TMI Blog2010 (4) TMI 910X X X X Extracts X X X X X X X X Extracts X X X X ..... e hon ble Supreme Court in the cases of CIT v. Gillanders Arbuthnot and Co. [1973] 87 ITR 407, CIT v. Smt. Nilofer I. Singh [2009] 309 ITR 233 (Delhi) and Dev Kumar Jain v. ITO [2009] 309 ITR 240 (Delhi). Thus, the action of the Assessing Officer should be reversed and the capital gain should be computed on the basis of full value of consideration. (2) The Commissioner of Income-tax (Appeals) erred in law and on facts in confirming an addition of ₹ 37,60,41,886 as short-term capital gain on sale of 23,90,000 shares transferred on May 10, 2005 by considering their date of acquisition as July 27, 2004 whereas the same was April 4, 2004 following Circular No. 704 dated April 28, 1995 reported at ([1995] 213 ITR (St.) 7). Thus, the said loss should be assessed as long-term capital loss as claimed by the assessee. (3) The Commissioner of Income-tax (Appeals) erred in law and on facts in confirming the disallowance of ₹ 22,03,822 under section 57(iii) of the Act on interest paid to others ignoring the facts and evidence placed on record. Thus, the action of the Assessing Officer should be reversed. The facts culled out from the assessment order are that the assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ad 41,51,648 10 4,15,16,480 Sale of shares 10-5-05 3288181 shares sold at ₹ 20 each 8,98,181 20 1,79,63,620 10-5-05 23,90,000 4,78,00,000 32,88,181 65,76,33,620 Closing balance of investments as on March 31, 2006 41,51,648 10 4,15,16,480 The Assessing Officer examined the transaction of sale. He came to the conclusion that sale to Shri R. P. Mittal was a colourable transaction as Shri R. P. Mittal and Smt. Sarla Mittal, the husband and wife duo, controlled the assessee-company. Since Hotel Queen Road Pvt. Ltd. was wholly own ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rchase No. of shares Rate Total value Difference (Rs.) (Rs.) (Rs.) 10-5-2005 8,98,181 185.68 16,67,74,248 1,66,07,608 10-5-2005 23,90,000 185.68 44,37,75,200 37,60,41,886 Total 32,88,181 61,05,49,448 Total capital gain (short-term) 37,60,41,886 The assessee had also claimed deduction of ₹ 22,03,822 under section 57(iii), while computing income under the head Income from other sources . In this connection, it was mentioned that share capital and reserve and surplus amounted to ₹ 9.60 crores on March 31, 2006. Therefore, advances of ₹ 9.20 crores, on which interest ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ation at the time of transfer of the shares to Shri R. P. Mittal. It was, inter alia, mentioned that Shri R. P. Mittal and Smt. Sarla Mittal were in effective control of the assessee-company and Hotel Queen Road Pvt. Ltd. The assessee-company managed the affairs of Hotel Queen Road Pvt. Ltd. in such a manner that other shareholders were kept in the dark not only in respect of management of affairs but also about the transfer of shares. In view thereof, the action of the Assessing Officer to bring a sum of about ₹ 37.60 crores to tax as short-term capital gain was upheld. In regard to computation of income under the residuary head, it was submitted that the interest paid to others was on account of substitution of funds deployed earlier to earn interest income. The money was borrowed to discharge the loan due to Shri R. P. Mittal, which was deposited with Hotel Queen Road Pvt. Ltd. Interest of about ₹ 90 lakhs was earned on such deposit from Hotel Queen Road Pvt. Ltd. On making the borrowings, the loan payable to Shri Mittal was reduced from ₹ 9.65 crores to ₹ 3.29 crores on March 31, 2006. The amount was deposited with Hotel Queen Road Pvt. Ltd. and the a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ment of equity, the assessee sold 32,88,181 shares to Shri R. P. Mittal at ₹ 20 per share. These shares comprised 8,98,181 shares originally acquired and 23,90,000 shares allotted by Hotel Queen Road Pvt. Ltd. to the assessee on July 27, 2004. Coming to the arguments, it is submitted that there is no dispute about the cost of acquisition of these shares. However, there is a dispute when the sale price was substituted by the Assessing Officer with the fair market value. The assessee was required to substantiate the sale price as the assessee-company as well as Hotel Queen Road Pvt. Ltd. were controlled by Shri R. P. Mittal and his wife. In this connection, a valuation report was filed showing the fair market value of the shares at ₹ 3.19 per share on the basis of last available balance-sheet of March 31, 2005. The valuation was made on asset backing method as the company was not carrying out any business. The value was low because no business was conducted by Hotel Queen Road Pvt. Ltd. between June, 2003 to October, 2008. In this period, the hotel was closed for extensive repairs and renovation. However, the Assessing Officer did not accept the sale consideration and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of about ₹ 9.65 crores were made from Shri R. P. Mittal, to whom no interest was paid. Monies were borrowed from third parties to discharge the liability towards Shri R. P. Mittal and interest of about ₹ 22 lakhs was paid on such borrowings. Therefore, it is argued that there was a nexus between borrowings from others and lending to Hotel Queen Road Pvt. Ltd. Thus, interest paid to others is deductible in computing the income under the residuary head. Coming to the issue of the period of holding the asset, the learned Departmental representative submitted that the assessee had itself shown the date of acquisition as July 27, 2004 (paper book 25) while working out short-term capital gains. The assessee-company was controlled by Shri R.P. Mittal and Smt. Sarla Mittal, who are the directors of the company. The sales are effected to Shri R. P. Mittal. The assessee has not placed on record the resolution of the board or the minutes of the board meeting in which it was decided to allot shares to the assessee. Thus, the claim of the assessee is based solely on correspondence between Hotel Queen Road Pvt. Ltd. and the assessee-company. The three letters have been signed eith ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Queen Road Pvt. Ltd. and the assessee-company was not required to be filed before any other authority or third party. Therefore, it is not available with anyone except the assessee and Hotel Queen Road Pvt. Ltd. The payments had been made by the assessee on the basis of the letter of Hotel Queen Road Pvt. Ltd. The assessee is not in a position to produce the board resolution as it had been excluded from the management of Hotel Queen Road Pvt. Ltd. as evidenced by the order of the learned Commissioner of Income-tax (Appeals) and page 84 of the paper book, being the letter dated October 15, 2009 addressed to the learned Commissioner of Income-tax (Appeals). In paragraph 2, it is mentioned that at present the management of the company is with the opposite group and minutes book of the hotel company is in their custody. In view thereof, no copy of the resolution can be filed. The primary case of the Assessing Officer is that the fair market value should be substituted in place of the sale consideration. Therefore, it is not a case of disallowance of non-business loss but computation of capital gains by enhancing the sale consideration. We have considered the facts of the case and su ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y him in making any addition or alterations thereto, but excluding any expenditure in respect of which any allowance is admissible under any provision of sections 8, 9,10 and 12 : (The remaining portion of section 12B is not relevant for our present purpose) While deciding this case, the hon ble court followed its own decision in the case of CIT v. George Henderson and Co. Ltd. [1967] 66 ITR 622 (SC). It was mentioned that the Legislature has made a distinction between the expression the full value of the consideration and fair market value of the capital asset . The 1922 Act provides for two exceptions, which are not applicable to the facts of our case. It was held that if these two conditions are not applicable, the main provision will become applicable in computing the capital gains by taking into account the full value of consideration for the transfer. The relevant portion quoted from the case of George Henderson and Co. Ltd. [1967] 66 ITR 622 (SC) by the hon ble court, which was followed by it, is reproduced below (page 626) : In case of a sale, the full value of the consideration is the full sale price actually paid. The Legislature had to use the words full v ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cision was followed by the hon ble court in the case of Dev Kumar Jain v. ITO [2009] 309 ITR 240 (Delhi). Coming to the cases relied upon by the learned Departmental representative, the facts of the case of CIT v. L. N. Dalmia [1994] 207 ITR 89 are that the assessee floated a private limited company called LNE. The assessee and his nephew became subscribers to the memorandum and articles of association. The certificate of incorporation was issued by the Registrar on June 6, 1969. The assessee sold 27,162 shares of Punalur Paper Mills Ltd. to LNE at ₹ 25 per share in May, 1969. LNE had not been incorporated till that date. LNE duly ratified the purchase of shares on June 7, 1969, i.e., after its incorporation. Thereafter, another lot of 12,000 shares of the same company were sold by the assessee to LNE at ₹ 25 per share. The assessee suffered a loss of ₹ 7 per share on the sale of 39,162 shares. The loss was disallowed by the Assessing Officer by treating it to be unreal and sham. The Appellate Assistant Commissioner and the Tribunal allowed the loss. The Tribunal was of the view that the transaction took place between the individual, being the holder of the sha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he court were as under (page 15) : 1. Whether, on the facts and in the circumstances of the case, the Tribunal could hold that a sum of ₹ 30,000 being the face value of three hundred fully paid up shares of Messers. Delhi Gate Services (P) Ltd., was not capital but revenue receipt in the hands of the petitioner liable to tax ? 2. Even if it be held that the aforesaid amount represented revenue receipt, could the Tribunal in law hold that the entire face value of the shares constituted revenue receipt which was assessable to tax ? In that case, question No. 1 was decided against the Revenue and in favour of the assessee. In regard to question No. 2, the hon ble court held that the Tribunal was right in its observation that where income was not received in money but in money s worth, its value had to be determined with reference to the market conditions prevailing at the time of receipt of the money s worth. Therefore, the Tribunal ought to have determined the market value of shares at that point as face value of the shares would not constitute the income. Thus, the ratio of the case is that if income is earned in money s worth, the fair market value will be the quantum ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d not have substituted fair market value of the shares transferred in place of consideration received or accruing. The learned Departmental representative also raised an alternative argument that the transactions were between the related parties. The assessee was a holding company of Hotel Queen Road Pvt. Ltd. Shri R. P. Mittal and his wife were controlling the affairs of both companies. In such a scenario, it was argued that the transaction of sale was not in the normal course of business and, therefore, the loss could not have been allowed. In this connection, we have already considered the decision in the case of L.N. Dalmia [1994] 207 ITR 89, in which it was held that the real question to be seen is whether there is any material change in position after transfer vis-a-vis the position before transfer. The facts of the case of L. N. Dalmia [1994] 207 ITR 89 were distinguished by the assessee before the learned Commissioner of Income-tax (Appeals) in letter dated August 17, 2009. Relevant paragraphs 2.15 to 2.17 are reproduced below : 2.15 Thus, Mr. Mittal pressurised for such transfer and it was decided by the appellant to transfer a part of the equity shares held by the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not appreciate the ground reality of the appellant and the then prevalent circumstances that as to why the 23,90,000 and 41,51,648 equity shares were allotted against cash contribution by Hotel Queen Road Pvt. Ltd. to the appellant in 2004-05 at par value if the said shares could be offered in the market at higher value by the said company. Admittedly, the only business being the hotel of the said company was closed for completion of renovation for want of funds. It was in dire need of money in any manner from any source. The assessing authority has not alleged that the said shares were purchased by the appellant by making underhand payments or not at the fair market value then. Even the appellant could have sold the shares in the market to somebody else at a huge premium amount as computed by the Assessing Officer, if those were so saleable and would have used the said liquid funds by financing the hotel company to enable it to commence commercial operations of the hotel. Since, these shares did not have any market at all at that time, those could not fetch what to say higher but any price at all and, therefore, those were so sold to Mr. Mittal because it was only he who could be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 90,000 shares. There is also dispute about control and management of the company between two rival groups. The assessee was indebted to Shri R. P. Mittal, who had advanced money without stipulation of charging interest. Thus, there is a qualitative difference in the facts of this case and the facts of the case of L. N. Dalmia [1994] 207 ITR 89. In that case, there was no dispute between the shareholders in regard to management of the company. However, as we shall see later while dealing with ground No. 2 there were two groups of shareholders in this case, one may be termed the R. P. Mittal group and the other as the Ashok Mittal group, these persons being brothers. Litigation was going on in regard to management of this company and Hotel Queen Road Pvt. Ltd. Further, there were reasons to transfer the shares to Shri R. P. Mittal as the assessee was indebted to him. The other difference is that the sale price of ₹ 20 per share in respect of 23,90,000 shares was more than the purchase price of ₹ 10. Thus, no loss but profit occurred in respect of sale of these shares. Having accepted this sale consideration, it would be difficult to countenance the argument that the origi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cates were handed over to Shri R. P. Mittal on July 27, 2004. The assessee treated these shares as a short-term asset and computed short-term capital gain on transfer of these shares at ₹ 2.39 crores. However, this position was sought to be altered in the course of assessment. In the proceedings, the assessee failed to produce minutes book to support whether any resolution was passed by the board of directors at any point of time for allotment of these shares. We may also add that the assessee has not furnished at any time any communication made to the Registrar of Companies in this matter or the copy of shareholders register showing the date on which these shares were entered against his name. The case of the assessee is built entirely on paragraph 2 of Board Circular No. 704 dated April 28, 1995. It is contended that in consonance with this circular, the period of holding should be counted from April 4, 2004. The Board circular deals with securities transaction undertaken through stock exchanges and it has been mentioned that the period of holding shall be reckoned from the date of the broker s note for purchase on behalf of the investors. For the sake of completeness, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... see held these shares for not more than 12 months from the date of transfer ? None of the contending parties referred to the provisions of the Companies Act in this matter. We have done a bit of research to understand the situation on clearer footing. Under that Act, a contract for allotment of shares stands at par with an executory contract under the Contract Act. An agreement to allot shares or take and pay for shares is specifically enforceable, as held in the case of Sri Lanka Omnibus Co. Ltd. v. L. A. Perera [1952] AC 76 (PC). The legal possibility of a valid executory contract for allotment of shares is recognised, provided there is an offer to take up shares which was communicated to and was accepted by or on behalf of the company. An executory contract to take up shares may be brought into existence in the same manner and subject to the same principles as under the Contract Act. The communication of acceptance need not be in writing. It may be verbal or may be inferred from conduct as held in Transport Co. Ltd. v. Tirunelveli Motor Bus Co. Ltd. [1955] 2 Mad LJ 141 at 147. The court mentioned at page 147 that a court has jurisdiction to decree specific performance of a co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ase. On perusal of evidence on record, it can be said that there was an offer made by the assessee-company to Hotel Queen Road Pvt. Ltd. for subscribing to about 22,50,000 shares. However, it was a conditional offer that the allotment must be made before March 31, 2004. This condition has not been satisfied by Hotel Queen Road Pvt. Ltd. It is also a matter of fact on record that the assessee had paid ₹ 2.39 crores to Hotel Queen Road Pvt. Ltd. by March 4, 2004 as share application money. However, it is not clear whether any board meeting took place or the directors by majority consensus decided to allot 23,90,000 shares to the assessee-company. As per the provisions of the Companies Act, the shares could be allotted only if a meeting had taken place to consider the conditional officer and a decision taken to allot the aforesaid shares to the assessee. In the case of Portuguese Consolidated Copper Mines Ltd. In re [1889] 42 Ch D 160 (CA), there was no proof available to show that the directors actually met to approve the transaction, but there was endorsement of five out of seven directors, which shows that they consulted one another and majority of them was of one mind and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nts, the onus of production of which for substantiating its claim was on the assessee, further weakens the case of the assessee. It may also be added that under the company law holder of equity shares is a term synonymous with the member of the company . Mere allotment of shares in the meeting of the board does not make an investor to be member of the company. He becomes the member only when his name is entered in the shareholders register after completing necessary requirements under the Companies Act. However, we may not take this factor into account as the case is covered by the decision in the case of SN. Zubin George [2004] 265 ITR 683 (Ker). In such circumstances, we are of the view that the learned Commissioner of Income-tax (Appeals) was right in holding that the assessee held the shares with effect from July 27, 2004 and, thus, the capital gain was to be treated as short-term capital gains . Thus, ground No. 2 is dismissed. Ground No. 3 is that the learned Commissioner of Income-tax (Appeals) erred in confirming the disallowance of ₹ 22,03,822 made under section 57(iii) on interest paid to others. The facts on record in regard to this ground, mentioned in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as that provision contains the words laid out or expended wholly and exclusively for the purpose of making or earning such income as against the words laid out or expended wholly and exclusively for the purpose of business . The provision under consideration requires proof of nexus between earning of income and the expenditure. In the case of T. S. Krishna v. CIT [1973] 87 ITR 429 (SC) it was held that payment of wealth-tax did not bear any direct or incidental relationship with earning of dividend income and, therefore, it is not deductible in computing income under the residuary head. In the case of Seth R. Dalmia v. CIT [1977] 110 ITR 644 (SC), one of the questions before the court was whether, on the facts and in the circumstances of the case, the Tribunal rightly rejected the assessee s claim for deduction of interest payment of ₹ 2,04,744 ? It was mentioned that the dividends, rights, bonuses, etc. were held by the bank for the benefit of the assessee after they were declared. If the assessee would not have paid the interest on the loan raised by him, he would not have been able to get the dividend income. Thus, there was a direct nexus between earning of dividend i ..... X X X X Extracts X X X X X X X X Extracts X X X X
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