Andhra Pradesh H.C : Whether the assessee is dealer in shares or a mere investor in the shares and whether the excess amount of Rs. 2,70,000 received from the sale of 2500 shares in XL Telcom (P) Ltd. is liable to capital gains tax or should be treated as capital receipt ?

High Court Of Andhra Pradesh

N.K. Leasing And Construction (P) Ltd. vs. CIT

Sections 28(i), 45

Asst. Year 1988-89

Bilal Nazki & G. Chandraiah, JJ.

Referred Case No. 75 of 1994

9th June, 2006

Counsel Appeared

Kodanda Ram, for the Petitioner : Ashok, for the Respondent


Bilal Nazki, J. :

Following two questions have been framed and referred to this Court by the Tribunal :

“(1) Whether the assessee is dealer in shares or a mere investor in the shares and whether the excess amount of Rs. 2,70,000 received from the sale of 2500 shares in XL Telcom (P) Ltd. is liable to capital gains tax or should be treated as capital receipt ?

(2) Whether the Tribunal was not justified in holding that the sum of Rs. 2,70,000 received by the assessee- company under deed of settlement dt. 28th March, 1988 was transferred towards the sale of 2500 shares of XL Telcom (P) Ltd. and not for allowing other group of shareholders to take over the management of the said company ?”

2. These questions arise in the following factual matrix : The assessee had purchased shares of WIMCO Ltd. on 7th May, 1986, Reliance Industries Ltd. on 9th April, 1986 and XL Telcom (P) Ltd. on 3rd Oct., 1986. All these shares were retained by the assessee till the asst. yr. 1988-89 when they were sold. The assessee incurred loss of Rs. 36,325 on the sale of shares of first mentioned two companies, but derived a profit of Rs. 2,70,000 on the sale of shares of last mentioned company. The shares of XL Telcom (P) Ltd. were surrendered to the company on 28th March, 1988. In the said transaction, the assessee got a profit of Rs. 2,70,000 and the net gain was assessed as Rs. 2,33,675. Case of the Revenue all along was that these shares were acquired for selling purpose at a future rate and therefore, the profits were assessable under the head “business”. The ITO gave a show-cause notice as to why the income derived from the sale of shares should not be assessed under the head “business”. The assessee took the plea that profit derived on surrender of shares to XL Telcom (P) Ltd. was in the nature of capital receipt and was not liable to tax. In their objections, the assessee also claimed that XL Telcom (P) Ltd. was consisting of Shankarlal Agarwal and his family as one group and Shri Sunderlal Agarwal and his associates as the other group and there were disputes between these two groups. A settlement had been arrived at on 28th March, 1988, whereby shares held by Sri Shankarlal Agarwal’s group including the assessee-company, were agreed to be transferred to the other group for a consideration and as per the settlement, the shares were sold for Rs. 5,20,000. It was also claimed that extra consideration was received in view of the other party abstaining from interfering with the managing and running of the company. Gain thus made was only in the nature of casual or capital receipt and would not be taxable. The ITO, however, held that the assessee invested in shares of other companies with a view to derive profit for itself. Assessment was completed for the year 1988-89 on 30th of March 1990 under s. 143(3) r/w s. 143(2)(b) of the IT Act, 1961 (hereinafter referred to as ‘the Act’). The CIT(A) also found that the assessee, in the first instance, had failed to file its return admitting the gain as long-term capital gain, but subsequently, the assessee revised its stand claiming that the excess income derived by sale of shares constituted a capital gain. The CIT(A) also went through the deed of settlement, dt. 20th of March 1988 and held that the excess consideration received by the assessee had close nexus with the shareholding in the company XL Telcom (P) Ltd. The Tribunal also confirmed the order. Thereafter, application for reference was made.

It may be stated at the outset that question No. 2 is a question of fact and not a question of law and therefore, we decline to answer the said question. Reliance has been placed on various judgments by the learned counsel appearing for either side. Before going to those judgments, certain clauses of the deed of settlement are needed to be reproduced. In para (G), it is stated— “(G) Whereas some irreconcilable differences have arisen between members of the first party and members of the second party in the matter of management and running of the third party company a few months adversely affecting the developmental activities of the third party company.”

In para (I) it is stated— “(I) Members of the third party company has also agreed to pay and discharge the deposit made by the members of the second party as detailed in the schedules hereinbelow.”

In para 1, it is further stated— “In consideration of the parties of the second party abstaining from interference with the management and running of the third party company and agreeing to sell their shares to the members of the first party or to their nominees, the members of the party of the first part have agreed to purchase 3800 equity shares : (total) from the members of the second party as set out hereinbelow :

There are some curious terms of settlement, whereby second party would agree to abstain from interference with the management and running of the third party company. After selling all their shares, how was it possible for them to interfere with the management of the company ? By cl. 5 also it was agreed that the second party would be getting out of the company without any goodwill or any dividend. There was no liability fastened on the second party.

The assessee relies on a judgment of the Patna High Court in Raghubar Narain Singh vs. CIT (1983) 35 CTR (Pat) 297 : (1984) 147 ITR 447 (Pat), which was in a different fact situation. There was a finding of the High Court that price received by the assessee was not only the price for the sale of the shares, but also the price for delegating the powers of office of managing director, and accordingly, the Court’s finding was that Tribunal was not correct in holding that the entire sum of Rs. 1,94,299 could be treated and taxed in law as capital gains of the assessee on account of the sale of the shares only and not also as a price for delegating the power ignoring the legal character of the agreement.

We have already pointed out certain terms and conditions in the agreement, which would show that there was outright sale of shares and the money received was nothing but the consideration for the sale of shares.

On the other hand, there is a judgment of Madras High Court in Venkatesh (Minor) & Ors. vs. CIT (2000) 162 CTR (Mad) 142 : (2000) 243 ITR 367 (Mad). In a fact situation, the Court held— “The argument for the assessees that the controlling interest in the company is capable of being transferred separately, apart from the transfer of shares is wholly untenable. The fact that the vendor has controlling interest and is in a position to place the vendee in control of the company by transferring all his shares or such part as would enable the vendee to exercise control over the company with the aid of the shares so transferred would only enhance the value of the shares transferred. The price paid by the vendee for acquisition of such shares remains the price of those shares though the price so paid is higher than the market price. Controlling interest is but an incidence of the shareholding and has no independent existence. Similar view was taken by the Madhya Pradesh High Court in the case of Smt. Maharani Ushadevi vs. CIT (1981) 131 ITR 445 (MP), wherein also it was pointed out that the controlling interest in a company is an incident arising from holding of a particular number of shares in the company and that such controlling interest cannot be transferred without transferring shares.

It is by reason of control over the shares, that the person controlling those shares is enabled to exercise control over the management. It is when he is in a position to control the management, that the interest held by him in the company is generally referred to as controlling interest. Without control over the shares there can be no question of any controlling interest. It is only by virtue of the ownership of the shares that the composition of the board of directors of the company can be controlled by exercise of the voting rights attached to those shares for the purpose of electing or removing a director. It is by reason of the control from within the board of directors that it is possible to co-opt the directors of the choice of the person holding the controlling interest.

The price paid for the shares by the vendee is therefore the price paid for acquiring the shares and the entire consideration is required to be considered for the purpose of computing the capital gains in the hands of the assessees.”

9. Learned counsel for respondents has referred to a judgment of Supreme Court in Dalhousie Investment Trust Co. Ltd. vs. CIT (1968) 68 ITR 486 (SC). In this case, the relevant facts, which were before the Supreme Court, were that the principal activity of the assessee was investment of its capital in shares and stocks. It changed its investments by sale of its shares and stocks from time to time. The income of the company was primarily derived from dividends on shares and interest received by it on the investments. These activities were covered by cls. (1), (3) and (4) of the memorandum of association. The objects mentioned were, “to acquire, hold, sell and transfer shares, stocks, debentures, debenture stocks, bonds, obligations and securities issued or guaranteed by any company constituted or carrying on business in British India and in the United Kingdom or in any colony, or dependency or possession thereof or in any foreign country and debenture stocks, bonds, obligations and securities, issued or guaranteed by any Government, Sovereign, Ruler, Commissioners, public body or authority supreme, municipal local or otherwise whether at home or abroad.” In the relevant accounting year, 21,046 shares were held by Kanoria group, including 6,977 shares in McLeod & Co. Ltd. held by the assessee. Mr. C.L. Kanoria resigned his office as director of McLeod & Co. Ltd. on 17th March, 1952 and the approval of the Government to his resignation was given by the Central Government on 16th Oct., 1952. Thereafter, Sri C.L. Bajoria joined the directorate of McLeod & Co. Ltd. 6,900 shares were sold by the assessee to Sri C.L. Bajoria or his nominees on 27th May, 1952, at a time when Sri C.L. Kanoria had already sent-in his resignation from the office of director, but the resignation had not been accepted by the Government till then. It has also been found that Sri C.L. Bajoria acquired 12,440 shares in all, including 6,900 shares purchased from the assessee, but there was no material on record to prove that his group obtained a controlling interest in McLeod & Co. Ltd., as a result of acquisition of these shares. But as a fact, it was held that after the resignation of Sri C.L. Kanoria, M/s C.L. Bajoria and Baijnath Jalan, both of M/s Soorajmull Nagarmull, became directors of McLeod & Co. Ltd.

In the abovementioned factual matrix, the Supreme Court held, “It appears to us that the facts and circumstances in this case can lead to no other conclusion except that these shares were purchased and sold by the assessee with the motive of earning a profit by such purchases and sales and not with the object of investing its capital in these shares in order to derive income from that investment. It is true that the principal business of the assessee was to invest capital and to derive income from dividends on shares and interest on other investments; but at the same time, the object contained in the memorandum of association of the assessee-company clearly showed that one of the objects was also to deal in shares, stocks, debentures, etc., by acquiring, holding, selling and transferring them………”

10. Learned counsel for respondents has also placed reliance on another judgment reported as New Era Agencies (P) Ltd. vs. CIT (1968) 68 ITR 585 (SC). In this judgment, the Supreme Court referred to the observations of Lord Justice Clerk in Californian Copper Syndicate vs. Harris (1904) 5 Tax Cases 159, 165-166. The observations taken note of are— “It is quite a well settled principle in dealing with questions of assessment of income-tax, that where the owner of an ordinary investment chooses to realize it, and obtains a greater price for it than he originally acquired it at, the enhanced price is not profit in the sense of Sch. D of the IT Act of 1842 assessable to income-tax. But it is equally well established that enhanced values obtained from realization or conversion of securities may be so assessable, where what is done is not merely a realization or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business. The simplest case is that of a person or AOP buying and selling lands or securities speculatively, in order to make gain, dealing in such investments as a business, and thereby seeking to make profits. There are many companies which in their very inception are formed for such a purpose, and in these cases it is not doubtful that, where they make a gain by a realization, the gain they make is liable to be assessed for income-tax.”

11. The contention, which was raised by the learned counsel for the assessee in this case was also raised before the Supreme Court that the entire amount received was not received as value of the shares, but was a composite payment for the price of shares and controlling rights. But the Supreme Court found— “So far as the appellant is concerned, what it parted with was the shares which it held and what it received was the payment for those shares. It follows therefore that the entire sum received by the appellant was the price of the shares disposed of by Mulraj Kersondas and consequently, the whole of the excess over the cost price of the shares was the profit of the appellant.”

12. In the present case also, what was received by the assessee by selling the shares, was the consideration for the shares and therefore, was assessable to tax.

13. The controversy in this case also appears to be covered by a judgment of Supreme Court in Juggilal Kamlapat vs. CIT (1970) 75 ITR 186 (SC).

14. The shares in the present case were purchased on 7th May, 1986, 9th April, 1986 and 3rd Oct., 1986 and were sold during the asst. yr. 1988-89, and as such, it could not be said that this was an investment in shares independent of the trading activity of the company.

For the reasons given hereinabove, we answer question No. 1 in favour of the Revenue and against the assessee.

[Citation : 285 ITR 330]

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