Whether an assessee is free to exercise his commercial wisdom to sell loss-making shares at any given point of time, even though this may amount to reduction of his tax liability - YES: HC

THE issues before the Bench are - Whether shares pledged with a bank, can be validly transferred within the meaning of section 2(47) of the Income Tax Act, even though the mandatory requirements of registering such transfer u/s 108 of the Companies Act, may not be fulfilled; Whether capital loss arising on sale of such shares can be claimed, when such transfer of shares may be challenged by the bank, on the grounds of breach of contract; Whether in such a case, the
transfer could be considered as a paper arrangement, merely because loss making shares were sold to a group company; Whether there are any restrictions in the Income Tax Act on sale of loss making shares and Whether an assessee is free to exercise his commercial wisdom to sell loss making shares at any given point of time, even though this may amount to reduction of his tax liability. And the verdict goes against the Revenue.

Facts of the case

Assessee, respondent is a company registered under the Companies Act. The assessee had sold certain shares of Rustom Spinners Ltd and had shown a long term capital gain. It had also sold 80200 equity shares of Rustom Mills and Industries Ltd. and had claimed long term capital loss of Rs.8,38,798/-. The AO noted that the shares of Rustom Mills and Industries Ltd., which the assessee sold were pledged with the IDBI Bank. The original share certificates were also lying with the said Bank. The assessee had also handed over duly executed transfer forms to IDBI. The AO, therefore, called upon the assessee to clarify how under such circumstances the assessee could sell the shares. The AO further noted that the purchaser company, viz. Bijal Investment Ltd and the assessee company, viz. Biraj Investment Pvt. Ltd. were part of the same group of companies. The AO also noted that directors of both these companies were common. He noticed that the husband of the common Director of these companies was the Managing Director of Rustom Mills and Industries Ltd. These companies, i.e. the assessee company and the purchaser company were therefore aware of the bad financial condition of Rustom Mills and Industries Ltd. The purchaser company was also aware that shares were pledged with IDBI and therefore delivery of shares was not possible. On the basis of these factors, the AO asked the assessee to justify the claim of long term capital loss on sale of such shares. In response, the assessee contended that law did not require that the transfer of share could happen only upon delivery of shares. The shares form a capital asset and for the purpose of computing the capital gain and loss, what was to be seen was the transfer as defined in section 2(47) which included extinction of any rights in the capital asset.

However, the AO was not convinced by such explanation. He was of the opinion that transfer of shares would be complete only when the share certificates along with duly executed transfer forms were delivered and since the share certificates were lying with IDBI who had lien over such shares, the shares therefore could not have been validly transferred. He was of the opinion that full transaction was intended for creating loss to the assessee so that its capital gains resulting from sale of shares of Rustom Spinners can be set off.

CIT(A) confirmed the findings of the AO, that the the entire transaction was a colourable device. He was, therefore, of the opinion that the ratio of the decision of the Supreme Court in the case of McDowell & Co. Ltd. v. CTI, would apply. The assessee appealed before the Tribunal where it was held that merely because the physical possession of the shares was with IDBI, it would not automatically follow that the person who was entitled to legal possession, that was, the assessee would be deprived of his right to deal with such goods until he secured the cooperation of the third party. The Tribunal was of the opinion that the assessee had the right to transfer the shares because legal title vested in the assessee. Aggrieved, the Revenue filed this appeal before the High Court.

The DR contended that such transfer could not have been registered without following the mandatory requirements contained in section 108 of the Companies Act.

In the counter argument, the AR contended that this was not a case of colourable device. The assessee in its own wisdom desired to dispose of certain loss making shares. No provision of the Act or any other provision of law prohibited the assessee from disposing of such assets. Simply because during the same year, the assessee also sold certain other shares for a profit, it cannot be stated that there was an attempt to avoid tax. It was also submitted that what section 108 of the Companies Act prohibited was registration of transfer of shares by the company without following certain mandatory requirements and not transfer of shares themselves by the owner of the shares. He, therefore, submitted that, the provisions of section 2(47) of the Act would apply and in relation to capital asset in question, transfer at least for the purpose of the Income Tax Act would be complete.

Having heard the parties, the High Court held that,

+ it may be that by virtue of pledging of shares with IDBI, having handed over the original share certificates to such financial institution along with the duly signed transfer forms, in so far as the assessee's relation with IDBI is concerned, there would be a serious question of validity of such transaction. We are, however, in the present proceedings, not concerned with such internal possible dispute between the assessee and the said financial institution. It may also be that if the purchaser Company desired to have such shares transferred in its name, such attempt would run into serious road block. Primarily, without the original share certificates in possession of the purchaser company, which was in possession of the IDBI Bank, the Company would not, in view of section 108 of the Companies Act, be able to register such transfer. Sub-section (1) of section 108 provides that a company shall not register a transfer of shares in or debentures of, unless a proper instrument of transfer duly stamped and executed by or on behalf of the transferor and by or on behalf of the transferee and further fulfilling the procedural requirements specified therein has been delivered to the company along with the certificate relating to the shares or debentures along with the letter of allotment of shares or debentures. Therefore, it would not be difficult to envisage that if the purchaser company had tried to register the same in its name by virtue of the present transfer, such attempt would be met with stiff resistance from IDBI Bank;

+ in the present proceedings, however, we are not concerned with internal disputes between the IDBI Bank and the assessee that may arise due to such transfer of shares. We are primarily concerned with the question whether by virtue of the agreement dated 24th March 1993, and the irrevocable power of attorney given by the assessee to the purchaser company on 30th March 1993, and also having received the full sale price of the shares, section 2(47) of the Act apply. In our opinion, the assessee did transfer whatever rights it had in the shares to the purchaser company. If such transfer is not recognized by the IDBI and there are other legal implications of breach of undertaking given to IDBI, such issue would have to be thrashed out between the concerned parties. Insofar as income tax proceedings are concerned, we are of the opinion that by virtue of section 2(47) of the Act, the assessee was entitled to claim that upon transfer of shares or interest thereon, it had suffered long term capital loss which it was entitled to set off against the capital gain on sale of shares during the same previous year;

+ we are not inclined to accept the Revenue's contention that this was a colourable device and that the entire arrangement was a paper arrangement. Firstly, there is no provision in the Act which would prevent the assessee from selling loss making shares. Simply because such shares were sold during the previous year when the assessee had also sold some shares at profit by itself would not mean that this is a case of colourable device or that there is a case of tax avoidance. Further, there is no restriction that such sale or transaction cannot be effected with a group company. As long as the Revenue could not doubt the sale price of the shares, it would not be open for the Revenue to contend that the assessee had shown loss which it did not really suffer. In the present case, it is not even the case of the Revenue that shares were sold at a price lower than the market rate. If that be so, the question of inflating the loss by transferring the shares to group company would not arise. Under ordinary circumstances, it is always open to the assessee in his own wisdom to either hold on to certain bunch of shares or to sell the same to avoid further loss, if he finds that market value of the shares is fast diminishing. It is equally open for the assessee to effect such sale during the same year when he also chooses to dispose of certain profit making shares. In the present case, of course, there is a further angle of the shares in question being pledged to IDBI and therefore it would not be possible for the assessee to deliver the original share certificates to its purchaser along with the duly signed transfer forms. As already noted, such special angle may have repercussion insofar as the legal relation between the assessee and the IDBI is concerned and insofar as the purchaser's right to have shares transferred in its name is concerned. This, however, by itself would not establish that the sale of shares was only a paper transaction and a device contrived by the assessee to claim loss which it did not suffer and thereby seek set off against the capital gain received by it during the year under consideration;

+ in the case of Commissioner of Income Tax v. Sakarlal Balabhai, a Division Bench of this Court observed that avoidance of tax cannot include every case of reduction of tax liability of an assessee. The assessee may enter into a transaction which has the effect of diminishing his income and consequently reducing his tax liability. In such a case, there would be no avoidance of tax, For example, a case where the assessee makes a gift of shares to his son. By reason of gift income from the shares would not accrue to the assessee but would accrue to the son and to that extent the income of the assessee would be diminished and his tax liability reduced. This cannot be regarded as a case of tax avoidance even if the motive of the assessee in making the gift was to save tax on the income from shares at a higher rate applicable to him;

+ under the circumstances, even without referring to the decision of the Apex Court in the case of Azadi Bachao Andolan and the observations made in the later decision in the case of Vodafone, we do not find that this a case which would fall within the parameters of the decision in the case of McDowell & Company Ltd. In the result, we answer the questions in the affirmative, i.e. in favour of the assessee and against the Revenue. Tax Appeal is accordingly dismissed.