COMMISSIONER OF INCOME TAX vs SANTOSH L. CHOWGULE and Others

DR. B. P. Saraf, J.

By this reference under s. 256(l) of the Income Tax Act, 1961, the Tribunal has referred the following questions of law to this Court for opinion at the instance of Revenue:

"1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that reorganisation of capital of the company by passing resolution on 30-9-1971 constitutes transfer of shares within the meaning of s. 2(47) of the Income Tax Act?

Whether, on the facts and in the circumstances of the case, the Tribunal is justified in law in holding that the capital loss on sale of irredeemable cumulative preference shares of Chowgule & Co. Ltd. constitute short-term capital loss to the assessee?"

These questions arise out of orders of the six appeals. As the facts of all the six appeals are identical, a single consolidated reference has been made by the Tribunal. The main order of the Tribunal being in ITA No. 102/Pn/1982 in case of Mrs. Sulakshana. S. Chowgule, the facts of that case have been set out in the statement of the case.

The material facts of Sulakshana Chowgule''s case are as follows ..

The assessee is an individual. The controversy pertains to assessment year 1977-78, the corresponding previous year being the year ended 31-3-1977. During the above previous year, the assessee sold certain irredeemable preference shares held by her in M/s Chowgule & Co. Pvt. Ltd. to two investment companies. The sale of these shares was made in July, 1976 and the assessee incurred a loss of Rs. 68,236 as a result thereof. The case of the assessee before the Income Tax Officer was that such shares were acquired by her on 30-9-1971 and since the sale was effected in July, 1976, i.e., within a period of 60 months from the date of acquisition, the loss was a short-term capital loss which she was entitled to set off against her income falling under other heads. The Income Tax Officer disallowed this claim of the assessee on the ground that she had sold the shares in a closely held company to another company in which she or her relatives were interested. According to the Income Tax Officer, the sale of shares made by the assessee was not genuine. He, therefore, disallowed, the claim of the assessee for set off of the loss from that transaction. The assessee appealed to the Appellate Assistant Commissioner against the above order of the Income Tax Officer. The Appellate Assistant Commissioner reversed the findings of the Income Tax Officer that the sale of shares made by the assessee to the two investment companies was not genuine. He, however, disallowed the claim of the assessee for set off of the loss on the ground that it was not a short-term capital loss but a long-term capital loss. He observed that as the company M/s Chowgule & Co. Pvt. Ltd. first came into existence in 1965 when its share capital consisted of equity shares of Rs. 100 each which shares were converted by resolution dt. 30-9-1971, into a new set of four different shares including irredeemable preference shares sold by the assessee, the irredeemable preference shares could be traced back to the original equity shares acquired by her in the year 1965. The assessee appealed to the Tribunal against the above decision of the Appellate Assistant Commissioner. The contention of the assessee before the Tribunal was that the equity shares acquired by the assessee which were exchanged by four different types of shares by resolution of the company dt. 30-9-1971 were different from the shares acquired by the assessee in exchange of the same. According to the assessee, the irredeemable preference shares sold by her did not exist prior to the resolution dt. 30-9-1971. Hence, there was no question of acquisition of those irredeemable preference shares prior to that date. It was contended on behalf of the assessee before the Tribunal that two types of shares, viz., equity shares held by the assessee since 1965 and the irredeemable preference shares obtained by her in exchange thereof consequent to the resolution dt. 30-9-1971 were different in nature as the rights and liabilities attracted to them were entirely different. On the other hand, the case of the Revenue before the Tribunal was that the irredeemable preference shares sold by the assessee were merely another form of equity shares which were already in existence. In support of this contention, reliance was placed by the Revenue on the decision of the Madras High Court in Commissioner of Income Tax Vs. G. Narasimhan (Decd) (by LRs), .- 1, wherein it was held that the reduction of capital would not involve any transfer because the shareholders remained the same. The assessee, however, relied on the decision of Andhra Pradesh High Court in Additional Commissioner of Income Tax Vs. Trustees of H.E.H. the Nizam''s Second Suplementary Family Trust, . The Tribunal accepted the contention of the assessee and held that there was an exchange of earlier equity shares with the new equity shares and preference shares on 30-9-1971 which amounted to transfer and that the assessee acquired preference shares only on 30-9-1971 and not before that. The Tribunal also held that the preference shares were not the same as equity shares because the rights and liabilities attached to the former were quite different from the rights and liabilities attached to the latter. The Tribunal, therefore, held that there was no question of the assessee acquiring the irredeemable preference shares prior to 30-9-1971, the date when they came into existence. In view of the above, the Tribunal allowed the appeal of the assessee and held that the assessee was entitled to treat the capital loss of Rs. 68,236 as short-term capital loss. Hence this reference at the instance of the Revenue.

We have heard Mr. R. V. Desai, learned counsel for the Revenue, who submits that in view of the facts and circumstances of the case, it cannot be said that the assessee acquired irredeemable preference shares on 30-9-1971. According to him, as the assessee obtained these shares along with some other equity shares as a result of reorganisation of the capital of the company by resolution dt. 30-9-1971, in exchange of the old equity shares held by her since 1965, these shares should be deemed to have been acquired on the date of acquisition of the equity shares in the year 1965. It was urged by the learned counsel that by resolution dt. 30-9-1971, no new asset came into existence. It was merely reclassification of existing assets, viz., existing equity shares into new equity shares and preference shares. It was, therefore, contended that the irredeemable preference shares sold by the assessee should be deemed to have been acquired by the assessee not on 30-9-1971, the date when they were issued, but on the date of issue of the equity shares in exchange of which they were issued to the assessee.

Mr. S. N. Inamdar, learned counsel for the assessee, on the other hand, submits that this is a clear case of short-term capital loss because the asset transferred by the assessee, viz., irredeemable preference shares, came into existence only on 30-9-1971, by virtue of the resolution of the company of that date and were acquired by the assessee as a result thereof. The said shares were sold by the assessee within 60 months from the above date in July, 1976. Our attention was drawn by the learned counsel to s. 85 of the Companies Act, which states that equity share capital is different from the preference share capital. It was contended that the two kinds of shares, i.e., equity shares and preference shares, are quite different in nature, in as much as rights and liabilities attached to them are entirely different. According to the learned counsel, no preference share ever existed prior to the resolution dt. 30-9-1971, and so there was no question of acquiring preference shares prior to that date. It was further contended that there was an exchange of equity shares held by the assessee by new set of shares including the irredeemable preference shares in question by resolution of the company dt. 30-9-1971. Reliance was placed in support of this contention on the decision of the Andhra Pradesh High Court in Nizam''s Second Supplementary Family Trust case (supra).

We have carefully considered the rival submissions. The controversy in this case is whether the irredeemable preference shares issued by the company pursuant to its resolution dt. 30th Sept., 1971 are different from the equity shares in lieu whereof they were issued and whether they can be deemed to have been held by the assessee from the date of their issue or from the date of issue of the equity shares in lieu whereof they were issued. This controversy assumes importance because if the date of the issue of the irredeemable preference shares is regarded as the date of the acquisition of these shares by the assessee, the loss suffered by the assessee by the transfer thereof would be a short-term capital loss which can be set off against the income under any other head, whereas, if they are deemed to have been held by the assessee from the date of acquisition of the original equity shares in exchange of which they were issued, the date of acquisition would be the year 1965 and the loss suffered by the assessee on the transfer thereof would be a long-term capital loss which cannot be adjusted against the income under any other head of income.

Short term capital asset has been defined in sub-section (42A) of s. 2 of the Act to mean a capital asset held by an assessee for a period not more than 60 months immediately from the date of its transfer. There is no controversy about the fact that these shares were not in existence prior to the resolution mentioned above. Chowgule & Co. Pvt. Ltd. came into existence in 1965. The equity shares of Rs. 100 each were held by three groups of HUFs. The assessee being a member of one of the HUFs had acquired the following shares in the said company in the manner and on the date noted against it :

Acquisition number

No. of shares

Manner and date of acquisition

1.

Equity shares of Rs. 100 each

400

As a result of partial partition of the HUF effected on 15-3-1971

2.

-Do-

1025

-Do- on 20-9-1971

Total

1,425

shares

By resolution dt. 30-9-1971, the capital of the company was reorganised as a result of which each equity share of Rs. 100 of the company was subdivided into three shares of Rs. 33.1/3 each and in lieu of every six sub-divided shares, the shareholder was given one share called "A" equity share, one share called "B" equity share, three shares called "C" equity shares and one 4 per cent irredeemable preference share. The above resolution reads as under:

"Resolved that 3,00,250 equity shares of Rs. 100 each subscribed and paid up by the company each be sub-divided into three shares of Rs. 33.1/3 each".

"Resolved further that of every six such sub-divided shares held by each share holder, one sub-divided share shall be called ''A'' equity shares and shall have rights attached thereto as mentioned hereinafter, one sub-divided share shall be called ''B'' equity share and shall have rights attached thereto as mentioned here in before ,three sub-divided shares shall be called ''C'' equity shares and shall have rights attached thereto as mentioned hereinafter and one subdivided share shall be called 4 per cent irredeemable cumulative preference share and shall have rights attached thereto as mentioned hereinafter".

As a result of the above resolution, in exchange of 1,425 equity shares held by the assessee in the above company, the assessee received, in addition to the equity shares of different types, 712,4-per cent irredeemable cumulative preference shares with the distinct right attached thereto. The assessee also got another 4,000,4-per cent irredeemable preference shares of Rs. 33.1/3 each on another partial partition of family which took place on 29-3-1972, bringing her total acquisition of such shares to 4,712 shares. These shares were latter sold by her in July, 1976, i.e., within a period of 60 months from the date of the resolution by which these shares came into existence in 1971. The question that arises for consideration is whether these preference shares are short-term capital asset or long-term capital asset. The answer to this question will depend on whether the irredeemable preference shares given to the assessee in exchange of the equity shares held by her were a different capital asset from the equity shares held by her since 1965. If they were different, then the irredeemable preference shares would be short-term capital asset because they came into existence only on 30-9-1971. If they can be said to be the same capital asset as the equity shares held by her prior to the said resolution, then of course, it would be a long-term capital asset.

To decide this controversy, we have perused the provisions of ss. 85 to 90 of the Companies Act, 1956, which deal with the different kinds of share capital and the rights attached thereto. Sec. 86 provides for issue of two kinds of share capital, namely, equity share capital and preference share capital. "Preference share capital" has been defined in cl. (1) of sub-section 85 as follows:

"''Preference share capital'' means, with reference to any company limited by shares, whether formed before or after the commencement of this Act, that part of the share capital of the company which fulfils both the following requirements, namely:

(a) that as respects dividends, it carries or will carry a preferential right to be paid a fixed amount or an amount calculated at a fixed rate, which may be either free of or subject to income tax: and (b) that as respect capital, it carries or will carry, on a winding up or repayment of capital, a preferential right to be repaid the amount of the capital paid-up or deemed to have been paid-up, whether or not there is a preferential right to the repayment of either or both of the following amounts, namely:

(i) any money remaining unpaid, in respect of the amounts specified in cl. (a), up to the date of the winding up or repayment of capital; and

(ii) any fixed premium or premium on any fixed scale, specified in the memorandum or articles of the company."

"Equity share capital", on the other hand, has been defined to mean share capital which is not preference share capital. The rights and obligations attached to the two kinds of share capital are different. On the face of the above provisions of the Companies Act, it is not possible to hold that the equity shares held by the assessee since 1965 and the irredeemable preference shares acquired by the assessee in exchange thereof pursuant to the resolution dt. 30-9-1971 were the same. That being so, the preference shares in question cannot be said to be acquired by the assessee prior to 30-9-1971, the date on which they came to an existence. In fact, consequent to the resolution dt. 30-9-1971, the equity share capital held by the assessee was exchanged by the three new types of equity shares and the irredeemable preference shares in question. It was not a case of change of nomenclature of the shares. It was an exchange of one kind of shares by another kind of shares, having different rights and liabilities.

We are supported in our above conclusion by the decision of the Andhra Pradesh High Court in Nizam''s Second Supplementary Family Trust (supra), decision of this Court in Manecklal Premchand Vs. Commissioner of Income Tax, , and the decision of the Gujarat High Court in Commissioner of Income Tax, Gujarat-I Vs. Chunilal Khushaldas, . In Nizam''s Second Supplement Family Trust (supra), it was held that conversion of preference shares into ordinary shares amounted to transfer by way of exchange within the meaning of s. 45(l) of the Income Tax Act, 1961 and the capital gains accruing on such conversion are liable to be taxed. In Manecklal Premchand v. CIT (supra), it was held that bonus shares issued by the company are acquired by the shareholder when they are issued and they must be taken to be held by the shareholder from the date of issue. In CTT v. Chunflal Khushaldas (supra), it was held that bonus shares issued by the company are acquired by the shareholder when they are issued and they must be taken to be held by the shareholder from the date of issue and not from the date of acquisition of the original shares in respect of which they were issued to the shareholder. This decision of the Gujarat High Court was also followed by this Court in Maneklal Premchand (supra),

We have also perused the decision of the Madras High Court in CIT v. G. Narasimhan (supra) on which reliance was placed by the Revenue. In that case the controversy was whether there was any transfer, exchange or relinquishment involved in reduction of capital for the purposes of capital gains tax under the Income Tax Act, 1961. The Madras High Court held that in reduction of capital, it cannot be said that there was a transfer of a capital asset nor can it be said that there had been any extinguishment of the rights of the shareholder as all the rights of the shareholder as a shareholder continued and remained. This view of the Madras High Court is, however, no more valid in view of the decision of the Supreme Court in Kartikeya V. Sarabhai Vs. The Commissioner of Income Tax, , wherein it has been held that reduction of the right in the capital asset would clearly amount to a transfer within the meaning of that expression in s. 2(47) of the Act. The Supreme Court, in the above case, observed:

"While it is no doubt true that the appellant continues to remain a shareholder of the company even with the reduction of share capital, it is not possible to accept the contention that there has been no extinguishment of any part of his right as a shareholder qua the company. It is not necessary for a capital gain to arise that there must be a sale of a capital asset, Sale is only one of the modes of transfer envisaged by s. 2(47) of the Act. Relinquishment of the asset or the extinguishment of any right in it, which may not amount to a sale, can also be considered as a transfer..."

In view of the above, we hold that in the instant case irredeemable preference shares were acquired by the assessee on 30-9-1971 pursuant to the resolution dt. 30-9-1971 and the same having been sold by the assessee within 60 months from that date, the capital loss on sale thereof constituted short-term capital loss to the assessee. In view of the above, the Tribunal in our opinion, was correct in holding that the assessee was entitled to treat the capital loss of Rs. 68,236 as short-term capital loss.

In the result, we answer both the questions referred to us in the affirmative and in favour of the assessee.

This reference is disposed of accordingly with no order as to costs.

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