Brief of the Case
Delhi High Court held In the case of CIT vs. M/s Abhinandan Investment Ltd. that 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. Further there is no scope to provide for a deduction of notional business loss which is neither incurred by the Assessee nor recorded in its audited books of accounts on the basis of notional costs of acquisition which are neither incurred by the Assessee, nor form a part of its audited accounts. It would be erroneous to impute notional cost after the Assessee has drawn up its Profit and Loss Account in accordance with the mandatory accounting standards and in accordance with the provisions of Section 211 of the Companies Act, 1956.
Facts of the Case
The Assessee is one of the companies belonging to the Jindal Group and was incorporated in the year 1983. The Jindal Group is mainly engaged in manufacturing and production of ferrous metal and alloys. M/s Jindal Iron & Steel Co. Ltd. (JISCO) & Jindal Strips Limited (JSL) and Saw Pipes Ltd. are among the principal manufacturing companies of the Jindal Group. In addition to the manufacturing concerns, Jindal Group also includes investment companies – such as the Assessee – which, inter alia, hold shares of the other manufacturing companies. During the initial 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 and (iii) JISCO 3,50,000 equity shares. At the material time, the shares of the aforesaid companies were not quoted at the stock exchange.
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. 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 basis.
During the relevant period, JISCO floated a rights issue of PCDs. In terms of the said issue, the Assessee was, inter alia, entitled to subscribe to five PCDs for every four shares held by the Assessee. The PCDs were to be converted to one share of JISCO. The Assessee renounced its entitlement for subscribing to 1,29,688 PCDs in favour of JSL on 15th February, 1992 i.e. one day after the rights issue opened for subscription. The shares of JISCO were quoted at a cum rights price of Rs.625/- on 3rd January, 1992 and were quoted at Rs.425/- per share ex rights on 6th January, 1992. On the basis of the aforesaid drop in prices, the Assessee claimed that the cost of acquisition of the rights was Rs.200/- per PCD. The rights to subscribe to PCDs were sold by the Assessee to JSL at a consideration of Rs.30 per PCD at an aggregate consideration of Rs.38,90,640/- (1,29,688 PCDs @ 30 per PCD). Thus, the Assessee claimed that it had incurred a loss of Rs.1,68,59,360/-.
The AO noted that the consideration for renunciation of rights had not been received in the financial year. The AO further noted that the renunciation of right forms was quoted on the stock exchange at a price ranging from Rs.260 to Rs.280 per PCD and, thus, had concluded that the sale was made below the market price. 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 of shares held by the Assessee from the stock-in-trade to investments; further renunciation of rights at below the market price; and the renunciation of rights to subscribe PCDs were sham transactions to purchase losses. He also concluded that the transactions were not in aid of the Assessee’s business or its stated object of holding investments on a long term basis.
Contention of the Assessee
The ld counsel of the assessee submitted that resolution dated 4th April, 1991 was bonafide as it was always the intention of the Assessee to hold shares of the Group Companies on a long term basis. He further submitted that transferring the shares from stock-in-trade to investments in the books was not relevant for the purposes of claiming the loss on renunciation of rights to subscribe to the PCDs of JISCO. He contended that whether the shares in question were held as stock-in-trade or as investments, the Assessee would, in either case, be entitled to claim the loss on renunciation of its rights to subscribe to the PCDs of JISCO.
He relied upon the decision of the Bombay High Court in CIT v. K.A. Patch: (1971) 81 ITR 413 (Bom) in support of his contention that the method of calculation of loss on renunciation of rights would remain the same even in a case where the rights in favour of the Assessee result by virtue of shares held as stock-in-trade.
He further submitted that ratio of the decision in case of Dhun Dadabhoy Kapadia (1967) 63 ITR 657 (SC) was squarely applicable to the facts of the present case. He submitted that the transaction for the sale of rights entitlement by the Assessee could not be termed as a sham transaction as the same had been given effect to. He submitted that the rights renunciated by the Assessee in favour of JSL had been exercised by JSL and JSL had subscribed to the PCDs of JISCO which were subsequently issued and registered in the name of JSL.
He further argued that the transaction of sale of rights to subscribe to the PCDs had been accepted by the AO as the consideration received by the Assessee was reflected in the Profit & Loss Account of the Assessee and the AO had accepted the same. He said that in the circumstances, it was not open for the AO to disallow the loss as this would amount to disallowing the deduction on account of cost 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.
Contention of the Revenue
The ld counsel of the revenue submitted that the Tribunal had grossly erred in not appreciating that the
AO had found the transactions to be a device to evade tax. He further pointed out that although the ITAT had observed that the Assessee had sold the shares of JSL as it was interested in subscribing to the rights 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.
He 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 (1967) 63 ITR 657 (SC). 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.
Held by CIT (A)
The CIT (A) rejected the appeals of the Assessee and held that it was amply clear from the behavior of the Assessee that it had entered into “collusive transactions along with sister concerns and was indulging in such transactions regularly to evade proper payment of tax”. The CIT (A) had further held that the principle laid down by the Supreme Court in the case of the McDowell & Co. v. CIT: 154 ITR 148 (SC) was fully applicable in the facts of the present case.
Held by ITAT
The ITAT accepted the Assessee’s contention and, consequently, the loss claimed by the Assessee on the renunciation of rights to subscribe to PCDs of JISCO was allowed to be set off against the profits made by the Assessee. The ITAT was of the view that the shares of JSL or JISCO held by the Assessee were investments and not trading assets. Consequently, it held that the Assessee was entitled to compute the cost of acquisition of rights to subscribe to PCDs in accordance with the Supreme Court’s decision in Dhun Dadabhoy Kapadia ((1967) 63 ITR 657 (SC)).
The ITAT further held that the Assessee had sold shares of JSL in order to subscribe to the PCDs of JISCO. It reasoned that each PCD of JISCO was for a sum of Rs.110/- and this would have involved expenditure of Rs.1.5 crores, which the Assessee would not be in the position to make if it did not sell 60,000 shares of JSL. The Tribunal concluded that the sale of shares of JSL by the Assessee was to preserve its assets and the sale of shares of JSL indicated that the Assessee was interested to buy the PCDs of JISCO.
Held by High Court
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
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. Also it was not the Assessee’s case that the said shares be treated as investments from the date they were purchased but were to be retained as investments after the date of the purported resolution. The resolution would have otherwise clearly stated so and the shares would be transferred at cost and not at cost or market value whichever was lower.
Whether the Assessee intended to retain the shares in question as investments or was the resolution only a self serving document to enable the Assessee to claim the profits from sale of shares as Capital Gains
First of all, it is necessary to note that although the resolution dated 4th April, 1991 specifically stated that the shares and debentures of Rs.82,55,810/- be transferred to investments in the Balance Sheet as on 31st March, 1992; 60,000 shares of JSL were sold in August 1991, that is, within a few months after the passing of the purported resolution and much prior to the end of the financial year. Thus, the said 60,000 shares of JSL, which were reflected as stock-in-trade, were never reflected as investments in the balance sheet as on 31st March, 1992. Secondly, none of the statutory filings with the Registrar of Companies reflected the shares in question as stock-in-trade prior to the transactions of sale of shares in question as the same were sold prior to the end of the financial year. Thirdly, the Assessee was not a widely-held company. Although, its shares were offered to public, 50% of the capital raised had been surrendered as undisclosed income of the Assessee; the clear import being that the shareholding was fictitious and undisclosed income of the promoters.
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 selling its rights to subscribe to the PCDs – and consequently acquire the shares of JISCO – at a fraction of the market value. These shares were purchased at the rate of Rs.300/- per share. Thereafter, within the same financial year, the Assessee sold 1,40,000/- shares of JISCO to JSL at Rs. 280/- per share. This transaction also did not reflect the Assessee’s intention to hold shares and debentures on a long term basis. The AO thus concluded – in our opinion rightly so – that the resolution was a sham and the actions of the Assessee were contrary to the Board resolution produced by the Assessee.
The Assessee appears to have claimed a change in the nature of his holdings depending on the tax incidence in the year in question; in AY 1988-89 the Assessee reflected to shares of JISCO purchased in that year at below cost – treating them to be stock-in-trade and 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. 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.
Whether the transaction of renunciation of rights for subscribing to PCDs of JISCO was a colorable device to contrive an artificial loss?
It is clear that the rights renunciation forms were quoted in the stock market at a price ranging from Rs.260 to Rs.280; yet, the Assessee had sought to transfer the same at a fraction of its market value. Further, the Assessee had also not received the consideration for same within the relevant financial year. Clearly, if the business purpose of the Assessee was to sell one of its assets, it would have done so at the best possible price and terms. However, in the present case, the Assessee had chosen not to do so. It is also relevant to note that the Assessee had sold shares of JSL and advanced the funds received there from to JSL. The ITAT had observed that the shares of JSL were sold to raise funds to subscribe to the rights issued to PCDs of JISCO. However, the Assessee had not subscribed to those shares but had also renounced its rights in favour of JSL. There is no explanation provided by the Assessee whatsoever for entering into this transaction.
It is important to note that the aforesaid transaction had not resulted in any real loss to the Assessee. Admittedly the price paid by the Assessee for purchase of shares of JISCO was less than the consideration received by the Assessee (Rs.30/- per PCD) for renouncing its rights to subscribe to PCDs of JISCO. Thus, against the cost of acquisition of less than Rs.10/- per share, the Assessee continued to retain the holding (albeit at an ex-right value) and was also entitled for the apparent sale consideration of Rs.30/- per right to subscribe to a PCD. However, despite not incurring any real loss, the Assessee had claimed a loss of Rs.1,68,59,360/- for renunciation 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.
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. 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.
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 reduction of tax liability cannot be viewed with suspicion by the Revenue. The decision in the case of Mcdowell 154 ITR 148 (SC) insofar as it relates to the issue of tax avoidance has now been explained to apply only to limited situations where an Assessee creates a colourable device or enters into a sham transaction to evade the tax, which is otherwise payable by him. Further in the case of Commissioner of Income Tax v. Sakarlal Balabhai: (1968) 69 ITR 186 (Guj), the Gujarat Court explained the meaning of tax avoidance and observed that “Tax avoidance postulates that the assessee is in receipt of amount which is really and in truth his income liable to tax but on which he avoids payment of tax by some artifice or device…..”. The Court further explained that such artifice or device may assume diverse forms but “there must be some artifice or device enabling the Assessee to avoid payment of tax on what is really and in truth his income”. Thus, whilst it is settled that the legitimacy of real transactions cannot be questioned merely for the reason that the same result in mitigating the Assessee’s tax liability, the Courts have also held that the colourable devices or subterfuges to evade tax would be impermissible. Clearly, the colourable device or a sham transaction would include a transaction and device which purport to show a situation which is much different from the substance of the transaction. In the present case, the transaction of sale of rights entitlement purports to indicate an alienation of a right while in fact at a group level, there has been no alienation of any rights. The transactions have been so executed to ensure that the rights remained within the Jindal Group. Such transactions which are for the sole purpose of contriving a loss cannot in our view be described other than a colourable device.
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. 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 its inter-related parties that implemented transactions for no commercial purpose but to create a tax loss while at the same time ensuring that the benefits of the assets remain within the group. This would be an abuse of the corporate form and such transactions, even though implemented, cannot be considered to be other than a colourable device for avoidance of tax.
As explained by the Supreme Court in Vodafone International Holdings B.V. (2012) 341 ITR 1 (SC) the question whether a scheme is a colourable or an artificial device would have to be considered in the context of the surrounding facts. In the present case, the facts clearly indicative the transaction to be a part of a scheme, the sole purpose of which is to evade tax payable on the gains made on sale of certain shares of JSL. Several companies within the group have adopted a similar stratagem to avoid tax on the gains made by them. In our view, this stratagem cannot be considered as legitimate and the ITAT erred in not holding so. In view of our decision, the loss claimed by the Assessee was a contrived loss and the transaction of renunciation of rights in question was a colourable device to claim such loss.
Whether such loss could be set off against Assessee’s business income
The Assessee has relied upon the decision in the case of Dhun Dadabhoy Kapadia ((1967) 63 ITR 657 (SC)) to contend that the Assessee could calculate its income/ loss from renunciation of rights to subscribe to PCDs 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 would also be applicable for computing business profits/losses. It is also relevant to bear in mind that in a later case, CIT v. B.C. Srinivasa Setty: (1981) 128 ITR 294 (SC), the Supreme Court had held that if a cost of acquisition of an asset could not be determined, the charge of tax would itself fail.
The Bombay High Court in K.A. Patch (1971) 81 ITR 413 (Bom) had accepted the Assessee’s contention and held that the principles accepted by the Supreme Court for determining the cost of acquisition of a rights entitlement for the purposes of computing capital gains would also be applicable for computing business profits. We, respectfully, are unable to concur with this view for several reasons. First of all, for the reason that the commercial and accounting principles for computing trading income/loss are materially different from the principles that may be applied by an ordinary person, who is not a trader, for calculating gains on capital assets. 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.
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. In our view, there is no scope to provide for a deduction of notional business loss which is neither incurred by the Assessee nor recorded in its audited books of accounts on the basis of notional costs of acquisition which are neither incurred by the Assessee, nor form a part of its audited accounts. In our view, it would be erroneous to impute notional cost after the Assessee has drawn up its Profit and Loss Account in accordance with the mandatory accounting standards and in accordance with the provisions of Section 211 of the Companies Act, 1956. Thirdly, for the reason that the Assessee has, admittedly, not incurred the cost of acquisition as claimed by the Assessee, in our view, it would be impermissible for an Assessee to inflate its cost of trading by costs that are neither incurred nor paid.
Further, if the Assessee felt it was necessary to reduce the value of its shares of JISCO held by it on account of alienation of the rights entitlement, an appropriate proportionate amount could be reduced from the cost of closing stock. In other words, it could reduce the cost of shares of JISCO in the same proportion as the diminution in the value of the price of its shares on account of the shares being traded on an ex rights basis, that is, the cost of shares of JISCO could be reduced by applying a factor of 425/625 – ex-right price divided by cum-right price.
Accordingly appeal of the revenue allowed.