are extinguished.

• The events which took place between the date of the SPA and April 2005 were merely in the nature of procedural formalities. In terms of the Circular, it is the contractual date followed by actual delivery which is relevant and in the present case, the contractual date was the date of the SPA viz. 27 January 2005.

Ruling of the ITAT

The ITAT held that the ‘transfer’ of shares took place in April 2005, on completion of all the prerequisites contemplated in the SPA and the capital gains arose in tax year 2005-06, for the following reasons:

• In terms of the SC decision in Shellate’s case (supra), the transfer would be considered complete only when the procedure required by corporate law is complied with. Accordingly, it would be considered complete when the delivery of share certificate along with transfer deed is handed over to the purchaser. In the present case, the custodian, as an agent of the Taxpayer, took the delivery of physical share certificates on execution of the SPA and the delivery to the custodian did not constitute delivery to the Buyer. The delivery to the Buyer took place in April 2005 when the shares were dematerialized by the custodian in favour of the Buyer after other terms of the SPA were complied with.

• The concepts of ‘sale’ and ‘extinguishment of rights’, as occurring in the definition of ‘transfer’, are not mutually interchangeable. If a particular transaction is a transaction of sale, then the part of the definition of transfer referring to ‘extinguishment of rights’ will not apply and the ‘transfer’ will happen only when the ‘sale’ is complete.

• Even with regard to extinguishment of right, the extinguishment should be irrevocable in nature in order to constitute a transfer. In the present case, the restrictions placed by the SPA on the Taxpayer merely resulted in suspension of the rights and not extinguishment of the rights. Prior to April 2005, the Taxpayer had the right to revoke the transaction on failure of the Buyer to comply with the agreed terms and reassume the rights kept under suspension.

• If the Taxpayer had revoked the transaction because of the Buyer defaulting, then the Taxpayer was bound to refund the advance sale consideration received from the Buyer in terms of the provisions of the Indian Contract Act and the Specific Relief Act. The provisions of these Acts oblige a person, who has received any advantage under an agreement or contract which is void or becomes void, to restore it or to make compensation to the person from whom he received it.

• In terms of the Circular, the contractual date of transfer in this case was 1 April 2005, since the parties had contemplated completion of all the prerequisites for the transfer of shares by that date. The Buyer also recognized the purchase of shares in tax year 2005-06 and not in tax year 2004-05.

Comments:- This ITAT ruling provides guidance that for the purposes of taxation of capital gains under the ITL, the transaction should be completed in a manner that it becomes irrevocable on the part of the taxpayer. The stage of completion of sale is reckoned, having regard to statutory approvals, consents or procedures which are prerequisites for completion of the sale.

Source: Mrs. Hami Aspi Balsara (Taxpayer) v ACIT. [2009-TIOL-789-ITAT-MUM]

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