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Capital gains vs Business income
February, 07th 2007

Citadell Agencies (P) Ltd. vs ACIT
Citation 2007 11 SOT 273 
 
Capital gains vs Business income
Sale of shares held as investment, Sale of bonus shares 

Summary AY 2001-02. The assessee was an investment company holding shares of various companies as investment. The resulting gains from sale of bonus shares after 17 months of their receipt was assessable as long term capital gain whereas the gains from shares held for less than 12 months was assessable as short term capital gains. However, the gains from sale of shares were not assessable as business income.

S.28 and s.45 of the Income Tax Act 1961 

ITAT, Mumbai

Citadell Agencies (P) Ltd. vs ACIT

I.T. Appeal No. 2759 (Mum.) of 2005 [Assessment Year 2001-02]

Shailendra K. Yadav, Judicial Member and K.K. Boliya, Accountant Member

18 April 2006

S.K. Tulsian and Paras A. Seth for the Appellant
R.N. Dash for the Respondent

ORDER

Shailendra K. Yadav, Judicial Member, - This appeal has been filed by the assessee against the order of the CIT(A) on the following grounds :

"1. On the facts and in the circumstances of the case and in law, the learned CIT(A) erred in confirming the investment activity as business and considering capital gain on business shares as business profit.

2. On the facts and in the circumstances of the case and in law, the learned CIT(A) erred in holding that the bonus shares received were in respect of trading shares and hence sale proceeds of bonus shares are taxable as business profit and ignored judgment in case of Madangopal Radhelal 73 ITR 652 (SC).

3. Appellant pled before Hon'ble Tribunal to direct Assessing Officer to assess income as returned and tax it under capital gains."

2. At the assessment stage, the Assessing Officer held that the profit arising to assessee on sale of shares is chargeable as part of the business profits and that includes sale of shares of M/s. Penta Soft Ltd. and M/s. Satyam Computers Ltd. This is against the assessee's claim that the said profit is chargeable to tax as long-term capital gain. The assessee, during the year under consideration, had claimed as having sold bonus shares of these two companies, which were allotted to it in September, 1999. Considering that the assessee held the said bonus shares for the period exceeding 12 months, it had claimed profit arising thereunder on sale of shares as chargeable to tax as long-term capital gains at a concessional rate. Besides this, the assessee had also shown sale of certain other shares that was claimed as short-term investments and, therefore, the profit arising therefrom was shown as short-term capital gains. This claim of the assessee was, however, not accepted by the Assessing Officer who observed that in the preceding accounting year, the assessee had been consistently engaged in the business of acquisition and sale of shares. Further, the holdings of these shares were mostly for limited periods. Only shares which were not in huge demand and the assessee was not in a position to sell were held for longer period, which the assessee was compelled to do. He took a view that the claim of the assessee-company that the profit arising from sale of shares is chargeable to tax as long-term capital gain and short-term capital gain respectively depending upon the period of holding cannot be accepted. Accordingly, the Assessing Officer proceeded to tax the entire profit other than what has been shown in the form of dividend as chargeable to tax as part of the business profits.

2.1 The matter was carried before the first appellate authority, who confirmed the order of the Assessing Officer. The learned Authorised Representative of the assessee submitted written submission where by it was contended that actually the assessee-company derived income by way of capital gains only and not as business income. He further pointed out that the assessee-company, since its inception, had been functioning as an Investment Company only and not as a trading Company. It would be clear from a study of the Memorandum of Association of the assessee-company and also its activities, since its inception, in the financial year 1999-2000. There was a single Clause with regard to the Main Objects of the Company, which reads as under :

"To carry on business as general merchants, traders, importers, exporters, brokers, adatias, representatives and commission agents in merchandise, goods, machinery and equipment including agricultural products; aquaculture, horticulture, floriculture, hatcheries, tobacco products, food and dairy products, sugar, apparel, yarn, textiles, glass and glass products, cosmetics, paints varnishes, dyes and pigments, oil and lubricants, fertilizers, pesticides, precious and semi-precious stones, diamonds, tea, coffee, granities, marble and other stones, pipes, tubes, cement and cement products, paper, plastic and plastic products, moulded luggage, packing and packing materials, musical and sports goods, telecommunication equipment, electrical, computers and peripherals, hardware, software and domestic appliances."

2.2 The assessee-company could not proceed in any of the above lines of business of the nature of trading in various commodities etc. due to various reasons. It was, however, possessed of considerable amount of funds consisting of its paid-up share capital of Rs. 12,00,200 and reserves and surplus in the nature of share premium received during the first year being financial year 1999-2000 amounting to Rs. 2,88,00,000 as on the last date of the first year being 31-3-2000. The company could not keep this huge fund lying idle and, hence, ventured on the other activity as per Clause 29 of the "Other Objects" of the Company as per its Memorandum of Association, which reads as under :

"To carry on the business of an Investment Company and to invest in, and require and hold, sell, buy or otherwise deal in shares, debentures, debenture stocks, bonds, units, obligations and securities issued or guaranteed by Indian or foreign Governments, States, dominions, sovereigns, municipalities, or public authorities or bodies and shares, stocks, debentures, debenture stocks, bonds, obligations and securities issued and guarnteed by any company, corporation, firm or person whether incorporated or established in India or elsewhere."

2.3 Thus the intention of the company, almost after its inception, was to act as an 'investment company' in the line of shares and stocks. This is evident from the conduct of the assessee-company since beginning to hold shares of a few selected companies for the purpose of earning dividend on the shareholdings and also to have the benefits in appreciation in the values of the shareholdings occasionally.

2.4 In the financial year 1999-2000 being the first year of existence of the company, corresponding to the assessment year 2000-01, the assessee-company earned gross income of Rs. 51,28,391.51 by way of profit on sale of investments. The assessee returned the total income of Rs. 49,17,003 consisting of mainly short-term capital gains of Rs. 51,28,392 and business loss of Rs. 1,57,601 being expenses for running the set up only. This return showing mostly short-term capital gains was duly accepted by the Department under section 143(1) of the Income-tax Act, 1961, on 15-3-2002, and refund of Rs. 4,176 was granted to the assessee-company. To the best of knowledge of the assessee-company, this position had not yet been tried to be revised or altered by the Department by taking resort to any provisions of the Income-tax Act like section 143(3), 263, 147 or 154 of the Act. Hence, this position and the version of the assessee of being an investor only in shares and stocks had already been accepted by the Department and the same had achieved finality.

2.5 While framing the assessment order for the year under present appeal viz., assessment year 2001-02, the Assessing Officer had mainly relied on the position of rather frequent purchases and sales of shares in the immediately preceding year viz., assessment year 2000-01. The main stand of the assessee was that on account of frequency in transactions in shares in the year, corresponding to the assessment year 2000-01, the assessee-company should be considered to be a trader in shares. In this regard, so far as assessment year 2000-01 is concerned, the matter stands closed by accepting the version of the assessee about the transactions being on investment account, by the Department, as discussed supra. The learned Departmental Representative supported its contention by various decisions. The policy of law is that there must be a point of finality in all legal proceedings, that stale issues should not be reactivated beyond a particular stage and that lapse of time must induce repose in and set at rest judicial and quasi-judicial controversies, it must in other spheres of human activity as held by the Hon'ble Supreme Court in the case of Parashuram Pottery Works Co. Ltd. v. ITO [1977] 106 ITR 1. The learned Authorised Representative of the assessee relied on the ratio of Privy Council in the case of CIT v. Khemchand Ramdas [1938] 6 ITR 414, wherein it was held that once a final assessment has been made, it cannot be reopened except and insofar as provided in the Act. This principle has been approved further in the following cases :

(a) ITO v. S.K. Habibullah [1962] 44 ITR 809 (SC);

(b) CIT v. Tribune Trust [1948] 16 ITR 214 (PC);

(c) Ahmedabad Mfg. and Calico Printing Co. Ltd. v. G. Mehta [1963] 48 ITR 154 (SC); and

(d) Controller of Estate Duty v. NA. Merchant [1975] 101 ITR 270 (Guj.) affirmed by the Supreme Court.

2.6 According to this principle, the Assessing Officer cannot change his mood and try to reopen a closed state of affairs. In the instant case, therefore, it was stated that once the position of the shares being held in the investment portfolio, which was accepted in the order under section 143(1) of the Act for the assessment year 2000-01, the Assessing Officer cannot try to change the position subsequently or in the assessment order or proceeding for the subsequent year without resorting to requisite the legal procedures in this regard. Since the major argument of the Assessing Officer in the present assessment order was based on the factual position for the assessment year 2000-01, he cannot draw adverse inference by altering the accepted position for that year, herein.

2.7 It was further pointed out by the learned CIT(A) that the activities of the assessee-company in acquiring shares of selected companies in a limited scale also support its contentions in that regard. During the year under consideration, the assessee-company earned short-term capital gains on disposal of shares of three companies only, namely, BHEL, Global Tale Ltd. and Infosys Techno Ltd., whereas long-term capital gains were earned by it on disposal of shares of Pentafour Software Ltd. and Satyam Computers Ltd. The assessee-company did not indulge in the activity of dealing in shares of a large number of companies in a regular and voluminous manner, nor did it enter into any difference transactions in shares. It was also submitted that the shares of the last named two companies were acquired by the assessee-company in August, 1999 under the exception of good performance by these two companies. Bonus shares were issued by these two companies which were continued to be held by the assessee-company and, ultimately, sold away in this year. The long-term capital gains had arisen in this year only on the disposal of these bonus shares in January, 2001, i.e., after about seventeen months from the date of acquisition of the original shares. The assessee-company enjoyed dividend of Rs. 2,92,379 and Rs. 33,717 on shares of Pentafour Software Ltd. and Satyam Computers Ltd. respectively according to its anticipation of reaping such dividend benefit. Further, it was submitted that the disposal of shares of these two companies in the current year fetched of Rs. 5.01 crores only as against their market value as on 31-3-2000 of Rs. 13.24 crores. This fact clearly shows that the assessee-company was not like a trader in shares who watched the fluctuation in market very keenly and catch hold of the earliest opportunity to dispose of their shares at the time when the prices of the shares reach or are very near the peak. On the other hand, this very fact of keeping the shares for a rather long time in the hope of a surge in the market and, ultimately, selling the shares when the declining trend of the price became very prominent, just to avoid further erosion of the values of the shares, distinguishes the character of the assessee-company as an 'investor' rather than as a 'trader' in shares. A 'trader' would have reacted much more sharply and also promptly to a declining trend in the market, it is only investor who goes on cherishing hope for a revival in the market conditions. It was further submitted that the assessee-company chose a particular line of shares viz., shares of software companies mostly for the purpose of making investments. For a regular dealer in shares, dealing in shares of different types of companies would have been the usual feature.

2.8 It was further pointed out by the learned Authorised Representative of the assessee that the assessee-company even acquired unquoted shares of companies like Dolat Capital Market and Nirpan Securities Limited through private arrangements in the hope of good performance by the companies coupled with the expectation of appreciation in the value of the shares. A regular trader would have hardly touched unquoted shares for his business purpose of trading in shares

In support of this contention assessee submitted as under :

(i) The assessee-company has, all along and in a consistent manner, depicted its acquisition of shares as 'investment' and has never treated the holding of shares as its stock-in-trade. This may not be a conclusive test but at the same time, a fairly good indicator about the activities and also the intention of the assessee-company.

(ii) The assessee-company has utilised its own fund and not used any borrowed fund in acquiring the shares. This also gives a fair indication about the character of the assessee-company being that of an investor only.

(iii) The infrastructure of the assessee-company is also rather very small a regular trader of shares would have required a much bigger infrastructure to study the market intently and also to carry on transactions in shares in large volumes. The total administrative expenses of the assessee-company during the year under consideration were only to the extent of Rs. 4,21,020.97 which included meagre salary payment of Rs. 1,92,077 only; and

(iv) The assessee-company chose a particular line of shares viz., shares of computer and software companies mostly for the purpose of making investments therein. For a regular dealer in shares, dealing in shares of different types of companies would have been the usual feature.

Although the assessee contends, in a general manner, that it is an 'investor' in shares throughout and was never a dealer in shares, yet as an alternative argument and without prejudice to the generality of the above contention, it is being pleaded specially that at least so far as this particular year is concerned and with regard to the shares of the two companies on disposal of which long-term capital gains have been claimed in this year, the income of the assessee-company should be treated as long-term capital gains instead of as business income. It is well-known principle of law that an assessee can act both as a trade as well as an investor in the same thing, article pr commodity in the same year. In this regard, the learned Authorised Representative on behalf of the assessee has relied on the judgment of Hon'ble Supreme Court in the case of CIT v. Madan GopalRadhey Lal [1969] 73 ITR 652, wherein it was explicitly held

"a trader may acquire a commodity in which he is dealing for his own purpose, and hold it apart from the stock-in-trade of his business. There is no presumption that every acquisition by a dealer in a particular commodity is acquisition for the purpose of his business; in each case the question is one of intention to be gathered from the evidence of conduct and dealings by the acquirer with the commodity."

(v) In the present case, on the authority of this judgment that, although, the assessee-company might have acted as a dealer in respect of the other shares in which it had rather quick acquisition and disposal, at least so far as the shares of Pentafour Software Ltd. and Satyam Computers Ltd. are concerned, it displayed all the characteristics of an investor in the lines as discussed above in detail and since these shares (bonus shares) were held by the assessee-company for seventeen months, the resultant gains arising to the assessee-company on ultimate disposal of these two sets of shares should be considered as long-term capital gains. The assessee-company acquired the shares of the two companies under consideration with the expectation of gaining bonus shares on the original holdings acquired by it, derived the bonus shares and after holding the bonus shares for sometime in the hope of reaping the maximum benefit and thereby, ultimately, sold away the shares when the declining trend in the price of the shares concerned became too evident. There was no trading activity involved at least in these two lots of shares as the assessee-company had not purchased and sold the shares.

(vi) In this context, reliance was placed on the judgment of Hon'ble Bombay High Court in the case of CIT v. Principal Officer, Laxmi Surgical (P.) Ltd. [1993] 202 ITR 601, wherein it was held

"when the impugned asset had been acquired by the assessee as capital asset as distinguished from business assets forming part of stock-in-trade, merely because the transaction was undertaken with the intention of earning profit because the company had suffered losses in the past but that by itself was not enough to give it the character of stock-in-trade or to bring the transaction within the ambit of an adventure in the nature of trade."

(vii) In addition, the learned Authorised Representative of the assessee relied on the judgments of Mumbai Bench of the Tribunal in the case of Addl. CIT v. Sri Sunder Iyer [IT Appeal No. 295 (Mum.) of 2001], wherein Tribunal observed as under :

"The assessee might have good knowledge of the share market as a broker but, in our opinion, this does not lead to the conclusion that the assessee would only be purchasing shares as stock-in-trade for the purpose of carrying on business. There is no law which prevents the share broker from making investments in shares. We hold that no material has been brought on record by the Assessing Officer to substantiate his finding that the assessee had been trading in shares in his individual capacity. The Assessing Officer has also failed to specifically point out that the borrowings were utilised for making investments in shares. The assessee had enough capital of his own to enable him to make the investments in shares. We find that the decision of Kerala High Court in the case of Kethan Kumar A. Shah (supra) relied upon by the ld. Counsel of the assessee is a direct decision on the matter and helps the case of the assessee. The shares held on capital account by the assessee in the instant case were never converted as stock-in-trade neither any entry in this regard was made in the assessee's books of account.....We have perused the reasoning given in the impugned order and we are of the view that the learned CIT(A) had taken correct decision in the matter."

Apart from assessee relied on the ratio laid down in the case of Asstt. CIT v. Kethan Kumar A. Shah [2000] 242 ITR 83, wherein the Hon'ble Kerala High Court observed as under :

"that profit on sale of certain shares held by the assessee, a share broker, as personal investment is assessable as capital gains and not as business income when the same were not converted by him into stock-in-trade, in the absence of any material to show that these shares were acquired in the course of the assessee's business."

On above line order of authorities below was opposed and Ld. DR supported the order of authorities below.

3. After going through the rival submission and material on record we find that in the present case, the stand of the assessee is that the assessee-company had never worked as a share broker. It is rather a new company and there is no history of the assessee-company being engaged in share dealings. The judgments, cited above, acknowledge the principle that a share broker or a dealer in shares may also have a separate character as an investor in shares. So far as the assessee-company is concerned, it had all along displayed all the characteristics of an investor only, as elaborately discussed above. The assessee engaged in making investment in shares for the purpose of earning dividend income and also reaping the benefits of appreciation in price of shares, which every investor in shares always does. The assessee-company had never indulged in bulk trading in shares nor in any speculative activities in share line. The learned Authorised Representative of the assessee, further, pointed out that the assessee-company utilizes its own funds only and depicts the transactions in shares under Investment Portfolio. It is settled legal principles of law that merely by booking profits from time-to-time, an investor does not lose his character as an investor and does not become a trader. The learned Authorised Representative of the assessee pleaded that after taking into consideration the totality of factual facts and legal aspects, the assessee-company be treated as an investor and the gains made by it in disposal of the shares under consideration be directed to be treated as capital gains.

3.1 As far as the gains arising to the assessee-company out of disposal of the shares of Pentafour Software Ltd. and Satyam Computers Ltd. are concerned, the gains arising to the assessee during the year under consideration be treated as long-term capital gains. As discussed above, the shares of these two companies as sold by the assessee-company during the year under appeal were not purchased, but simply received as bonus shares. These shares should be considered as having been held by the assessee-company as investments, even though the other shares might be considered as trading shares.

3.2 The only issue in this appeal preferred by the assessee relates to treatment of the investments made by the assessee-company in shares as business transactions and corresponding assessment of capital gains arising to the assessee-company on disposal of the shares in investment as business profits. All through the stand of the assessee is that it derived income by way of capital gains only and not business income. According to the Memorandum of Association, the main object of the assessee-company was of variety of activities for the reason best known to the assessee, it could not do well on main objects as mentioned in above. However, the assessee possessed considerable amount of funds consisting of its paid-up share capital and reserves and surplus of the nature of share premium received during the first year being financial year 1999-2000 as a prudent businessman the assessee ventured on the other activity as per Clause 29 of the "Other Objects" of the Company as per its Memorandum of Association as discussed above. As per the said Clause, the assessee engaged its funds in the line of share and stocks. The assessee held shares of a few selected companies for dividend on the shareholdings and also to have the benefit of appreciation in the values of the shareholdings.

3.3 In the financial year 1999-2000 being the first year of existence of the company, corresponding to the assessment year 2000-01, the assessee-company earned gross income of Rs. 51,28,391.51 by way of profit on sale of investments. The assessee returned total income of Rs. 49,17,003 consisting of mainly short-terms capital gains of Rs. 51,28,392 and business loss of Rs. 1,57,601 being expenses for running the set-up only. The said return showing mostly short-term capital gains was duly accepted by the Department under section 143(1) of the Income-tax Act, 1961, on 15-3-2002, and refund of Rs. 4,176 was granted to the assessee-company. There is nothing on record to rebut this fact. There is also nothing on record that the Department reviewed or revised the same under section 143(3), 263, 147 or 154 of the Act.

3.4 The assessment order framed by the Assessing Officer for the year under consideration, viz., 2001-02, the Assessing Officer had mainly observed that the assessee frequently purchases and sales of shares in the immediately preceding year, viz., 2000-01. The main thrust of the Assessing Officer was that on account of frequency in transactions in shares, the assessee-company should be considered to a trader in shares. The policy of law is that there must be a point of finality in all legal proceedings. The issues should not be reactivated beyond a particular stage and that lapse of time must induce repose in and set at rest judicial and quasi-judicial controversies, as held by the Hon'ble Supreme Court in the case of Parashuram Pottery Works Co. Ltd. (supra). This principle has been approved in various decisions. Accordingly, the Assessing Officer is not supposed to open a closed chapter. It is not disputed by the revenue, that share being held in the investment portfolio, as accepted in the order under section 143(3) of the Act for the assessment year 2000-01, which should not be disturbed. The Assessing Officer should not deviate settled portion without resorting to requisite the legal procedures in this regard.

3.5 According to the learned Authorised Representative of the assessee, in the year under consideration, the assessee-company earned short-term capital gains on the disposal of shares of three Companies only, namely, BHEL, Global Tale Ltd. and Infosys Techno Ltd., whereas long-term capital gains were earned by it on disposal of shares of Pentafour Software Ltd. and Satyam Computers Ltd. The stand of the assessee is that it not indulged in the activity of dealing in shares of a large number of companies in a regular and voluminous manner. The shares of the last named two companies were acquired by the assessee-company in August, 1999 under the exception of good performance by these two companies. Bonus shares were issued by these two companies which were continued to be held by the assessee-company and, ultimately, sold away in the year under consideration. The long-term capital gains had arisen in this year only on the disposal of these bonus shares in January, 2001, i.e., after about seventeen months from the date of acquisition of the original shares. Meanwhile, the assessee-company enjoyed dividend of Rs. 2,92,379 and Rs. 33,717 on the shares of Pentafour Software and Satyam Computers Ltd. respectively. The disposal of shares of these two companies in the current year fetched of Rs. 5.01 crores only as against their market value as on 31-3-2000 of Rs. 13.24 crores. It shown that the assessee-company was not like a trader in shares who watched the fluctuation in market very keenly and catch-hold of the earlier opportunity to dispose of their shares at the time when the prices of the shares reach or are very near the peak. On the other hand, this very fact of keeping the shares for a rather long time in the hope of a surge in the market and, ultimately, selling the shares when the declining trend of the price became very prominent, just to avoid further erosion of the values of the shares, distinguishes the character of the assessee-company as an 'investor' rather than as a 'trader' in shares. A 'trader' would have reacted much more sharply and also promptly to declining trend in the market.

3.6 The assessee-company chose a particular line of shares, viz., shares of software companies mostly for the purpose of making investments. For a regular dealer in shares, dealing in shares of different types of companies would have been the usual feature. The assessee-company even acquired unquoted shares of companies like Dolat Capital Market and Nirpan Securities Limited through private arrangements in the hope of good performance by the companies coupled with the expectation of appreciation in the value of the shares. A regular trader would have hardly touched unquoted shares for his business purpose of trading in shares. The conduct of the assessee shows that acquisition of shares as investment and has never treated the holding of shares as its stock-in-trade. There is nothing on record to suggest that the assessee used borrowed funds in acquiring the shares. But its own funds were utilised which is a fair indication about the character of the assessee-company being that of an investor only. The infrastructure of the assessee-company is also very smaller a regular trader of shares would have required much bigger infrastructure to study the market intently and also to carry on transactions in shares in large volumes. The assessee-company chose a particular line of shares viz., shares of computer and software companies mostly for the purpose of making investments therein. For a regular dealer in shares, dealing in shares of different types of companies would have been the usual feature as held in the case of Madan Gopal Radhey Lal (supra).

3.7 As far as the shares of Pentafour Software Ltd. and Satyam Computers Ltd. are concerned, it displayed all the characteristics of an investor as discussed above. Since these shares were held by the assessee-com-pany for seventeen months, the resultant gains arising to the assessee-company on ultimate disposal of these two sets of shares deserve to consider as long-term capital gains. Our this view get strength from the ratio. Hon'ble Bombay High Court in the case of Principal Officer, Laxmi Surgical (P.) Ltd. (supra), wherein it was observed as under :

"when the impugned asset had been acquired by the assessee as capital asset as distinguished from business assets forming part of stock-in-trade, merely because the transaction was undertaken with the intention of earning profit because the company had suffered losses in the past but that by itself was not enough to given it the character of stock-in-trade or to bring the transaction within the ambit of an adventure in the nature of trade."

3.8 Similar view was taken by Mumbai Bench of the Tribunal in the cases of Sri Sunder Iyer (supra) and in the case of CIT v. Sri Ramdeo Agarwal [IT Appeal No. 4912 (Mum.) of 2001 and also in the case of Kethan Kumar A. Shah (supra) as discussed above. It is new Company and there is no history of the assessee-company being engaged in share dealing. The above decision acknowledge the principle that a share broker or a dealer in shares may also have a separate character as an investor in shares. So far as the assessee-company is concerned, it has all along displayed all the characteristics of any investor only as already discussed above elaborately. It is not justified on the part of the Department to deviate from earlier to settled portions. There is nothing on record to suggest that the assessee-company had ever indulged in bulk trading in shares or in any speculative activities in share line. As we have discussed earlier that the assessee has been using its own funds only depicts the transaction in shares under Investment Portfolio. Taking all facts and circumstances into consideration, we hold that the assessee-company was an investor and gain made by it on disposal of the shares under consideration should be assessed as capital gain. We hold accordingly.

4. As a result, the appeal of the assessee is allowed.

 
 
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