Vk Duggal
(320 Points)
Replied 02 November 2007
Part-2
In view of the above, the AO observed that the interest-bearing loans taken from BFL and KSL were with a view to reduce taxable income. He further held that the agreement has also been framed in such a way to reduce the current year's income by claiming interest liability, whereas the debit from the investments made by KCPL, if any, will be available only after 31st December, 1997. He, therefore, held that the interest had not been paid for the purposes of business and, therefore, the interest paid to BFL and KSL amounting to Rs. 56,90,959 and Rs. 70,90,274, respectively could not be allowed as deduction.
On appeal, the CIT(A) concurred with the findings of the AO observing that the agreement between the assessee and KCPL was a sham agreement and was entered into to reduce the tax liability. He further held that there were disputes in implementation of the agreement and yet both the parties did not refer the matter to the arbitrator. According to him, "the agreement was only on paper."
Dr. Sunil Pathak, the learned counsel for the assessee, drew our attention to the agreement between the assessee and KCPL placed at pp. 99 to 105 of the paper book and submitted that as per this agreement, the assessee desired to invest some funds in the stock market. The group concern KCPL was already investing its funds in the stock market and, therefore, the assessee thought of placing its funds with KCPL instead of dealing in stock market operations on its own. KCPL had the infrastructure for this line of business available with itself. It had engaged certain consultants. According to the learned counsel, the salient features of the agreement were as below :
(i) The assessee would advance a sum not exceeding Rs. 10 crores to KCPL between April, 1994 to December, 1994.
(ii) KCPL would invest the money in shares, securities, bonds and units, etc.
(iii) That assessee had agreed not to charge any interest on the advances made.
(iv) KCPL was always required to main a portfolio of the scrips to the extent of amounts advanced by the assessee.
(v) The assessee reserved the option of purchasing any of the scrips after 31st December, 1977, at a consideration of 25 per cent below cost. Till that time i.e., 31st December, 1977, the assessee could not exercise any option asking for any return on the amounts advanced to KCPL.
(vi) The assessee was required to exercise the option at least in respect of 50 per cent of the scrips in value and for the balance amount it could be given compensation by KCPL. The option was to be exercised by the assessee before 30th June, 1998.
(vii) The assessee had a lien on all the investments in scrips made by KCPL till advances are repaid or option is exercised.
As regards the contention of the AO that there was no need to advance the amount when there was already a debit balance of Rs. 5,62,05,888 with KCPL, the learned counsel submitted that the amount was advanced free of interest and in the past KCPL had also advanced amount to the assessee free of interest. The investment of Rs. 5.62 crores was out of the assessee's own funds. Thus, the assessee did not link this amount with stock investments because when approached, KCPL also hinted that fresh investments be made if the assessee wanted to make a foray in stock market. According to the learned counsel, there is nothing wrong in the commercial world about such transactions. Dr. Pathak further submitted that there was no practice of taking interest-free loans or advances from BFL or KSL which were public limited companies. The AO has certainly erred in holding that there was such a practice. In the investment companies of the group, the loans were given from one to another without interest on many occasions, but no such interest-free loan was taken from BFL or KSL. On the other hand, taking such loan would have required the Company Law Board/Board of Directors/AGM approval, etc. Thus, the AO erred in holding that the assessee should have taken interest-free loans from BFL and KSL for advancing to KCPL. According to the learned counsel, when the assessee approached KSL and BFL for ICDs (Inter-corporate deposits), both the companies could spare the funds in April, 1994, itself. The assessee thus accepted the ICDs. It naturally handed over the funds to KCPL immediately, because the interest meter had already started on ICDs and there was no reason as to why the assessee should keep the funds idle with itself. This was a time when the share market was also booming and the assessee thought that if the funds are made available immediately to KCPL, it may buy the shares at lesser price because later on, the prices would increase and the assessee would be a loser. For example, if a share is purchased for Rs. 100 in April, the assessee may buy it under the agreement with KCPL for Rs. 75 but if the same share goes up in December, 1994, the assessee may have to shell out a higher price for acquiring the same share from KCPL. Secondly, the agreement itself stated that the assessee would make the funds available from April to December, 1994. Thus, the assessee's action of advancing money in April was very much as per the terms of the agreement.
Dr. Pathak further submitted that as per the agreement before the CIT(A) it was submitted that the scrips worth Rs. 5.67 crores (refer p. 99 of the paper book) were already taken over by the assessee from KCPL and the CIT(A) erred in not taking cognizance of this development. Further, it was also submitted that as on 31st December, 1977, when the assessee was to exercise the option for buying the scrips, the share market was tremendously down and, therefore, the assessee sought further time from KCPL for exercising the option. In this connection, he drew our attention to the correspondence placed at pp. 119/122/124/125 of the paper book. Dr. Pathak submitted that by 16th February, 1999, the assessee had settled the account on this transaction with KCPL (p. 134 of paper book). According to the learned counsel, the reason why the assessee went into this transaction was that in 1994 the stock market was booming and as the assessee realised that it could get certain funds from BFL and KSL, it made these investments. He drew our attention to the figures of BSE Index on pp. 137 and 138 of paper book. He submitted that the CIT(A) is not justified in holding that the agreement was only on paper. He submitted that it was a genuine agreement and it was duly acted upon by the assessee. He further submitted that the CIT(A) erred in concluding that the agreement was sham and, therefore, interest has to be disallowed. The assessee had entered into real transactions and these transactions were not entered on the basis of a pretence and accordingly, the CIT(A) is not justified in brushing aside the agreement which was duly acted upon by the assessee.
Shri Naresh Kumar, the learned senior Departmental Representative strongly supported the order of the CIT(A). He submitted that the advance given was in April, 1994 itself, i.e., much before the date of 31st December, 1994, when the real operation of buying shares was to begin. The manner in which the period before 31st December, 1994, is to be regulated remains out of context of the agreement. The assessee was required to pay Rs. 10 crores only by December, 1994, yet the assessee chose to pay this amount in April, 1994. By preponing the payment, the assessee does not stand to gain in any manner whatsoever and, therefore, preponing of the advance was not in the interest of the assessee. He wondered as to how the assessee was to be benefited by advancing the amount before the due date. Since the liability under the agreement of the assessee to advance the amount was to start only in December, 1994, the interest paid by the assessee for the period from April to December, 1994, is not for the purpose of business and hence is not an allowable deduction under s. 37(1) of the IT Act. Moreover, on the date of agreement, the assessee-company had already advanced a sum of Rs. 5,62,05,888 to KCPL. This was an interest-free advance. The assessee could have adjusted this amount against the amount payable under the agreement, which was not commercial exigency. He further submitted that it is also interesting to note that the amount advanced as per the agreement has been shown in the tax audit report jointly along with other debit balances of the assessee. KCPL has also not shown the same itself. There was thus no separate account filed before the AO in respect of Rs. 9.85 crores obtained as per the agreement. Therefore, interest on this advance is not allowable deduction.
Shri Naresh Kumar further drew our attention to the fact that the loans advanced to KCPL were interest-free, whereas the assessee has taken interest-bearing loans. Therefore, as observed by the CIT(A), this agreement has been entered into, merely to circumvent the decision of the Bombay High Court in the case of CIT vs. Bombay Samachar Ltd. (1969) 74 ITR 723 (Bom). According to the learned senior Departmental Representative, it is not an agreement which a prudent businessman would enter into. The assessee had given interest-free advance of Rs. 10 crores. The benefit, if any, would accrue to the assessee only after three years. In 1994, when the assessee advanced a sum of Rs. 10 crores to KCPL, the stock market was in its last phase of the bull run. The BSE-Sensitive Index had already fallen from a peak of about 4,600 to about 3,800. The newspapers were full of the story of Harshad Mehta's manipulation and JPC had been constituted. In fact, all keen watchers of the stock market were predicting a fall in the market. Therefore, according to the learned senior Departmental Representative to presume that the market would continue rising for the next three years, was not a conclusion which a prudent man would draw.
Shri Naresh Kumar further submitted that it is interesting to note that in its books of account, KPCL has not shown it as advance against shares. No note to this effect has been given in the balance sheet of KCPL. No future liability in respect of the reduction in cost of 25 per cent has been accounted for in the books of account of KCPL, even though KCPL is under the same management. In fact, in its assessment proceedings, KCPL has shown it only as interest-free advance. Thus, conflicting statements by two companies under the same management would show the sham nature of the agreement. The learned senior Departmental Representative submitted that the agreement should be read keeping in view the surrounding circumstances and in support of this contention, he relied upon the judgment of the Hon'ble Supreme Court in CIT vs. Durga Prasad More 1973 CTR (SC) 500 : (1971) 82 ITR 540 (SC).
We have considered the rival submissions and perused the facts on record. The main reason for disallowing the interest on the inter-corporate deposits from BFL (Rs. 9.85 crores) and from KSL (Rs. 5.35 crores) is that the agreement entered into with KCPL was a sham agreement. We have gone through the agreement and we have also reproduced the salient features of the agreement in para 33 supra. It is noted that the agreement provided for the executive informing KEIPL of the investments made from time to time (cl. 2). The assessee had a lien on all the investments in scrips till the advance was repaid (cl. 9). KCPL had agreed to maintain a minimum portfolio of scrips to the extent of the amounts advanced (cl. 9) as lastly, considering the recession in case opting for scrips was not profitable, it was provided that the assessee will get compensation also from KCPL (cl. 6). After going through the contents of the agreement, we hold that it was not a sham agreement. A transaction is sham when it is a pretence. In this case, both the companies to whom interest has been paid were having taxable income. It is not a case that by claiming interest in KEIPL (the assessee) the group has resorted to any tax planning. The ICDs from BFL and KCL could have been taken by KCPL and interest was allowable in its hands. Thus, we fail to understand as to how the CIT(A) can hold the view that the agreement is sham. Secondly, as discussed above, the agreement was implemented fully as on the date and hence, it could not be concluded that it existed only on paper. Thirdly, merely because interest is claimed in this year and the profit will be taxable in the future years can also not be the reason for disallowing the interest. Under the IT Act, deduction of interest is as per s. 36 under which interest on borrowings for the purpose of business is allowable, even though the profits therefrom are accruing in the later years. For example, in the case of a company newly set up, the interest is allowable in the first year of borrowings, but the profits may accrue later on; that does not mean that interest is to be disallowed. In view of this fact, we hold that the CIT(A) is not justified in holding that the agreement is sham, because for the proposition that an agreement can be considered to be sham only if it is a pretence and not a reality as held in Trade Team (P) Ltd. vs. Dy. CIT (1995) 54 ITD 306 (Bom), and Sir Sunder Singh Majithia vs. CIT (1942) 10 ITR 457 (PC).
As regards the contention of the AO that there was no need to advance the amount when there was already a debit balance of Rs. 5.62 crores with KCPL, it is noted that the amount was advanced free of interest and in the past KCPL had also advanced amounts to the assessee free of interest. The investment of Rs. 5.62 crores was out of company's own funds. Thus, the assessee did not link this amount with stock investments because when approached, KCPL also hinted that fresh investments be made if the assessee wanted to make a foray in stock market. In our opinion, there is nothing wrong in the commercial world about such transactions. It is because it is the prerogative of the assessee how to run its business and the AO cannot force upon the assessee to adjust the earlier amount against the transaction.
Reliance has been placed by the authorities below that KCPL has shown these loans as interest-free in its assessment proceedings. We fail to see as to how this stand contradicts with the assessee's stand. The funds were interest-free and that is why KCPL admitted. Thus, this reasoning of the AO confirmed by the CIT(A) and reiterated by the learned senior Departmental Representative is also of no use to the Revenue for disallowance.
As regards the contention of the learned senior Departmental Representative that the assessee was already in finance business and hence it could have invested the money itself in share market and the second contention that every body knew that the markets would crash and such investments in the share market were not justified in the interest of its business, we hold that all these presumptions are totally irrelevant for the present issue. After all, it is the prerogative of the businessman how to run the business and the Department cannot advise the assessee to maximise its profits. We further note that the assessee, although was investing in finance market itself, it did not have the expertise and the proper infrastructure like consultants, executives, etc., and, therefore, it rightly decided to do this business through KCPL and not on its own. The contention of the learned senior Departmental Representative that everybody knew that the market will crash is not justified, because at the time when the agreement was made between the assessee and KCPL, it was shown that the market was good and the index was rising. Thus, it cannot be said that the assessee knew that the market will crash. In the case of Bombay Samachar Ltd. (supra), the Hon'ble Bombay High Court held that the only conditions required to be satisfied in order to enable the assessee to claim a deduction in respect of interest on borrowed capital are; firstly, that money must have been borrowed by the assessee; secondly, it must have been borrowed for the purpose of business; and thirdly, the assessee must have paid interest on the said amount and claimed it as a deduction. In our opinion, all the three conditions laid down by the Hon'ble Bombay High Court are fulfilled by the assessee. First of all, it did borrow the amount of Rs. 4 crores from BFL and Rs. 5.85 crores from KSL; these amounts were borrowed for the purpose of business; because the assessee wanted to make a foray in the share business and, thirdly, the assessee did pay interest to BFL and KSL which are both public limited companies and who accounted for these amounts in their respective books of account for taxation purposes. In the case of Bombay Samachar Ltd. the High Court has further held that even the assessee had ample resources at its disposal and need not have borrowed is not a relevant matter for consideration.
In the light of above discussion, we hold that the assessee did borrow the two amounts of Rs. 4.00 crores from BFL and Rs. 5.85 crores from KSL for business purposes to utilise these amounts for business and accordingly, there is no justification for the impugned additions of Rs. 56,90,959 (BFL) and Rs. 70,90,274 (KSL). We accordingly delete the same.
Ground No. 9 reads as under :
"The learned CIT(A) erred in holding that interest under ss. 234B and 234C is mandatory and erred in confirming the levy even when there was no express direction in the order of such levy and when these sections were not attracted on the facts of the case at all."
This ground is consequential in nature. The AO is directed to charge interest under ss. 234B and 234C after taking into consideration the relief allowed in this order.
In the result, the appeal is allowed in part.
K. C. SINGHAL, J.M. : 30th May, 2000
After going through the order proposed by my learned brother very carefully, I have not been able to persuade myself to agree with the conclusions and findings arrived at by him in paras 16 to 20 of that order for the reasons given hereinafter.
The question for our consideration relates to the determination of the cost of acquisition of original shares purchased prior to 1st April, 1981, and bonus shares received after 1st April, 1981. With reference to the original shares, it has been held by my learned brother that the assessee is not entitled to opt the fair market value as on 1st April, 1981, as provided in s. 55(2)(b). According to him, the cost of acquisition of such shares is the value taken by the assessee on the date of conversion of shares from stock-in-trade to capital assets that is on 1st July, 1988. Such value was Rs. 17 per share at which shares were originally purchased long back prior to 1st April, 1981. As a consequence thereof, it was further held that indexation should be made from asst. yr. 1989-90 to the year of sale i.e., asst. yr. 1995-96. The reasons for coming to this conclusion given by him may be stated as under :
(1) That Expln. (iii) to s. 48 introduced w.e.f. 1st April, 1993, has made a significant difference in computation of capital gain. According to him, the words "for the first year in which the asset was held by the assessee" means the first year in which the asset was held as capital asset and not the year in which it was not held as capital asset.
(2) If the contention of the assessee is accepted, it would amount to double benefit which is not permissible in view of the Supreme Court decision in the case of Escorts Ltd. vs. Union of India & Ors. (1992) 108 CTR (SC) 275 : (1993) 199 ITR 43 (SC). According to him, the value of shares on 1st July, 1988, was Rs. 50 per share while the assessee had converted into capital asset at Rs. 17 per share. If the assessee had valued the same at Rs. 50 per share then he would have been assessable on such difference as business income. The reliance was placed on the two decisions of the Supreme Court in the case of Kikabhai Premchand vs. CIT (1953) 24 ITR 506 (SC) and in the case CIT vs. Bai Shirinbai K. Kooka (1962) 46 ITR 86 (SC). The decision of the Gujarat High Court in the case of Ranchodbhai Bhaijibhai Patel (supra) and Bombay High Court decision in the case of Keshavji Kanondas, (supra) relied on by the learned counsel for the assessee were held to be distinguishable.
With reference to the cost of bonus shares, it has been held by him that cost has to be determined according to the decision of the Supreme Court in the case of Escorts Farm (Ramgarh) Ltd. vs. CIT (1996) 136 CTR (SC) 434 : (1996) 222 ITR 509 (SC) and the ratio laid down by the Supreme Court in the case of Shekhawati General Traders Ltd. vs. ITO (1971) 82 ITR 788 (SC) cannot be applied to the facts of this case inasmuch as the original shares were not held as capital assets prior to 1st April, 1981. Consequently, the indexation was allowed from asst. yr. 1989-90 to the assessment year in which the bonus shares were sold.
After giving deep thoughts to the arguments of the rival parties, the case law referred to as well as the relevant provisions of the statute, it is not possible for me to agree with the legal findings given by my learned brother. Admittedly, the original shares were acquired by the assessee prior to 1st April, 1981. The only objection against the assessee is that prior to 1st July, 1988, such shares were held as stock in trade and not as capital asset. So the crux of the matter is whether this factor goes against the assessee. The cost of the acquisition has been defined by s. 55(2)(b). Relevant portion of the same is being reproduced as under :
"55(2) ...... (a) .......
(b) in relation to any other capital asset, -
(i) where the capital asset became the property of the assessee before the Ist day of April, 1981, means the cost of acquisition of the asset to the assessee or the fair market value of the asset on the 1st day of April, 1981, at the option of the assessee."
The bare reading of the above section shows that relevant date is the date when the capital asset became the property of the assessee. In my considered opinion, the asset becomes the property of the assessee only once that is when it is purchased by the assessee. When it is acquired by other modes specified in s. 49, then the date of such acquisition is the date when the previous owner acquired such asset. In order to avail the option under s. 55(2)(b), there is no requirement of law that assessee must have held the property as capital asset as on 1st April, 1981. Had it been so intended by the legislature, it would have been easily provided so.
The language used by the legislature is clear and unambiguous and therefore, nothing can be imported into it. In order to charge the assessee under the head "capital gain", the only requirement is that asset on the date of transfer must be a capital asset. Further, in order to avail the benefit of indexed cost of acquisition, the asset must be long-term capital asset. There is no dispute that these two conditions are satisfied in the present case. Once these two conditions are satisfied, then, in my opinion, there is no bar for availing the option under s. 55(2)(b).
This very question came up for judicial consideration for the first time before the Gujarat High Court in the case of Ranchodbhai Bhaijibhai (supra). In that case the assessee owned large area of agricultural land. He obtained the permission of the Collector to put the land to non-agricultural use on 23rd January, 1963, and thereafter, sold the land to two builders in April, and July, 1963. It was claimed by the assessee that the lands were agricultural lands and, therefore, the profits were not assessable as capital gains. Alternatively, it was claimed that the assessee was entitled to deduct the cost of acquisition of the capital asset equal to the market value of the land as on 23rd January, 1963, when such lands became capital asset. It was held by the Bombay High Court that lands were not agricultural lands within the meaning of s. 2(14) of IT Act, 1961, and, therefore, profits from sales were chargeable as capital gains. Regarding alternate contention of the assessee, it was held that assessee was entitled to deduct the cost being fair market value as on 1st January, 1954, since the lands were acquired prior to that date. The relevant observations of their Lordships were as under :
"The only circumstance which must be satisfied in order to attract the charge to tax on capital gains under s. 45 is that the property transferred must be a capital asset at the date of transfer. It is not necessary that it should have been a capital asset on the date of acquisition by the assessee. The words 'cost of acquisition of the capital asset' used in s. 55(2) emphasize two aspects - one is 'acquisition' and the other is 'cost'. The reference clearly is to the time when the capital asset was acquired. Where the property transferred was not a capital asset on the date of its acquisition but became one subsequently, only its character has changed, and there cannot be two different acquisitions of the property, one as a non-capital asset and the other as a capital asset. It would be wrong to introduce such a legal fiction, as it would be plainly contrary to the language of s. 48(ii) read with s. 45.
The intention of the legislature must be gathered from the words used. It is well-settled that what is unexpressed by the legislature must be taken as unintended." (Headnote)
The perusal of the above judgment clearly shows that the only condition which must be satisfied is that the property purchased should be capital asset on the date of transfer and it is, therefore, not necessary that it should be capital asset also on the date of acquisition. This decision has been followed by the Madras High Court in the case of M. Venkatesan vs. CIT (1983) 144 ITR 886 (Mad) and also by Kerala High Court in the case of CIT vs. Smt. Subaida Beevi (1986) 57 CTR (Ker) 324 : (1986) 160 ITR 557 (Ker).
The Bombay High Court which is also a jurisdictional High Court has also followed the said decision of the Gujarat High Court in the case of Keshavji Karsondas, (supra). In that case, the assessee transferred his agricultural lands on 17th June, 1971, which were acquired by his grandfather prior to the year 1941, and the assessee had become the owner of the land by devolution. Such agricultural lands were not capital assets till 1st April, 1970, by virtue of definition in s. 2(14). For the purpose of computing capital gains, it was contended on behalf of the assessee that market value of land as on 1st April, 1970, should be taken as cost of acquisition inasmuch as such lands became capital assets on that date. The High Court following the decision of the Gujarat High Court rejected the contention of the assessee by holding as under :
"Held that what was relevant was the "cost of acquisition" and not the date on which the asset became a capital asset for the purpose of levy of capital gains tax. The cost of acquisition did not change. It was the cost on the date when the asset was actually acquired by the assessee or by his grandfather. The property which was transferred could become the property of the assessee only at one point of time. It would not become the property of the assessee as a non-capital asset at one point of time and as a capital asset at another point of time. The date of acquisition of the land for the purposes of s. 48 r/w s. 49(2) of the Act was the date when the land in question was acquired by the grandfather of the assessee prior to 1941. The assessee, therefore, had the option either to take the original cost of acquisition or its fair market value as on 1st January, 1954. Therefore, for the purpose of determining capital gains, the cost of acquisition of the agricultural land belonging to the assessee had to be taken as on 1st January, 1954, and not as on 1st April, 1970 (see pp. 740F, 742B, C, 741D, E, 742A, G, H)."
The above discussion shows that all the High Courts have taken the uniform view of the matter by holding that :
(1) The year of acquisition is only one that is the year in which it is purchased for the first time by the assessee. However, when it is acquired by other modes specified in s. 49, it is the year in which the previous owner acquired it.
(2) The only condition to be satisfied is that asset must be capital asset only on the date of transfer.
(3) It is not necessary that it should also be capital asset on the date of acquisition or on the statutory date.
(4) Where the asset was acquired prior to this statutory date under s. 55(2)(b), the assessee is entitled to opt the fair market value on such statutory date despite the fact that it was not capital asset on such date and became capital asset much after this statutory date.
As far as provisions of Expln. (iii) to s. 48 are concerned, it my view, such provisions are not at all apposite for determining the cost of acquisition. Such provisions read as under :
"(iii) 'indexed cost of acquisition' means an amount which bears to the cost of acquisition the same proportion as the cost inflation index for the year in which the asset is transferred bears to the cost inflation index for the first year in which the asset was held by the assessee or for the year beginning on the 1st day of April, 1981, whichever is later;"
A bare reading of the aforesaid provisions clearly shows that such provisions are relevant only for computing the indexed cost of acquisition by applying a particular formula. Even according to this formula, the indexed cost of acquisition cannot be determined unless cost of acquisition is known. So, the legislature has itself made distinction between cost of acquisition and indexed cost of acquisition. The words "for the first year in which the asset was held by the assessee" qualifies the words "cost inflation index." So what the legislature intends is to take the cost inflation index for the year in which asset was held for the first time or year beginning 1st April, 1981, whichever is later, and then to increase the same in the same proportion in which cost inflation index has increased to year in which asset is sold. This Explanation presupposes the existence of cost of acquisition which clearly shows that it has nothing to do with the determination of cost of acquisition. Rather this Explanation can be applied only after determination of cost of acquisition. Therefore, in my considered opinion, this Explanation is not apposite at all for determining the cost of acquisition.
Further, in my opinion, no conclusion can be drawn that interpretation put forth by the assessee would result in double benefit to the assessee by valuing the shares at cost i.e., Rs. 17 per share on the date of conversion against the market value of Rs. 50 per share on that date on one hand and adopting the fair market value as on 1st April, 1981 at Rs. 52.50 as cost of acquisition for the purpose of computing capital gains on the other hand. Such conclusion, if drawn, would be against the judgment of the Supreme Court in the case of Sir Kikabhai Premchand (supra). In that case, the assessee was a dealer in silver and shares. Accounts were maintained as per mercantile system of accounting and stock was valued at cost. During the year under consideration, he withdrew certain silver bars and shares from the business for settling them on trust and credited the business with the cost price of such silver bars and shares.
According to the AO, the business should have been credited with the market value. Hence, he assessed the amount of difference between market value and cost price in respect of the assets so withdrawn by the assessee. The matter reached the Supreme Court and it was held that no income arose to the assessee as a result of transfer of silver bars and shares to the trustees. The relevant observations of their Lordships were as under :
"As regards the first contention, we are of opinion that the appellant was right in entering the cost value of the silver and shares at the date of the withdrawal, because it was not a business transaction and by that act the business made no profit or gain, nor did it sustain a loss, and the appellant derived no income from it. He may have stored up a future advantage for himself but as the transactions were not business ones and as he derived no immediate pecuniary gain the State cannot tax them, for under the IT Act the State has no power to tax a potential future advantage. All it can tax is income, profits and gains made in the relevant accounting year."
In view of the above observations, it cannot be said that the assessee obtained any benefit by valuing the shares at cost on the date of conversion. In facts, no profit accrues to the assessee till shares are sold. There are also no provisions in the IT Act to the effect that profits would be deemed to accrue on the date of conversion of stock-in-trade into investment. On the contrary, the legislature has provided in the converse situation that profits would accrue to the assessee under s. 45(2). Therefore, the assessee could not be taxed even assuming that it would have valued the shares at market value on the date of conversion. Whatever profit has arisen on the sale of such shares has been offered for taxation in accordance with the law in the year under consideration. Hence, the question of double benefit does not arise. Consequently, the decision of the Supreme Court in the case of Escorts Ltd. (supra) is not apposite for the disposal of the issue before us.
In view of the above discussion, it is held that the original shares which were sold in the year under consideration became the property of the assessee prior to 1st April, 1981. The fact that such shares were initially held as stock-in-trade and later on converted into capital asset on 1st July, 1988, are not relevant for the purpose of determining the year and cost of acquisition. Thus, in my considered opinion, the assessee was entitled to opt the fair market value as on 1st April, 1981, as cost of acquisition.
The next question for consideration is as to whether the statutory cost of acquisition can be affected by issue of bonus shares subsequent to statutory date of acquisition. This issue came up for consideration before the apex Court in the case of Shekhavati Genreal Traders Ltd. (supra). It has been held in this case that where statutory cost is to be taken, then any event prior or subsequent to such date are irrelevant and thus statutory cost of acquisition remains unchanged. In that case, the assessee had sold 22,000 shares in asst. yr. 1962-63 which were acquired on 29th March, 1949. Under s. 55(2)(b), the assessee opted for fair market value as on 1st January, 1954, as cost of acquisition and claimed the deduction accordingly from the sale consideration. The same was accepted by the AO. Subsequently, the AO issued notice under s. 148 on the ground that claim of assessee regarding fair market value as on 1st January, 1954, was in complete disregard of the fact that the same shares had been given as bonus shares in subsequent year i.e., after 1st January, 1954. According to him, the cost of acquisition should have been spread-over the original shares and bonus shares issued after 1st January, 1954, in view of the Supreme Court judgment in the case of CIT vs. Dalmia Investment Co. Ltd. (1964) 52 ITR 567 (SC). This action of the AO was challenged in the writ petition before the High Court and ultimately, the matter reached the Supreme Court. Their Lordships at p. 793 held as under :
"Where the capital asset became the property of the assessee before the first day of January, 1954, the assessee has two options. It can decide whether it wishes to take the cost of the acquisition of the asset to it as the cost of acquisition for the purpose of s. 48 or the fair market value of the asset on the first day of January, 1954. The word 'fair' appears to have been used to indicate that any artificially inflated value is not to be taken into account. In the present case it is common ground that when the original assessment order was made the fair market value of the shares in question had been duly determined and accepted as correct by the ITO. Under no principle or authority can anything more be read into the provisions of s. 55(2)(b)(i) in the manner suggested by the Revenue based on the view expressed in the Dalmia Investment Co.'s. The High Court completely overlooked the fact that for the ascertainment of the fair market value of the shares in question on 1st January, 1954, any event prior or subsequent to the said date was wholly extraneous and irrelevant and could not be taken into consideration."
In view of the above observations, it has to be held that once the fair market value on statutory date is opted, it remains unaltered by any event.
The judgment of the Supreme Court in the case of Escorts Farm (Ramgarh) Ltd. (supra), heavily relied upon by the Revenue is clearly distinguishable on facts. Even the apex Court itself has distinguished the earlier judgment in the case of Shekhavati General Traders (supra). In the case of Escorts Farms (supra), shares sold by the assessee were admittedly purchased after statutory date i.e., on 1st January, 1954. The assessee contended that such cost cannot be changed on account of issue of bonus shares. Reliance was placed on the decision of Supreme Court in the case of Shekhavati General Traders (supra). The apex Court turned down such plea of the assessee and held that the above decision was distinguishable on facts inasmuch as shares were acquired by the assessee after the statutory date. Their Lordships distinguished the above judgment at p. 522 as under :
"In this case, the High Court has found that the original shares sold were admittedly purchased after 1954 and, therefore, the option of taking the fair market value as on 1st January, 1954 (the statutory cost), was not available to the assessee. It appears to us that the principles laid down in Shekhawati General Traders Ltd. vs. ITO (1971) 82 ITR 788 (SC), cannot be applied to a case where the assessee did not and could not exercise the option of the statutory cost of acquisition in the place of the actual cost of acquisition. The said decision is distinguishable. In view of the larger Bench decisions of this Court, it is fairly clear that where bonus shares are issued and some of the original shares are sold subsequently, their actual cost has to be reckoned only on the basis of 'average value' (as held in Dalmia Investment and other cases) except in rare cases, where 'actual cost' is notionally adopted or determined as it existed on the relevant statutory date (Shekhawati General Traders Ltd. vs. ITO (supra). In the instant case, the High Court was justified in law in holding so and in further holding that the subsequent issue of the bonus shares has the effect of altering the original cost of acquisition of the shares as held by this Court in CIT vs. Dalmia Investment Co. Ltd. (1964) 52 ITR 567 (Pune) and other cases."
In view of the above discussion, it is held that assessee was entitled to opt the fair market value as on 1st April, 1981, since the shares sold by the assessee became the property of the assessee prior to 1st April, 1981. Once such option was exercised, such statutory cost cannot be changed in any circumstances whatsoever. There is no dispute of the fact that fair market value as on 1st April, 1981, was Rs. 52.50 per share. Therefore, the assessee is entitled to deduction of statutory cost of acquisition of Rs. 52.50 per share subject to further indexation by taking asst. yr. 1981-82 as base year. It is clarified that Revenue has allowed indexation by taking asst. yr. 1989-90 as base year on the ground that asset became capital asset on 1st July, 1988. Since it is held by me that shares acquired by the assessee became the property of the assessee prior to 1st April, 1981, and the assessee was entitled to opt the fair market value as on 1st April, 1981, the assessee is entitled as consequence thereof to substitute the said cost by indexed cost of acquisition by taking the base year as 1981-82. The order of CIT(A) is, therefore, set aside on this aspect of the issue and AO is directed to take the cost of acquisition at Rs. 52.50 per share and further substitute the same by indexed cost of acquisition by taking asst. yr. 1981-82 as base year.
The other aspect of the matter relates to the determination of the cost of acquisition of bonus shares issued after 1st April, 1981. This issue has been discussed in para 20 of the proposed order. My learned brother has proceeded on the basis that the assessee is not entitled to opt the fair market value as on 1st April, 1981, since it was held by him that original shares became the capital asset after statutory date. So according to him, the cost of bonus shares was to be determined by spreading the original cost of Rs. 17 per share over the original shares and bonus shares as held by Supreme Court in the case of Escort Farm (Ramgarh) Ltd. (supra). According to him, the judgment of Supreme Court in the case of Shekhavati General Traders (supra) was not applicable.
In my considered view, the judgment of Supreme Court in the case of Escort Farm (supra) cannot be applied to the facts of the present case inasmuch as in that case original shares were admittedly purchased after the statutory date while in the present case the original shares were admittedly acquired and became the property of the assessee prior to this statutory date as discussed and held by me in the earlier part of the order. It is also not in dispute that cost of bonus shares cannot be taken as 'Nil' since it has to be computed by spreading the cost of acquisition over the original shares and bonus shares as held by Supreme Court in the case of Dalmia Investment Co. Ltd. (supra). So the short question is how to compute the cost of bonus shares where the original shares are acquired prior to statutory date.
This issue came up for consideration before Hon'ble Madras High Court in the case of CIT vs. G. N. Venkatapathy (1997) 139 CTR (Mad) 324 : (1997) 225 ITR 952 (Mad). In that case, shares were acquired by the assessee prior to 1st January, 1964, which was the statutory date while bonus shares were issued in the year 1975. In asst. yr. 1978-79, certain bonus shares and original shares were sold by the assessee. In computing the capital gains, the assessee took the fair market value as on 1st January, 1964, in respect of original shares and the same was spread over the original shares and bonus shares in determining the cost of bonus shares. The assessee showed loss on the sale of shares which was accepted by the AO. Later on the order of AO was scrutinised by the CIT, order of AO was erroneous inasmuch as the cost of bonus shares should have been computed by spreading over the actual cost and not the fair market value as on 1st January, 1964. The Tribunal, however, held that method of computing the cost of bonus shares by the assessee was correct one. Hence, the order of CIT under s. 263 was quashed. On reference to the High Court, it was held that the Tribunal was right in holding that cost of bonus shares was to be computed by spreading over the statutory cost of acquisition over the original shares and bonus shares and not the actual cost of acquisition. Such conclusion was arrived at by the High Court after applying the ratio of Supreme Court judgment in the case of Shekhavati General Traders Ltd. (supra) and following its earlier decision in the case of CIT vs. Prema Ramanujan (1991) 96 CTR (Mad) 101 : (1991) 192 ITR 692 (Mad). This issue again came up before the Madras High Court in the case of S. Ram vs. CIT (1997) 143 CTR (Mad) 65 : (1998) 230 ITR 353 (Mad) wherein it was held as under :
"In a case where the original shares were obtained before 1st January, 1954, and the bonus shares were obtained after 1st January, 1954, and where the assessee exercised his option as per the provisions of s. 55(2) of the IT Act, 1961, to adopt the fair market value as prevalent on 1st January, 1954, while ascertaining the cost of acquisition of the bonus shares, it is not possible to adopt one value for the original shares, viz., the value as on 1st January, 1954. Once the value of the original shares is determined in accordance with the statutory provisions, thereafter the said value is unalterable. The said value should be adopted for the purpose of dividing the same by bonus shares as well as the original shares. Any alteration to the above method would be hit by the provisions contained in s. 55(2). While ascertaining the value of bonus shares the value of the shares as opted by the assessee as on 1st January, 1954, as per the provisions of s. 55(2) has to be taken into account and both the original shares and the bonus shares should be clubbed together and the average value of such share should be found by dividing the fair market value opted on 1st January, 1954, by the total number of shares."
In view of the above three decisions of Madras High Court and Supreme Court judgment in the case of Shekhavati General Traders Ltd. (supra), it is held that it is the statutory cost of acquisition on 1st April, 1981, which is to be spread over the original shares and bonus shares for determining the cost of bonus shares. In the present case, the statutory cost has been taken at Rs. 52.50 per share. The total original shares were 68,740 against which assessee received 68,740 bonus shares in June, 1981. Thus, the total holding on 20th June, 1981, was 1,37,480 shares. Again in October, 1989, the assessee obtained another 1,37,480 bonus shares. Thus, the total holding came to 2,74,960 shares. Thus, the cost of bonus shares would be 1/4th of the statutory cost of acquisition which comes to Rs. 13.125 per share and not Rs. 4.38 as held by AO.
Before parting with this aspect of the issue, it is to be pointed out that learned counsel for the assessee had contended that cost of bonus shares should be determined differently on the basis of holding on the respective dates of issue of bonus shares. According to him, the cost of bonus shares issued in 1981 should be ascertained by spreading over this statutory cost over 1,37,480 shares and, therefore, the same should be taken at Rs. 26.25 per share while the cost of bonus shares issued in 1989 may be taken at Rs. 13.12 per share. This contention of the learned counsel for the assessee cannot be accepted. The principle of spreading over the cost of the acquisition is that number of holding in the hands of assessee may be increased from time to time but the value of such holding remains constant. By issue of bonus shares, neither the company becomes poorer nor the shareholders become richer. The Hon'ble Supreme Court in the case of Dalmia Investment Co. Ltd. (supra) quoted with approval at p. 579 of the report the following observations of the Supreme Court of United States in the case of Eisner vs. Macomber (1920) 252 US 189 : 64 L.Ed.521 :
"A stock dividend really takes nothing from the property of the corporation, and adds nothing to the interests of the shareholder. Its property is not diminished, and their interests are not increased. .......... The proportional interest of each shareholder remains the same. The only change is in the evidence which represents that interest, the new shares and the original shares together representing the same proportional interest that the original shares represented before the issue of the new ones. ........... In short, the corporation is no poorer and the stock-holder is no richer than they were before. ..........."
In view of the above principle, the total cost of the original shares together with the bonus shares would remain the same as it was before the issue of bonus shares. Thus, the numbers of holding may go on changing by issue of bonus shares, but the cost of total holding would remain the same. Accordingly, the aforesaid contention of Mr. Pathak is rejected.
The next aspect of the matter is the computation of indexed cost of acquisition. Explanation (iii) of s. 48 defines the indexed cost of acquisition. Such provisions have already been quoted by me. It provides that the cost of acquisition shall be adjusted in the same proportion in which the cost inflation index for the first year in which asset is held by the assessee or the year beginning on 1st April, 1981, whichever is later bears to the cost inflation index for the year in which it is sold. The cost of acquisition has to be determined under s. 55(2)(b) which in the case of bonus shares has already been determined by me at Rs. 13.125 per share which will be taken into consideration for determining the indexed cost of acquisition. However, the base year for indexation will be the year in which bonus shares were issued because it is this year when such shares came into existence and were held by the assessee for the first time. Accordingly, the base year for such bonus shares issued for the first time will be asst. yr. 1982-83 since such shares were issued in June, 1981, while the base year for the second issue of bonus shares would be asst. yr. 1990-91 since such shares were issued in October, 1989. The contention of the learned counsel for the assessee that base year should be taken as asst. yr. 1981-82 in respect of all bonus shares, therefore, cannot be accepted in view of clear language of Expln. (iii) to s. 48. The order of CIT(A) is accordingly modified and the AO is directed to compute the indexed cost of acquisition of bonus shares in the light of above discussion.
Except as stated above I agree with the remaining part of the order of my learned brother.
REFERENCE UNDER S. 255(4) OF THE IT ACT, 1961
B. L. CHHIBBER, A.M. : 30th May, 2000
As there is a difference of opinion between the A.M. and the J.M., the matter is being referred to the President of the Tribunal with a request that the following questions may be referred to a Third Member or to pass such orders as the President may desire :
"(1) Whether, on facts and in law, the assessee is entitled to opt the fair market value on the statutory date i.e., 1st April, 1981, as cost of acquisition in respect of original shares purchased before 1st April, 1981, and as a consequence thereof, he is further entitled to substitute the said cost by indexed cost of acquisition by taking asst. yr. 1981-82 as base year ?
(2) Whether, on facts and in law, the cost of bonus shares can be determined by spreading over the statutory cost of acquisition of original shares over the original and bonus shares ? If yes, then whether index cost of acquisition can be determined by taking asst. yr. 1982-83 as base year for the bonus shares issued in June, 1981 and by taking asst. yr. 1990-91 as base year for bonus shares issued in October, 1989 ?"
ITA No. 188/Pn/1999
B. L. CHHIBBER A.M. : April, 2000
This appeal by the assessee is directed against the order of the CIT(A)-I, Pune.
The assessee is an investment company floated by Kalyani group. During the year under consideration, it has shown long-term capital gain on the sale of shares of Bharat Forge Ltd. and also income on account of dealing in the shares of other companies.
The first grievance of the assessee is that the AO has erred in computing the long-term capital gain on sale of shares of Bharat Forge Ltd. at Rs. 10,44,29,160 as per Annexure of his order and further the CIT(A) is not justified in confirming the action of the AO.
The facts and the arguments of both the sides are identical to those discussed by us in our order of date in ITA No. 30/Pn/99 in the case of Kalyani Exports & Investments (P) Ltd. Pune (a group case). As such, our aforesaid decision will apply mutatis mutandis to the facts of the present case. For the detailed reasons given therein, we decline to interfere and dismiss this ground.
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