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2015 (11) TMI 1219 - DELHI HIGH COURT

2015 (11) TMI 1219 - DELHI HIGH COURT - TMI - Loss in respect of renunciation of rights to subscribe to partly convertible debentures (hereafter ‘PCD’) - according to the Revenue, the transaction was entered into solely for the purpose of contriving a loss - whether the transaction of renunciation of rights for subscribing to PCDs of JISCO was a colourable device to contrive an artificial loss? - Held that:- In the present case, the facts clearly indicative the transaction to be a part of a sche .....

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relinquished its rights to subscribe to PCDs and the transaction had been implemented by JSL subscribing to the PCDs and in the circumstances, it could not be disputed that the transaction was genuine. It was contended that such transaction were permissible in law and, therefore, the tax effect of such transactions would necessarily follow. It was further contended on behalf of the Assessee that it is permissible for an Assessee to part with its asset with a view to book a loss. In our view, it .....

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uld be an abuse of the corporate form and such transactions, even though implemented, cannot be considered to be other than a colourable device for avoidance of tax.

In case the Assessee had actually paid the cum rights price of ₹ 625/- for purchase of the shares, the reduction in value of the shares on an ex-right basis would be duly reflected in the value of the closing stock. The Assessee not having paid the price of ₹ 625/- cannot claim a loss on account of a drop in i .....

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ued, it could do so by proportionally reducing the value of its shareholding in the same proportion as the drop in price of quoted shares. In other words, it could reduce the cost of shares of JISCO in the same proportion as the diminution in the value of the price of its shares on account of the shares being traded on an ex rights basis, that is, the cost of shares of JISCO could be reduced by applying a factor of 425/625 – ex-right price divided by cum-right price. - Decided against assessee. .....

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appears to have claimed a change in the nature of his holdings depending on the tax incidence in the year in question; in AY 1988-89 the Assessee reflected to shares of JISCO purchased in that year at below cost – treating them to be stock-in-trade and in AY 1992-93 sought to treat them as investments to avoid tax on the gains. None of the Assessee’s actions in the previous year 1991-92 indicated any change in the Assessee’s intention regarding its holding in shares and debentures. The ITAT obse .....

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happened in the year in question is that the Assessee sold substantial shares and renounced rights to subscribe to PCDs contrary to its stated intention of holding the same on a long term basis.

In view of the above, the income received by the Assessee from sale of shares of JSL and the renunciation of rights to subscribe to the PCDs of JISCO was rightly held by the AO as business income and not income under the head capital gains. As discussed later, the Assessee could not have claim .....

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er dated 12th January, 2001 passed by the Income Tax Appellate Tribunal (hereafter ITAT ) in ITA No. 5425(Del)/94. The said appeal (ITA 5425(Del)/94) was preferred by the Assessee against an order dated 18th July, 1994 passed by Commissioner of Income Tax (Appeals) [hereafter CIT(A) ] whereby the Assessee s appeal against an assessment order dated 22nd April, 1993, passed by the Assessing Officer (hereafter AO ) in respect of Assessment Year 1992-93, was rejected. 2. The controversy involved in .....

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0 nos. of shares at the aggregate consideration of ₹ 7,14,900/-). As against the aforesaid cost actually paid, the Assessee had claimed a cost of acquisition of rights entitlement to subscribe to PCDs at the rate of ₹ 200 per share of JISCO on the basis of which such rights were acquired. 3. According to the Revenue, the transaction was entered into solely for the purpose of contriving a loss by unjustifiably relying on a decision of the Supreme Court in Dhun Dadabhoy Kapadia vs. CIT .....

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hat the assessee had incurred loss on sale of its entitlement to acquire partly convertible debentures and the assessee is entitled to set off the alleged loss from the capital gains/income earned by the assessee? 5. The present appeal was heard alongwith CIT v. M/s Sun Investments Ltd.: ITA 91/2002 and CIT v. M/s Stainless Investment Ltd.: ITA 305/2002 in respect of companies which also belong to the Jindal Group and where similar issues were involved. The learned counsel for the parties argued .....

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s. JISCO & Jindal Strips Limited (hereafter JSL ) and Saw Pipes Ltd. are among the principal manufacturing companies of the Jindal Group. In addition to the manufacturing concerns, Jindal Group also includes investment companies - such as the Assessee - which, inter alia, hold shares of the other manufacturing companies. 6.2 It is not disputed that the investment companies within the Group are under an overall common management and that the registered offices of some of the investment compan .....

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declared that 50% of the public issue i.e. ₹ 6 lacs was its income. This declaration was made under an amnesty scheme available at the material time. 6.3 During the initial assessment year i.e. AY 1984-85, the Assessee company made investments in shares of the following companies:- (i) JSL, 79,800 equity shares. (ii) Nalwa Steels Ltd., 50,000 equity shares (iii) JISCO 3,50,000 equity shares At the material time, the shares of the aforesaid companies were not quoted at the stock exchange. .....

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March, 1993 at a total price of ₹ 3.92 crores i.e. ₹ 280/- per share to JSL. 6.5 On 4th April, 1991 the Directors of the Assessee company passed a resolution to the effect that the shares and debentures held in various companies which were shown as stock-in-trade were to be now reflected as investment as the said securities were intended to be retained on a long term basis. 6.6 During the relevant financial year, the Assessee sold an aggregate of 60,000 (sixty thousand) equity share .....

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ee. The PCDs were to be converted to one share of JISCO. The rights issue opened on 14th February, 1992. 6.8 The Assessee renounced its entitlement for subscribing to 1,29,688 PCDs in favour of JSL on 15th February, 1992 i.e. one day after the rights issue opened for subscription. 6.9 The shares of JISCO were quoted at a cum rights price of ₹ 625/- on 3rd January, 1992 and were quoted at ₹ 425/- per share ex rights on 6th January, 1992. 6.10 On the basis of the aforesaid drop in pric .....

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right to subscribe to 1,29,688 PCDs - computed at ₹ 200 per share. 6.11 The AO noted that the consideration for renunciation of rights had not been received in the financial year. The AO further noted that the renunciation of right forms was quoted on the stock exchange at a price ranging from ₹ 260 to ₹ 280 per PCD and, thus, had concluded that the sale was made below the market price. 6.12 The AO had noted that the sale proceeds received by the Assessee for sale of shares hel .....

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had earned substantial income. In order to reduce the taxable profits, these companies had renounced rights to subscribe to securities in favour of other companies belonging to the same group at a price much below the market value and, further, on the basis of the notional cost of acquisition, claimed a loss which was sought to be set off from the profits earned from the sale of shares of JSL, JISCO and/or Saw Pipes Ltd. The AO noted that the Assessee could not provide any reason for selling th .....

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transfer of shares held by the Assessee from the stock-in-trade to investments; further renunciation of rights at below the market price; and the renunciation of rights to subscribe PCDs were sham transactions to purchase losses. He also concluded that the transactions were not in aid of the Assessee s business or its stated object of holding investments on a long term basis. 6.14 Aggrieved by the assessment made by the AO, the Assessee appealed before the CIT(A). The CIT(A) rejected the appeals .....

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Assessee s contention and, consequently, the loss claimed by the Assessee on the renunciation of rights to subscribe to PCDs of JISCO was allowed to be set off against the profits made by the Assessee. The ITAT was of the view that the shares of JSL or JISCO held by the Assessee were investments and not trading assets. Consequently, it held that the Assessee was entitled to compute the cost of acquisition of rights to subscribe to PCDs in accordance with the Supreme Court s decision in Dhun Dada .....

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e Assessee was interested to buy the PCDs of JISCO. Submissions 7. Mr Rohit Madan, Learned counsel appearing for the Revenue contended that the Tribunal had grossly erred in not appreciating that the AO had found the transactions to be a device to evade tax. He further pointed out that although the ITAT had observed that the Assessee had sold the shares of JSL as it was interested in subscribing to the rights issue floated by JISCO, the facts indicated quite to the contrary. He submitted that ad .....

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-in-trade to investments in the balance sheet as on 31st March, 1992 solely for the purpose of taking benefit of the decision of the Supreme Court in Dhun Dadabhoy Kapadia (supra). He contended that the shares in question had been held by the Assessee as stock-in-trade and the resolution to transfer them to investments was taken only once the Assessee contemplated sale of the said shares. He contended that this was apparent from the fact that the shares in JSL were sold within the same financial .....

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ant for the purposes of claiming the loss on renunciation of rights to subscribe to the PCDs of JISCO. He contended that whether the shares in question were held as stock-in-trade or as investments, the Assessee would, in either case, be entitled to claim the loss on renunciation of its rights to subscribe to the PCDs of JISCO. He relied upon the decision of the Bombay High Court in CIT v. K.A. Patch: (1971) 81 ITR 413 (Bom) in support of his contention that the method of calculation of loss on .....

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renunciated by the Assessee in favour of JSL had been exercised by JSL and JSL had subscribed to the PCDs of JISCO which were subsequently issued and registered in the name of JSL. He earnestly argued that in the circumstances, the transaction of sale of rights in question could not be considered as a paper or a sham transaction. He referred to the decision of the Madras High Court in M.V. Valliappan v, ITO: (1988) 170 ITR 238 (Mad) in support of its contention that the principles enunciated by .....

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of acquisition. He submitted that if the transaction was held to be a sham transaction, then the consideration received by the Assessee also ought to have been reduced from the profits declared by the Assessee. Mr Vohra conceded that this argument had not been urged by the Assessee in the alternative at any stage - neither before the AO nor at any later stage - as the Assessee was consistently canvassing that the transaction in question was a genuine transaction. Reasoning and Conclusion Questio .....

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he value of ₹ 18.59 lacs as investments and ₹ 82.55 lacs as stock-in-trade. According to the Assessee, the Board of Directors had on 4th April, 1991 decided to retain the investments held as stock-in-trade on a long term basis and accordingly passed a resolution to that effect. The relevant extract from the minutes of the meeting held on 4th April, 1991 is as under:- RESOLVED THAT the shares and debentures of ₹ 82,55,810/- (Rupees eighty two lakhs fifty thousand eight hundred t .....

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hares were to be retained as investments was a sham. According to him, the said claim was designed to evade tax due on income from sale of shares of JSL and further claim a loss on renunciation of rights to subscribe to PCDs of JISCO. The Assessee s contention that it was entitled to claim a business loss on account of sale of rights to subscribe to PCDs of JISCO by following the method of computing cost of acquisition as approved by the Supreme Court in Dhun Dadabhoy Kapadia (supra) was also re .....

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subscribe to the PCDs - as stock-in-trade upto AY 1991-92. It is also relevant to note that the Assessee had purchased 7500 shares of JISCO in the financial year relevant to the assessment year 1988-89 for a consideration of ₹ 1,35,000/- which was reflected as a part of the closing stock at a value of ₹ 97,500/-. Thus, it appears that the Assessee had booked a loss for the AY 1988-89 on account of the difference in the purchase value and the value at which the closing stock had been .....

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o contend to the contrary. 16. The ITAT proceeded on the basis that it was always the intention of the Assessee to hold the shares in question as investments and not to trade in them. In our view, this is unsustainable because the Assessee had itself reflected the shares in question as stock-in-trade. The Assessee had also further valued the closing stock at cost or market value, whichever was lower; undisputedly, this treatment could only be accorded to shares held as stock-in-trade and not as .....

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levant to the AY 1990-91 that it was, inter alia, engaged in sale and purchase of shares. The resolution purportedly passed by the Board of Directors of the Assessee on 4th April, 1991 also recorded that the shares and debentures valued at cost or market value, whichever is lower as on 31st March 1991 be transferred from stock-in-trade to investments. Thus, it was not the Assessee s case that the said shares be treated as investments from the date they were purchased but were to be retained as i .....

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rofits from sale of shares as Capital Gains. 18. First of all, it is necessary to note that although the resolution dated 4th April, 1991 specifically stated that the shares and debentures of ₹ 82,55,810/- be transferred to investments in the Balance Sheet as on 31st March, 1992; 60,000 shares of JSL were sold in August 1991, that is, within a few months after the passing of the purported resolution and much prior to the end of the financial year. Thus, the said 60,000 shares of JSL, which .....

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d as undisclosed income of the Assessee; the clear import being that the shareholding was fictitious and undisclosed income of the promoters. 19. In the above circumstances, the AO was rightly skeptical as to the resolution dated 4th April, 1991 and found it necessary to examine the actions of the Assessee. It was at once apparent that the actions of the Assessee were not in conformity with the purported resolution dated 4th April, 1991. Whilst the resolution indicated that the Board of Director .....

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JSL were not used to liquidate the liabilities but substantial amounts were advanced to JSL. The AO also noted that sale transactions entered during the year in question involved the maximum amount since the incorporation of the Assessee. 20. It is also relevant to note that the Assessee further acquired 40,000 shares of JISCO in July 1992, that is, within a few months of selling its rights to subscribe to the PCDs - and consequently acquire the shares of JISCO - at a fraction of the market val .....

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sly, the ITAT reasoned that the shares of JSL were sold to raise funds to enable the Assessee to subscribe to the rights issue of PCDs of JISCO and held as under: The reasons for selling these shares were that assessee company became entitled to subscription to the convertible debentures of JISCO. Each debenture issued by JISCO was for a sum of ₹ 110/- and an investment in debentures would have involved approximate of ₹ 1.5. Crore and if the assessee company would not have sold its 6 .....

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erial before the ITAT to arrive at the above conclusion. This was also contrary to the statement of the Assessee s director who was examined by the AO. Most importantly, the Assessee did not utilize the sale proceeds of 60,000 JSL shares (Rs.1,72,60,000/-) to subscribe to the PCDs of JISCO but sold the rights to JSL for a fraction of its value. The ITAT also failed to appreciate the reasons that had prompted the AO and the CIT(A) to hold that the shares of JSL and JISCO could not be considered a .....

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es and debentures. The ITAT observed that there were hardly any transactions in the past and on that basis concluded that the Assessee was in substance an investment company. However, the ITAT failed to appreciate that the Assessee had consciously held itself out as a company engaged in sale and purchase of shares; it was also assessed on the income earned from business and also claimed deduction on account of business expenses incurred by the Assessee. The shares in question were, concededly, h .....

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ssee could not have claimed any business income on account of renunciation of rights to subscribe to the PCDs. 25. The first question is, accordingly, answered in affirmative, in favour of the Revenue and against the Assessee. 26. There is yet another aspect of the matter that requires to be noted. Assuming arguendo that the Assessee s claim that it had transferred shares and debentures from stock-in-trade to investment during the year in question is accepted; even then, the Assessee could not c .....

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securities in accordance with the regulations made under the Securities and Exchange Board of India Act, 1992 (15 of 1992), but does not include- (i) any stock-in-trade [other than the securities referred to in sub-clause (b)]], consumable stores or raw materials held for the purposes of his business or profession; xxx 28. Undisputedly, the Assessee had held the shares in question as stockin- trade prior to 4th April, 1991 and had claimed that it had decided to retain the shares and debentures .....

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ck-intrade and subsequently converted as an investment. The conversion of stock-in-trade into investments would not immediately yield any business income/loss as an Assessee cannot be held to trade with itself [see: Kikabhai Premchand v. CIT: (1953) 24 ITR 506 (SC)]. However, it is possible to contend that once the asset is sold, the income or loss resulting therefrom would subsume within it the business income/loss at the time of conversion from stock-in-trade to capital asset. Thus, in the yea .....

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be in the nature of capital gains. However, we must add that none of the counsel addressed any arguments on this issue. In the circumstances we do not consider it appropriate to finally decide the same and leave the question open to be decided in an appropriate case. Question No. (ii) 30. The second question relates to whether the Assessee could claim that it has incurred a loss on the sale of its right to subscribe to the PCDs of JISCO and further set off the said loss against the other income .....

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sought to transfer the same at a fraction of its market value. Further, the Assessee had also not received the consideration for same within the relevant financial year. Clearly, if the business purpose of the Assessee was to sell one of its assets, it would have done so at the best possible price and terms. However, in the present case, the Assessee had chosen not to do so. In the circumstances, the AO had called upon the Assessee to explain the reason for transferring its rights at below the .....

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the rights issued to PCDs of JISCO. However, the Assessee had not subscribed to those shares but had also renounced its rights in favour of JSL. There is no explanation provided by the Assessee whatsoever for entering into this transaction. 34. It is important to note that the aforesaid transaction had not resulted in any real loss to the Assessee. Admittedly the price paid by the Assessee for purchase of shares of JISCO was less than the consideration received by the Assessee (Rs.30/- per PCD) .....

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such loss could be claimed by the Assessee is a separate matter; but, in our view, it cannot be disputed that such loss could at best be described as notional. 35. The transaction of renunciation of rights in favour of JSL ensured that the right to subscribe remained within the group. Thus, looking at the transaction at a group level, it is apparent that the right to subscribe to the PCDs and consequently acquire further shares of JISCO was not alienated and remained within the Jindal Group. 36 .....

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as been argued on behalf of the Assessee that it was open for the Assessee to enter into such transactions to mitigate its tax liability. However, we are not persuaded to accept this contention. 38. It is now well established that although tax planning is permissible but a colorable device to avoid payment of tax would be impermissible. Justice Chinnappa Reddy in his concurring opinion in Mcdowell (supra) had held that in our view the proper way to construe a taxing statute, while considering a .....

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what they really are and refuse to give judicial benediction . Justice Ranganath Misra speaking for the majority held that tax planning may be legitimate provided it is within the framework of law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious method. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges . 39. The decision .....

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upreme Court held that the above view of Justice Chinnappa Reddy was a far cry from the majority opinion and further concluded that the decision in Mcdowell (supra) cannot be read as laying down that every attempt at tax planning was illegitimate and must be ignored. 40. The Supreme Court in Azadi Bachao Andolan (supra) approved the following passage from the decision of the Gujarat High Court in Banyan and Berry v. Commissioner Of Income Tax: (1996) 222 ITR 831 (Guj):- The court nowhere said th .....

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t it has been made. The facts and circumstances which lead to McDowell s decision leave us in no doubt that the principle enunciated in the above case has not affected the freedom of the citizen to act in a manner according to his requirements, his wishes in the manner of doing any trade, activity or planning his affairs with circumspection, within the framework of law, unless the same fall in the category of colourable device which may properly be called a device or a dubious method or a subter .....

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n to evade the tax, which is otherwise payable by him. 42. In Commissioner of Income Tax v. Sakarlal Balabhai: (1968) 69 ITR 186 (Guj), the Gujarat Court explained the meaning of tax avoidance and observed that Tax avoidance postulates that the assessee is in receipt of amount which is really and in truth his income liable to tax but on which he avoids payment of tax by some artifice or device..... . The Court further explained that such artifice or device may assume diverse forms but there must .....

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e issue whether transaction pertaining to sale of shares of a non-resident holding company which resulted in transferring the controlling interest in downstream Indian subsidiary, was a device to evade tax. In that context, the Supreme Court observed that whether a transaction is used principally as a colourable device for the distribution of earnings, profits and gains, is determined by a review of all the facts and circumstances surrounding the transaction . The Court held that if an actual co .....

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facts of that case, the Court came to the conclusion that the corporate structure was not created for avoidance of tax but for other genuine business purposes. 45. It follows from the aforesaid decision that in order to examine whether a transaction is a device or a subterfuge the answer to the question whether the transaction has any reasonable business purpose would be a vital consideration. Clearly, the use of corporate form to evade tax would be impermissible and it is, thus, necessary in t .....

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estment companies including the Assessee entered into transactions for renunciation of rights with related companies of the same group. These incestuous transactions were for no other business purpose but to contrive a loss in the hands of the companies such as the Assessee who had incurred a tax liability on account of the gains made. It is claimed that the transactions of sale of rights entitlement had resulted in a tax loss, although no real loss had been incurred by these companies inasmuch .....

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to the rights that were sold by the Assessee at a fraction of its market value. Viewed from the perspective that all companies were related and a part of the Jindal Group, the rights to subscribe to PCDs were not alienated and remained within the Group. The corporate structure of the entities within the group was used for contriving the transactions which would conjure a tax loss in the hands of the companies - including the Assessee - which had incurred a tax liability. 46. In Azadi Bachao Ando .....

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and obligations which they give the appearance of creating. Clearly, the colourable device or a sham transaction would include a transaction and device which purport to show a situation which is much different from the substance of the transaction. In the present case, the transaction of sale of rights entitlement purports to indicate an alienation of a right while in fact at a group level, there has been no alienation of any rights. The transactions have been so executed to ensure that the rig .....

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f evading tax. It has been argued that the Assessee had in fact relinquished its rights to subscribe to PCDs and the transaction had been implemented by JSL subscribing to the PCDs and in the circumstances, it could not be disputed that the transaction was genuine. It was contended that such transaction were permissible in law and, therefore, the tax effect of such transactions would necessarily follow. It was further contended on behalf of the Assessee that it is permissible for an Assessee to .....

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that the benefits of the assets remain within the group. This would be an abuse of the corporate form and such transactions, even though implemented, cannot be considered to be other than a colourable device for avoidance of tax. 48. As explained by the Supreme Court in Vodafone International Holdings B.V. (supra) the question whether a scheme is a colourable or an artificial device would have to be considered in the context of the surrounding facts. In the present case, the facts clearly indica .....

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unt if the AO held the transaction of sale of rights entitlement to be a sham or a colourable device. We are also unable to accept this argument as no such contention was advanced even before the CIT(A) or the ITAT. The Assessee had simply declared profits as per its profit and loss account for charge of tax no claim for rendering the profits had been made and there is no reason for the AO to reduce the same. No alternative arguments had been advanced before the AO. The Assessee had claimed a no .....

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id issue, we deem it appropriate to consider the same. 51. The Assessee has relied upon the decision in the case of Dhun Dadabhoy Kapadia (supra) to contend that the Assessee could calculate its income/ loss from renunciation of rights to subscribe to PCDs of JISCO by claiming the cost of acquisition of the rights entitlement as the difference in cum-right price and an ex-right price of shares of JISCO. It has also been contended that the method of computation of cost of acquisition as approved .....

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956 at a price of ₹ 105 per share (face value of ₹ 75 and a premium of ₹ 30). Thus, the Assessee - who was not a dealer in the shares - became entitled to subscribe to 710 ordinary shares of TISCO. She did not subscribe to her entitlement but sold her entitlement to subscribe 710 shares of TISCO for a consideration of ₹ 45,262.50/-. It is important to note that there was no dispute between the Assessee and the Revenue that the amount received was taxable as capital gains. .....

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ice of TISCO shares - was claimed to be the cost of acquisition of the rights and the same was accepted. The contention of the Revenue that the cost of acquisition should be taken as Nil was rejected as the Court held that the Assessee would suffer some loss in the value of her existing shareholding by reason of increase in the issued share capital of TISCO. It was necessary to determine the cost of acquisition of the rights entitlement for the capital gains to be computed. It is also relevant t .....

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he Bombay High Court in K.A. Patch (supra) had accepted the Assessee s contention and held that the principles accepted by the Supreme Court for determining the cost of acquisition of a rights entitlement for the purposes of computing capital gains would also be applicable for computing business profits. We, respectfully, are unable to concur with this view for several reasons. First of all, for the reason that the commercial and accounting principles for computing trading income/loss are materi .....

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for a trader, the costs incurred by him are subsumed in his trading account, which is mandatorily required to be drawn up. It is neither necessary nor an accounting practice to determine profit and loss on each piece of trading asset that is sold. Therefore, there is no necessity or occasion for trader to separately determine the cost of acquisition of each item of goods sold by him; he is only required to prepare a trading account while reflecting the aggregate sales and purchases. Thus, in a .....

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red to in case of companies - or accepted accounting practices. Typically, a trading account would include Opening Stock, which would be the same as the Closing Stock of the preceding year and would be valued at cost or market price, whichever is lower. The purchases made during the year would also be debited to the trading account. All revenues earned by the Assessee as well as the closing stock would be reflected as a credit in the trading account. The closing stock would be the stock-in-trade .....

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eipt which would be credited to the trading account. The cost incurred by the Assessee would be naturally subsumed in the value of the closing stock, assuming that the shares on the basis of which rights entitlement has been granted to an Assessee are still retained by him at the end of the closing period. In the present case, the Assessee has, admittedly, credited the income from sale of rights entitlement in the Profit and Loss Account. Undisputedly, all costs incurred by the Assessee as well .....

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ould indisputably reflect its income. The same has also been audited. In our view, there is no scope to provide for a deduction of notional business loss which is neither incurred by the Assessee nor recorded in its audited books of accounts on the basis of notional costs of acquisition which are neither incurred by the Assessee, nor form a part of its audited accounts. In our view, it would be erroneous to impute notional cost after the Assessee has drawn up its Profit and Loss Account in accor .....

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