Whether when assessee's shares are pledged only to raise loan, such an activity gives rise to capital gains, and difference between market value and face value is to be taxed - NO: Bombay HC

THE issues before the Bench are - Whether when assessee's shares are pledged only to raise loan, such an activity gives rise to capital gains, and the difference between the market value and the face value is to be taxed; Whether when only the right to use an asset is transferred for a fixed tenure, its consideration is to be spread over the term of its lease period as per AS 19 and Whether such a case is a fit case for invocation of revisionary authority u/s 263. And the verdict goes against the Revenue.

Facts of the case

Assessee concern had filed its ROI declaring loss of Rs.277 crores and it was also accompanied by computation in accordance with the provisions of Section 115 JA. On assessment, the order was passed determining the loss at Rs.276 crores under the

normal provisions of the Act and determining the income of Rs.394 crores under the provisions of Section 115 JB . On appeal, the CIT found that the assessment order passed appeared to be erroneous and prejudicial to the interest of the revenue on two counts. Consequently, notices for revision u/s 263 were issued to the assessee on the ground that shares of Reliance Infocomm Ltd. (RIL) were transferred at the rate of Rs.1/- per share to one Mukesh Ambani when the market value of the share was Rs.53.01 per share. Therefore, the notice proposed to assess a sum of Rs.2635 crores as a short term capital gain being a difference between market value per share and face value per share. It was also submitted that an

amount of Rs.3037 crores received from Reliance Infocomm Ltd. as fees for grant of Indefeasible Right of Connectivity (IRC) for a period of 20 years was income accrued to the assessee in the assessment year 2004-05 itself.

On appeal, CIT(A) held that the assessment order was erroneous as well as prejudicial to the interest of the revenue and he exercised powers u/s 263. It was held that there had been a sale and a difference of Rs.2635 crores (between market value of the shares and the face value of the shares) was assessable to tax as short term capital gain. So far as the amount of Rs.3037 crores is concerned he held that the entire amount of Rs.3037 crores received as fees for IRC was a income chargeable to tax. On further appeal by assessee, the Tribunal allowed the assessee's appeal and recorded a finding of fact that there was no transfer/sale of 50 crores shares of RIL but only transaction of loan by pledge of shares for the purpose of securing a loan of Rs.50 crores taken from one Mukesh Ambani. So far as tax-ability with regard to amount of Rs.3037 crores received as IRC fees from RIL under agreement was concerned, the Tribunal after a detailed examination of the Agreement concludes RIL had only a right to use the network during the tenure of the agreement. This was so as the agreement was in the nature of a lease between Reliance Infocomm Ltd. and the assessee. Therefore the Tribunal by placing reliance upon AS formulated by the ICAI concluded that the fees had to be spread over the period of the lease as the entire fees had not accrued during the AY 2004-05. The Tribunal upheld the treatment given by the assessee to the IRC fees received from RIL by having offered an amount of Rs.63.28 crores as the income accrued for the five months between November 2003 to March 2004. Further, the Tribunal held that the condition precedent to invoke powers u/s 263 did not exist and the same was incorrectly exercised by the CIT.

Having heard the matter, the High Court held that:

++ the Tribunal has on consideration of all facts concluded that there was no transfer of shares but only a pledge of shares for the purposes of obtaining a loan. This short term loan of Rs.50 crores was repaid on 24.12.2004 as is evident from audited accounts and annual reports for the AY 2004-05. In case it was not a loan, as rightly observed by the Tribunal there would have been no occasion to repay the amounts. Further the appellant before us has not disputed the fact of return of loan and also the receipt of pledged shares from Mukesh Ambani. In fact, the evidence in the form of transaction statement of Demat Account was produced at the time of hearing showing the return of 5-crores shares of RIL to the respondent on 24/10/2012 i.e. the date when the loan was returned by the respondent to one Mukesh Ambani. Besides, the finding of the Tribunal is a finding of fact and the revenue has not been able to show that the same was in any manner perverse. Consequently, this question does not raise any substantial question of law and is dismissed;

++ the Tribunal has on examination of the agreement entered into between RIL and the assessee concluded that RIL in terms of the agreement had only a right to use the network during the tenure of the 20 year agreement. Further that the agreement was liable to be terminated at the sole discretion of RIL and consequently, the amount received as advance for 20 years lease period would have to be returned on such termination for the balance un-utilized period. Further the Tribunal held that the Agreement was only in the nature/form of a lease agreement. On application of the AS-19 formulated by the ICAI, a lease income arising from operating lease should be recognized in the statement of profit and loss in a straight line method over the term of the lease. Further the SC in the matter of J.K. Industries ltd. v. CIT has up held the theory of matching principles and application of accounting standards so as to avoid distortion of income. Therefore, the respondent assessee had in terms of AS-19 correctly spread the entire fee of Rs.3037 crores over the period of 20 years and to pay tax thereon over the entire period. In view of the above, this question also does not raise any substantial question of law and therefore is dismissed;

++ the present appeal as filed by the revenue is also required to be dismissed as the revenue has not challenged the order of the Tribunal holding that exercise of powers of revision u/s 263 by the CIT was bad in law. Once the revenue has accepted the finding of the Tribunal that the CIT could not have exercised the powers u/s 263, no occasion to examine the two questions raised by the revenue can arise. In view of the above, the questions raised are merely academic and need not be entertained.