I-T - Whether when bank purchases non-convertible debentures at discount and there is actual delivery, loss resulting from such transactions is speculative loss u/s 43(5) and not capital loss - NO, it's capital loss: Madras HC

CHENNAI, MAR 02, 2012: THE issue before the Bench is - Whether when the bank purchases non-convertible debentures at discount and there is actual delivery, the loss resulting from such transactions is speculative loss u/s 43(5) and not capital loss - Whether non-convertible debentures are neither commodity nor shares or stocks. And the verdict goes in favour of assessee.

Facts of the case

The erstwhile company viz., M/s New Ambadi Investments Private Limited, was merged with M/s New Ambadi Estates Private Limited with effect from 01.04.2006. The said erstwhile company was a private limited company carrying on the business of investments and the relevant assessment year is 1993-1994. For the said assessment year, the assessee filed its return of income on 31.12.1993 admitting the loss of Rs.10,08,121/-. The said return was processed under Section 143(1)(a) of the Income Tax Act on 22.07.1994 and later taken up for scrutiny and notice was issued under Section 143(2) of the Act and the assessment was completed under Section 143(3) of the Act and determined the total taxable income at 1,36,570/-. While computing the taxable income, the assessing officer rejected the contention that the loss at Rs.11,44,692/- claimed by the assessee as capital loss and held that it was only speculative loss under Section 43(5) of the Act and the same cannot be set off against capital gain. Aggrieved by that order, the assessee had filed an appeal before the Commissioner of Income Tax (Appeals). The said CIT (Appeals), rejected the contention and dismissed the appeal. Aggrieved by that order, the assessee filed an appeal before the Income-tax Appellate Tribunal. The Tribunal, upheld the claim of the assessee and allowed the appeal and held that it was only a capital loss.

On appeal before the HC, the counsel for the Revenue contended that the order passed by the Tribunal was wrong since the transaction squarely fell within the purview of Section 43(5) of the Income Tax Act. The counsel contended that the Tribunal ought to have appreciated that the non-convertible secured debentures were transferred in favour of the bank and not to the existing shareholder. Therefore, the transaction was settled ultimately otherwise than by actual delivery. Therefore, the Tribunal was wrong in holding that the loss in the transaction was capital loss.

The counsel appearing for the assessee-respondent contended that the transaction relating to the non-convertible secured debenture will not come within the definition of "speculative transaction" under Section 43(5) of the Act. He further contended that non-convertible debenture would neither be considered as a commodity nor shares or stocks. The expression commodity or shares or stocks will not include debentures. He further submitted that the present transaction was related to allotment of debentures and therefore, the question of purchase or sale of commodities will not arise since there was no existence of the commodity before the allotment. He further submitted that the Tribunal had given a categorical finding that there was actual delivery and the bank had purchased the said non-convertible debentures at discount and therefore, the order passed by the Tribunal is in accordance with law and the same had to be confirmed.

Held that,

++ the assessee claimed a loss of Rs.11,44,692/- as Khoha loss on the sale of partly convertible debenture of the two companies. The assessee held equity shares of M/s Tube Investments of India Limited and M/s Carborandum Universal Limited. The abovesaid companies needed finance and therefore, they tapped the resources of its shareholders and brought the Banker to hold its debentures. Both the companies came out with a scheme to issue Partly Convertible Debentures (PCD in short) for its existing shareholders. The said PCD consisted of equity shares and non convertible security debenture. The face value of each, particularly, PCD was Rs.100/-. When the shareholders subscribing to the said partly convertible debentures, they are entitled to get one equity share of face value of Rs.10/- with a premium of Rs.40/- and one non convertible secured debenture face value of Rs.50/-;

++ the procedure of the scheme shows that the existing shareholders who apply for the PCDs are allotted PCDs on the basis of some formula depending upon the applications received. Following such allotment the conversion of the PCD takes place as equity share that is received by the existing shareholder and the second portion which the existing shareholder had agreed to be given over to the bank is sent to the bank directly. The second portion of PCD represented by NCSD is not received by the existing shareholder and it is this feature that the Department is construing as delivery not taken but transferred in favour of the bank as a speculative transaction;

++ the Department had clearly overlooked the first step of allotment of PCD to the existing shareholders only. This PCD is then converted into equity share portion and the NCSD portion. The origin of NCSD is the PCD that is allotted only to the existing shareholder and therefore, it has to be construed as if the NCSD that is brought out from PCD is allotted in favour of the existing shareholder and then transferred to the bank. To our mind there could be no other construction possible because, at the time of allotment of PCDs the amount of Rs.38/- per PCD paid by the bank is treated as a loan to the existing shareholder and this loan is treated as satisfied by the issue of the NCSD to the bank. The most important connection link is the company that received the application for PCDs from the existing shareholder and the bank has come forward to purchase the debentures but at a discount. The amount of application money relatable to the NCSD portion which the existing shareholder would never get back, is a loss suffered and is a capital loss that could get adjusted against the income from capital gains. The assessee being in the business as an investment company, the loss suffered to the extent of Rs.12/- or Rs.15/- per PCD, is obviously a capital loss and in the circumstances of the case, for the aforesaid reasons, it is held as a capital loss;

++ the Tribunal has correctly held that there is an actual delivery and constructive delivery and they will not come within the purview of the "speculative transaction". The counsel appearing for the Revenue is unable to bring any fresh evidence to show that there is no actual delivery in the present case. Therefore, the finding given by the Tribunal in this aspect is based on valid materials and the same is confirmed;

++ the definition of Section 43(5) of the Act is inclusive one. It includes only shares and stocks. Debentures are not included. Therefore, the learned counsel appearing for the assessee submitted that the debentures, viz., in the present case, the transaction is relating to non-convertible security debentures, which will not fall within the definition of "commodity" or "stocks" or "shares". In support of his contention, he relied on the the judgment of the Supreme Court cited supra in R.D.GOYAL AND ANOTHER V. RELIANCE INDUSTRIES LIMITED wherein it has been held that debentures cannot come within the definition of shares as well as the stock. The expression debentures and shares conveyed separate meaning;

++ in the present case, the convertible secured debentures portion is given to the bank which is akin to giving up the right. Therefore, the above judgment also supports the case of the assessee. Following the principles enunciated in the judgment of Apex Court in R.D.Goyal's case. We are of the view that the transaction relating to the partial non-convertible security debentures will not come within the expression "commodity" or "shares" or "stocks" and since there was no allotment the question of purchase or sale will not arise;

++ we are of the view that the transaction involved in the present case will not come within the definition of "speculative transaction" as defined under Section 43(5) of the Act. Therefore, we are of the view that the order passed by the Tribunal is in accordance with law and the same is liable to be confirmed