TMI Blog2000 (5) TMI 173X X X X Extracts X X X X X X X X Extracts X X X X ..... 5-96. The assessments have been completed by the Asstt. Commissioner of I.T., Company Circle-4(5), Hyderabad, vide her separate proceedings under section 143(3) of the Income-tax Act, 1961, dated 27-3-1998. M/s. KNB Investments (P.) Ltd. has returned an income of Rs. 15,73,540 and M/s. KAR Investments (P.) Ltd. has returned an income of Rs. 23,63,720. The Assessing Officer made additions of Rs. 32,85,00,000 in the case of the former and Rs. 29,70,73,500 in the case of the latter and determined a total and taxable income of Rs. 33,00,73,540 and Rs. 29,94,37,220 respectively. It is against the above additions that the appellant-companies have preferred these second appeals before the Tribunal, as the first appeals were dismissed, and the additions confirmed by the learned CIT(A). 3. Dr. Reddy's Laboratories Ltd. is a company in which the appellant-companies have substantial investments as shares in the capital. The said company had made a preferential allotment of equity shares to the appellant-companies in the previous year relevant to the assessment year under appeal. M/s. KNB Investments (P.) Ltd. was allotted 9,00,000 shares and M/s. KAR Investments (P.) Ltd. was allotted 8,13, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Dr. Reddy's Laboratories Ltd. convened an Extraordinary General meeting on 16-3-1994 to consider and pass certain important resolutions regarding matters like increasing the authorised share capital of that company, issue of bonus shares, issue of shares in international market for tapping NRI sources and named as Euro-issue for a sum not exceeding 75-million US Dollars and also among other things to offer shares of the company to its promoters. And in the matter of offering shares to its promoters, a special resolution was passed to offer and allot 22,50,000 Equity Shares of Rs. 10 each at a premium of Rs. 80 per share to the 'promoters group' consisting of Dr. Anji Reddy, Shri M.P. Chary, their family members and relatives, companies, trusts, AOPs formed or controlled by them. 7. On the basis of the above decision, the Board of Directors of Dr. Reddy's Laboratories Ltd., offered allotment of equity shares to the appellant-companies through their letters dated 25-4-1994. M/s. KNB Investments (P.) Ltd. made an application for 9,00,000 equity shares on 7-5-1994 and paid Rs. 90 lakhs as application money @ Rs. 10 per share. M/s. KAR Investments (P.) Ltd. also applied for 8,13,900 e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s and circumstances of the case, she came to a finding that the appellant-companies have derived benefits of Rs. 365 per share in the deal of preferential allotment; and that those benefits arose from business carried on by the companies. As the benefits have arisen from the business carried on by the appellant-companies, the Assessing Officer held that the value of that benefit has to be treated as income liable to tax under section 28(iv) of the Income-tax Act, 1961. 9. The differential price per share was Rs. 365. M/s. KNB Investments (P.) Ltd. has acquired 9,00,000 shares. Therefore, the total value of the benefits would be Rs. 32.8 00,000. Likewise M/s. KAR Investments (P.) Ltd. has acquired 8,13,900 shares and the benefits would be of Rs. 29,70,73,500. Accordingly, the Assessing Officer proposed an addition of income of Rs. 32,85,00,000 in the assessment of M/s. KNB Investments (P.) Ltd. and Rs. 29,70,73,500 in the assessment of M/s. KAR Investments (P.) Ltd. 10. The appellant-companies filed detailed objections to the propositions made by the Assessing Officer through their letter dated 12-3-1998. The objections run as follows:-- 1. The special resolution authorising p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rcular No., 710, dated 24-7-1995. 11. The Assessing Officer considered all the above objections in detail, but declined to accept them for the following reasons: 1. In Abbot's case cited by the appellants, it was held that the tax payer should be assessed in respect of the year when the option to purchase shares was given. In the present case, in pursuance to their resolution dated 16-3-1994, Dr. Reddy's Laboratories Ltd. made the offer to exercise the option on 25-4-1994 as evident from the copy of share application marked as Annexure 'G' to the assessment order. The Companies made the applications on 17-5-1994 and 9-5-1994. Shares were allotted on 10-5-1994. All the events have taken place in the financial year 1994-95 which is the previous year relevant to the assessment year 1995-96. Therefore, the issue of taxability has been rightly considered for the assessment year 1995-96. 2. The benefits have been derived by the appellant-companies in the course of their business of investment. It is revenue in nature and therefore, taxable. The same items may be capital asset in one hand and the receipt of the same may be on revenue account in the other hand. It was held that share ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 5. The main objects of the appellant-companies as set out in their Memorandum of Association are to carry on the business of investment, to acquire stocks and shares and to deal in them. The main activities carried on are doing investments in group companies as promoter. In all the returns filed so far, the business has been declared as investment in companies. This is supported by the Auditors' Report from time to time. In their order, the A.P. High Court has observed while approving the scheme of amalgamation in C.P. No. 01/95, that the appellant-companies were engaged in the business of investment in securities and shares and finances. In his statement made on 6-3-1998, Dr. K. Anji Reddy, the Chairman of the companies has, stated that these companies are the vehicles of investment of himself and his family members and are part of promoters group and the shares were preferentially allotted to prevent any possible hostile take-over of Dr. Reddy's Laboratories Ltd. In the light of the above facts and evidences, it is to be held that the appellant-companies were doing the business in shares of group companies. 6. There is a clear nexus between the benefits derived by the appellant ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the business of investment, (b) to assist or aid in promoting companies; and (c) to buy and sell moveable assets of all kinds. 2. In the merger petition filed before the Hon'ble High Court, the appellant companies have stated to have carried on business of investment in securities and shares and finances. 3. The appellant companies have been consistently filing their returns of income declaring income under the head 'Profits and gains of business or profession' and they raised the objections that they were not carrying on business only when it was proposed under section 28(iv). 4. The appellant companies have helped in promoting Dr. Reddy's Laboratories Ltd. and other group-companies by way of substantial subscription to promoters' equity, pledging its shares to banks for the benefit of Dr. Reddy's Laboratories Ltd. 5. The assessee-companies have invested in the shares on borrowed funds and the return from such investments being negligible, the investments have to be held as made for earning profit at the time of sale at a later date. 6. The contention of the appellant-companies that the shares were acquired for controlling interest in Dr. Reddy's Laboratories Ltd. was n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... incipal ground No. II reads as follows- "Ground II 1. The CIT(Appeals) erred In confirming the action of the Asstt. Commissioner of Income-tax Company Circle 4(5), Hyderabad ('the ACIT') by holding that the benefit has arisen to the appellant on the preferential and concessional allotment of shares of Dr. Reddy's Laboratories Ltd. "TRL" in terms of section 28(iv) of the Act. 2. He further erred in making various immaterial, irrelevant and/or incorrect observations and conclusions which were contrary to and in total disregard of the actual facts and/or on misconstrued facts and were based purely on inferences, surmises, conjectures and including in particular that the appellant company did indulge in real substantial organised course of activity with the set purpose of earning profit and in view of that it was carrying on the business of holding of investments. 3. He failed to appreciate and ought to have held that: (a) The appellant company was investment company and was holding shares of group companies including shares of DRL and as such had derived income from investment in shares and securities; (b) the preferential allotment of shares in Dr. Reddy's Laboratories ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t and not on revenue account; (p) there was no benefit or perquisite arising on account of issue of preferential equity shares in DRL; (q) the Appellant had no right, much less vested right, to receive the equity shares from DRL at concessional price and as such no perquisite or benefit can be said to have arisen; (r) there was no nexus between the business of the Appellant, if at all any, and the benefit which the Appellant had derived, if at all any; (s) the question of the applicability of provisions of section 28(iv) did not arise inasmuch as the value of benefit or perquisite was not arising from; business; and (t) on the facts and circumstances of the case, the said addition was unjustified and unwarranted. 4. The Appellant prays that, it be held that the difference of the price of allotment of shares in DRL, at preferential rate and prices of shares quoted on stock exchange on the date of allotment of the shares could not be brought to tax under section 28(iv) of the Act." 19. The grounds regarding the valuation of benefit are as follows: "Without Prejudice to Above Ground - IV 1. The CIT (Appeals erred in confirming the action of the ACIT in considerin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessee at any time during the previous year; (iv) the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession ........... 22. The learned Senior Counsel stated that in the Scheme of the above provisions, clause (iv) would be applicable only in the preface of clause (i) above. Therefore, accordingly to him, the said circumstances are as follows: 1. That the appellant-companies should have carried on any business at any time during the previous year; 2. That there should be a benefit arising to the appellant-companies; 3. That the benefit must be one arising from the business carried on by the appellant-companies; 4. That the benefit, if any, must be revenue in character; must be of income in nature; 5. That the benefit has arisen to the appellant-companies in a business transaction they had with Dr. Reddy Laboratories Ltd. (DRL). 23. He contended that none of the above circumstances have been satisfied in the case of the appellant-company. M/s. KNB Investments (P.) Ltd. and M/s. KAR Investments (P.) Ltd.; and absolutely there is no justification to hold that the appellant-companies have enjoye ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e previous year comprised only of dividends and interest. They have not invested in the shares of any outside companies; nor did they deal in the shares of these companies. The appellant-companies have not indulged in any systematic or organised activities in any line of business, including investment. Their expenditure related to certain bare minimum establishment expenses only. In the circumstances, it could not be held that the appellant-companies have been carrying on any business during the relevant previous year. While referring to the Memorandum of Association of the appellant-companies, the statements and affidavits filed before the Hon'ble A.P. High Court in the context of amalgamation proceedings, filing of returns for earlier assessment years disclosing income under Business head etc., the lower authorities were only mentioning to peripheral and irrelevant issues and they are not decisive in looking into the real question whether the appellant-companies have carried on any business during the previous year. The Memorandum of Association of a company may include a number of object clauses. Generally, they are enabling clauses by which a company can carry on its activities ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ential allotment. Therefore, there is no meaning in comparing the issue price of Rs. 90 per share to the market price of Rs. 455 per quoted share. As such a comparison is unfounded. Accordingly, no benefit has arisen by virtue of preferential allotment of shares. If at all benefit has to be derived, the shares have to be sold. That could be made only after three years. One does not know what would be the market price after three years from the date of preferential allotment. The quoted price of Dr. Reddy's Laboratories during the 23 months ending May, 1994 had fluctuated between a high price of Rs. 560 per share to a low price of Rs. 62.50 per share. The average price was Rs. 248 per annum. Therefore, it is very unsafe to hold that the sale of those shares would fetch a profit compared to the issue price. The price may even come down. As the situation was uncertain regarding the sale price at the time of sale, no benefit could be considered on the basis of the difference between the market price and the issue price on the date of allotment. If at all there could be a profit on sale of shares allotted on preference, that profit would arise only at a future date after three years on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... se, and therefore, the whole exercise of the Assessing Officer was quite uncalled for. He stated that the mandatory circumstances did not exist because- 1. The appellant-companies have not carried on any business, but only held selected shares; 2. They do not have any business relationship with Dr. Reddy's Laboratories Ltd. 3. The transaction of allotment of shares was not in the nature of business. 4. Therefore, the benefit if any could not be held to be arising out of business. 5. No benefit arising as savings in expenditure is not income; 6. The benefit if any, again is not revenue in nature, and 7. Cash payment does not attract section 28(iv). 28. The learned Senior Counsel finally consolidated his propositions in the following lines- 1. For there to be a benefit to be taxed under section 28(iv), there must be 'business income' taxable under section 28(1) in the first place. Where there is no business, there can be no taxation of a perquisite or benefit, as that must arise from the business carried on under section 28(1). 2. The appellant-companies having neither sold the shares of Dr. Reddy's Laboratories Ltd. [except one solitary transaction of sale by M/s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (b) Rameshwar Prasad Bagla v. CIT [1973] 87 ITR 421 (SC); and (c) CIT v. H. Holck Larsen [1986] 160 ITR 67 (SC). 9. In the above mentioned cases, the Hon'ble Supreme Court has categorically stated that the fact that the objects in the Memorandum of Association provided for trading in shares or the fact that the appellant had borrowed to purchase the assets or shares was a factor which did not detract from the fact that the shares were on capital account. 10. In fact propositions above are also supported by the decision of the Hon'ble Supreme Court in Distributors (Baroda) (P.) Ltd.'s case the principle that the shares purchased with a view to obtaining a managing agency would not be stock-in-trade, namely business assets. There has been no systematic organised activity of investment with a view to making profit in order to make the activity carried on by the appellant as the business of holding investment. 11. Where in accordance with law and after compliance with the requisite legal formalities under SEBI or under the Companies Act/law shares are purchased at "lesser price", section 28(iv) cannot apply as it does not apply to cases where an assessee is able to purchase at ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e shares of which are quoted on the stock market cannot mean that a liability arises under section 28(iv) of the Income-tax Act. 17. In any event in view of the value of the shares having been determined by M/s. C.C. Chokshi Co., at Rs. 88 issue at Rs. 90 is fully supportable. 18. In view of the lock-in-period statutorily required of the said shares, the appellant companies did not have any benefit or perquisite accruing in the said assessment year. In any event, the value of the shares could only be taken without prejudice to the above at the market value prevailing on the expiry of the lock-in-period, viz., Rs. 217. 19. The wide fluctuations in the quoted price from time to time shows that where there is a lock-in-period one cannot assess a benefit on the basis of the then prevailing market price. The facts specifically stated in the above prepositions mainly relate to the case of M/s. KNB Investments (P.) Ltd., but the facts are similar in the case of M/s. KAR Investments (P.) Ltd., except that there was no transfer of any share of diano Hotels and there as one solitary transaction of sale of Dr. Reddy's Laboratories shares. In the preceding previous year M/s. KAR Invest ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ility of preferential allotment of shares. He submitted that the shares of Dr. Reddy's Laboratories are quoted at Stock Exchange at Rs. 455 per share, whereas the appellant-companies got the same for Rs. 90 per share. The allotment was not made to the public at large, including its existing shareholders, other than the appellant-companies. The benefit of concessional rate or preferential allotment was not extended to all the shareholders, but it was extended only to selected members, viz., the two appellant-companies. By virtue of this discretion itself, it is quite apparent that the preferential allotment of shares was made with a specific intention of conferring benefits on the appellant-companies. The learned Senior Departmental, Representative further pointed out that there is no point in distinguishing between the benefit so derived under section 28(iv) as capital or revenue. Since the benefit has arisen out of the business carried on by the assessee, and as such it is treated as benefit, there is no further need of examining the nature of that benefit, viz., capital or revenue. Such characterisation is not contemplated under the provisions contained in section 28(iv) of the A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or Departmental Representative has filed a synopsis of the Department's submissions. In support of its contention that the assessee carried on the business of holding of investments, it is stated therein that the assessee-companies had a systematic, organised, continuous activity of investing in the equity of group companies as evident from the Balance Sheets. Investments are made in a number of group companies on a regular basis, whenever group companies needed to raise funds. The appellant-companies have also admitted to have carried on business of investments in shares and securities through the Memorandum of Association; reports of the auditors; reports of official liquidators; returns of income filed for earlier years; and submissions made before the High Court of Andhra Pradesh in the amalgamation proceedings. Holding of investments is a business activity, as recognised by the Hon'ble Supreme Court in Distributors (Baroda) (P.) Ltd's case. That principle was applied by the Madras High Court in Amalgamations (P.) Ltd.'s case. M/s. KAR Investments (P.) Ltd. had sold 4,000 shares of Dr. Reddy's Laboratories in financial year 1993-94 at Rs. 1255 per share, which is the market pri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... business of holding investments, and therefore, the benefit has directly arisen from the business transaction in the ordinary course. The words used in section 28(iv) are 'arising from', which have wider import as opposed to the words 'derived from'. Reliance is placed in this behalf on the following decisions (a) VP. Warrier v. CIT [1990) 181 ITR 303 (MP). (b) R.L. Kasliwal's case. (c) Protos Engineer Co. (P.) Ltd v. CIT [1995] 211 ITR 919 (Bom.). (d) Oil India Ltd v. CIT [1995] 212 ITR 225 (Ori.). 4. Reiterating its stand that the benefit involved in the present cases is clearly income under section 2(24), it is stated that the question whether the benefit in question is of capital or revenue nature does not arise because of section 2(24)(va). It is stated further that it is not necessary for every assessee to have every type of income listed in section 28. 5. It is argued that the sale of 4,000 shares by M/s KAR Investments (P.) Ltd. during the financial year 1993-94 at Rs. 1,255 and forward contract for sale of shares to M/s Margadarsi Financiers at Rs. 500 per share or average quotation of preceding 15 trading days, are clearly indicators to the assessee's own est ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f appellants' paper-book Vol. I. The shares have been valued on break-up-method. Profitability also has been taken into consideration linking between historical profits and estimated future maintainable profit (Para 14.5 of the Report-page-77 of paper-book). On that basis, the shares of Dr. Reddy's Laboratories Ltd. have been valued at Rs. 90 per share as on 31-3-1994 (Page 69 of paper-book-Annexure C of the Report--Paras 11.3 and 11.4 of the Report). The above value of Rs. 90 per share has been worked out before considering the Bonus issue, preferential issue and Euro Issue of shares made by M/s. Dr. Reddy's Laboratories Ltd. after 31-3-1994. When those issues were also taken into consideration, the share value has come down to Rs. 88 per share. In the said Valuation Report, the consultants have considered the price fluctuations of the shares of M/s. Dr. Reddy's Laboratories Ltd. in the stock market, for a period of 23 months ending May, 1994 (Para 16.7 of the Report Page 83 of paper-book Vol. I,). The market price has fluctuated from the highest price of Rs. 560 per share in April 1994 to the lowest price of Rs. 62.50 per share in the third quarter of 1992. The summary of the mar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . 36. Where the benefit is related to the prevailing market price, the issue to be considered is whether there is any sustainable basis for a comparison of issue price with the market price. One of the objects of preferential allotment of shares was to retain the control of Dr. K. Anji Reddy and his associates in the ownership and management of M/s. Dr. Reddy's Laboratories Ltd., even after the Euro-issue of shares. This objective was made clear in the Explanatory statement circulated by M/s. Dr. Reddy's Laboratories Ltd. among its shareholders, pursuant to section 173(2) of the Companies Act, 1956. The Explanatory statement was a legal requirement to accompany the notice of the Extraordinary General Meeting, where special resolutions were proposed to be considered and passed. The relevant explanation in respect of the preferential allotment of 22,50,000 equity shares given as item No. 4 of the said statement reads as follows- "In the light of the proposed Euro-issue and to guard against any take over bid by any other company, Indian or foreign that may arise out of the globalisation of Indian Economy which is possible in the international corporate scenario particularly in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing having more than 50% of voting power is of course the ideal situation for the promoters' group in any company. But in real life of corporate affairs, one hardly comes across such an ideal and academic situation. Where there is no majority shareholding, the next best alternative is to retain controlling interest by holding at least 25% of the equity, so that effective control can be held in the day to day affairs and policy management of the company. The status quo could be maintained by avoiding basic changes in the dynamics of the company structure. In this perspective, the preferential issue of shares by Dr. Reddy's Laboratories Ltd. cannot be considered independent of the object of the issue discussed above. A clear nexus is established between the object of retaining controlling interest and the preferential issue of shares. 37. When the shares were acquired by the appellant-companies with the specific objective of retaining the controlling interest in Dr. Reddy's Laboratories Ltd., there cannot be a presumption that those shares were acquired for resale in the stock market and earn profit out of that. If a person acquires a large block of shares with the object of the ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a comparison is hypothetical. 40. The appellant-companies had no plan to procure shares from the stock market. Therefore, the market price did not apply. It was a preferential allotment lawfully made. It was made for some strategical purpose of ownership and control. The new shares were locked up for a period of three years. It was not possible to sell the shares during the relevant previous year. The premises relied on by the revenue pre-suppose the arising of benefit in the nature of income on the principle of contemplated sale. The shares could be sold only after three years. The share value is highly susceptible to market fluctuations. We have already noted from the share valuation report that the shares of Dr. Reddy's Laboratories have fluctuated from Rs. 62.50 to Rs. 560 per share during the 23 month period ending May, 1994. In the circumstances, one cannot safely predict what would be the market price of Dr. Reddy's Laboratories Ltd.'s shares after the expiry of three years. The market value depends on a lot of factors including general economic conditions, market buoyancy, the status of particular industry and the financial image of the particular company, etc. The appel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... six items as such are not sufficient; every one of them should be in the nature of income. The income, obviously need to be real Clause (iv), if edited for our purpose reads as follows: "The value of any benefit arising from business....". That is, the benefit must be one arising from business during the relevant previous year. While defining the scope of total income in section 5 of the Act, the law has made a two-fold characterisation, viz, income accruing or arising. But while dealing with benefit in the nature of income in the context of section 28, law has conspicuously omitted the concept of "accruing" and has prescribed only 'arising'. "Benefit arising" implies benefit arising in the previous year. In other words, the law has made the nature of benefit under section 28(iv) very clear and precise. That is, the benefit must be income in character; and it should be arising in the relevant previous year. In the present case, the income is prospective on the condition of the future sale of shares. That income which is prospective in nature cannot be construed as "benefit arising" to the appellant-companies in the relevant previous year. 43. The basis of the argument that the a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... alue and the preferential issue price at Rs. 90 per share are cross-matching. In between them, there is no price difference, and therefore, there is no benefit either. 45. In view of the above findings, we are of the considered opinion that the benefit contemplated by the Assessing Officer on the basis of the comparative price differential between the preferential issue price and the market price of Dr. Reddy's Laboratories shares cannot be construed as "benefit" much less a "benefit in the nature of income" arising to the appellant-companies from business during the precious year relevant to the impugned assessment year 1995-96. As far as the relevant previous year is concerned, the benefit or advantage was only conceptual in nature as the real advantage or benefit would be in the nature of eventual capital gain to be derived on the sale of those preferentially allotted shares on a future date which would be beyond the close of the relevant previous year. Therefore, the additions made by the Assessing Officer in the assessments of the appellant-companies under section 28(iv) of the Income-tax Act, 1961 are not sustainable in law. The addition of Rs. 32,85,00,000 made in the case ..... X X X X Extracts X X X X X X X X Extracts X X X X
|
