Gujarat High Court
Aditya Medisales Ltd vs Deputy Commissioner Of Income Tax ... on 10 August, 2016
Author: Akil Kureshi
Bench: Akil Kureshi, A.J. Shastri
C/SCA/10217/2011 JUDGMENT
IN THE HIGH COURT OF GUJARAT AT AHMEDABAD
SPECIAL CIVIL APPLICATION NO. 10217 of 2011
FOR APPROVAL AND SIGNATURE:
HONOURABLE MR.JUSTICE AKIL KURESHI
and
HONOURABLE MR.JUSTICE A.J. SHASTRI
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1 Whether Reporters of Local Papers may be allowed
to see the judgment ?
2 To be referred to the Reporter or not ?
3 Whether their Lordships wish to see the fair copy of
the judgment ?
4 Whether this case involves a substantial question of
law as to the interpretation of the Constitution of
India or any order made thereunder ?
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ADITYA MEDISALES LTD....Petitioner(s)
Versus
DEPUTY COMMISSIONER OF INCOME TAX CIRCLE 1(1)....Respondent(s)
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Appearance:
MR SAURABH N SOPARKAR SENIOR ADVOCATE WITH MR MONAAL J
DAVAWALA AND MRS SWATI SOPARKAR, ADVOCATE for the Petitioner(s)
No. 1
MR KM PARIKH, ADVOCATE for the Respondent(s) No. 1
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CORAM: HONOURABLE MR.JUSTICE AKIL KURESHI
and
HONOURABLE MR.JUSTICE A.J. SHASTRI
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C/SCA/10217/2011 JUDGMENT
Date : 10/08/2016
ORAL JUDGMENT
(PER : HONOURABLE MR.JUSTICE AKIL KURESHI)
1. The petitioner has challenged a notice dated 11.1.2011 (wrongly typed as 11.1.2010) for reopening the petitioner's assessment for the assessment year 20052006.
2. Brief facts are as under. The petitioner is a limited company registered under the Companies Act. For the assessment year 20052006, the petitioner filed the return of income on 31.10.2005 declaring income of Rs.57.73 lacs (rounded off). This return was taken in scrutiny by the Assessing Officer. The Assessing Officer framed assessment on 27.12.2007 determining the petitioner's total income at Rs.5.86 crores (rounded off). To reopen such assessment, impugned notice came to be issued. The Assessing Officer had recorded the following reasons to issue such notice :
"Facts :
A survey u/s.133A of the Incometax Act was carried out in the case of assessee company on 27 th & 28th September 2010. During the course of survey and post survey investigations, statements of Shri Girish Desai, whole time director of the assessee company and Shri Hiten. C. Timbadia, FCA, Tax Auditor (u/s.44AB of the IT Act, 1961) of the assessee company were recorded. On the basis of the documents found during the course of survey, statements of above mentioned persons and the return of income filed by the assessee company, the following Page 2 of 17 HC-NIC Page 2 of 17 Created On Sat Aug 13 02:34:39 IST 2016 C/SCA/10217/2011 JUDGMENT discrepancies emerged:
The assessee was engaged in the business of trading in shares and securities, apart from other business activities. During Financial Years 199596, 199697 and 199798, the assessee purchased certain shares out of interest bearing borrowed funds and held it as "stockintrade".
The assessee kept claiming interest on such borrowed funds as its expenses and kept reducing its taxable income. The A0 made disallowance u/s.14A. The assessee took the below mentioned grounds of appeal before the Honorable ITAT for earlier years completed assessments: a. "1.2 The CIT (Appeals) ought to have considered that the shares are held as stockintrade and not as investment. Hence, the stock--intrade is mainly held for the purpose of earning profits on sales of shares and dividend income is merely incidental to the holding of stockintrade. b. 1.3 The CIT(A) ought to have considered that the entire borrowings made by the appellant was for the purpose of business which includes the investment made in stockin trade and accordingly the interest on borrowing would be deductible expenditure u/s.36(1)(iii). From the above quoted. grounds of appeal filed by the assessee, it becomes absolutely clear that the shares held as "stockintrade" by the assessee. were purchased from interest bearing borrowed funds and interest have been claimed as expenses from year after year since the date of purchase of such shares.
These shares in question, purchased by the assessee as "stockintrade" continued to be held as "stockintrade"
till 31.03.2004.
Meanwhile, a new Amendment was made in the Income Tax Act. Through this amendment, sale of shares held as 'investment' through recognized StockExchanges became free from incidence of tax u/s.10(38) with effect from A.Y.2005O6.
The assessee showed the above referred shares as Page 3 of 17 HC-NIC Page 3 of 17 Created On Sat Aug 13 02:34:39 IST 2016 C/SCA/10217/2011 JUDGMENT transferred from 'stockintrade' to 'investment' at the same old historical purchase cost as cost of purchase on 1.4.2004 relevant to A.Y. 200506.
The Tax Auditor, Shri Hiten C. Timbadia, did not mention a word about this change, affecting taxable income of the assessee in the Tax Audit Report, inspite of the specific requirement of the Tax Audit u/s.44AB of the I T Act, 1961.
Statement of Shri Hiten Timbadia, Tax Auditor was recorded on oath and he expressed regrets for this willful omission on his part.
Since there is differential tax treatment between 'stockin trade' and 'investment' under the Income Tax Act, any change or transfer can be done at market price and not at cost price. Any change in the value of 'stockintrade' would directly affect taxable income under the Income Tax Act, profit arising on sale of shares held as 'stockintrade' is taxable as business income at the maximum marginal rate whereas profit earned on sale of shares held as 'investment' is free from incident of tax u/s.10(38) w. e f. A.Y. 200506.
In view of the above mentioned facts, I have reason to believe that the income chargeable to tax has escaped assessment because of collusion between the Assessee and the Tax Auditor, wherein the Auditor did not mention the fact of a transfer of shares held as 'stock in trade' to "investment', at cost price in its Tax Audit report. This willful omission on part of the Tax Auditor also tantamounts to professional misconduct as it defeats the very purpose and intention of the Tax Audit u/s.44AB of the Income Tax Act, 1961.
The malafide of the assessee is also proved by the fact that the assessee showed a highly suppressed market value of the shares in question in its account statements. The market value of shares of M/s. Sun Pharmaceuticals Industries Ltd, held by the assessee as on 1.4.2004 was Page 4 of 17 HC-NIC Page 4 of 17 Created On Sat Aug 13 02:34:39 IST 2016 C/SCA/10217/2011 JUDGMENT Rs.397,66,33,989/ as compare to Rs.l57,0l,72,947/ reflected by the assessee.
When the statement of Shri Girish Desai, whole time Director of the company was recorded during the course of survey, he admitted that he was aware of the consequences and he was also aware that by naming 'stockintrade' as 'investment' they can escape taxability. During earlier years, when disallowance was made under section 14A, the assessee kept insisting that the shares in question have been purchased from interest bearing borrowed funds and the interest on them allowable business expense as they have been held as 'stockin trade', and the intention of the assessee is earning of business income. However, when the 'stockintrade' was converted into 'investment' by the assessee, assessee purposely did not disallow the interest component on them in AY 200506, as any such disallowance would have attracted the attention of the A0 during scrutiny proceedings.
During the course of survey and post survey investigations, the assessee tried to prove that these shares were purchased from interest free funds, which is contrary to the stand taken by them, as mentioned earlier, in the case of same shares during earlier assessment years.
The quantum of income escaping assessment is worked out as under:
Market price of shares as on l.4.2004 for the quoted shares
1. Shares of Sun Pharma Ind. Ltd., 2010198 equity shares + 4020396 bonus shares = 6030594 shares value of share of company as on 1.4.2004 (Average Price) Rs.659.4l/ Market price of shares of Page 5 of 17 HC-NIC Page 5 of 17 Created On Sat Aug 13 02:34:39 IST 2016 C/SCA/10217/2011 JUDGMENT Sun Pharma lnd. Ltd. Rs.397,66,33,989/ The cost of acquisition Rs.9,l6,98,559/ Profit Rs.388,49,35.430/.
2. Shares of Equity of Zigma Software Ltd.
490629 equity shares Value of share of Zigma Software Ltd. as on 1.4.2004 average price Rs.19.91 Market price of share of Zigma Software Ltd. Rs.97,68,423/ Cost of acquisition Rs.43,20,000/ Profit Rs.54,48,423/ Income escaping for the year which remained to be taxed is Rs.389,03,83,853/.
In this case, the assessment was finalised u/s.143(3) of the IT Act. However, since the Tax Auditor did not disclose full and complete facts relating to this transfer in his Audit Report, and the issue escaped AO's attention. The case needs to be reopened u/s.147 of the Incometax Act, 1961."
3. The petitioner raised detailed objections under communication dated 26.5.2011. Such objections were however, rejected by the Assessing Officer by an order dated 8.7.2011.
4. From the materials on record, it can be seen that the assessment which was framed after scrutiny is sought to be reopened by issuance of a notice beyond a period of four years from the end of relevant assessment year.
5. In the context of such reopening, counsel for the petitioner raised three broad contentions :
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1) That there was no failure on part of the petitioner to disclose truly and fully all material facts. Reopening of assessment beyond a period of four years was therefore, invalid.
2) The sole issue of the conversion of shares held by the company as stockintrade into investment was examined by the Assessing Officer during the scrutiny assessment.
3) In any case, there was no taxing event by mere conversion of such shares. This being the sole ground on which the Assessing Officer seeks to reopen the assessment, the same must fail. In this context, counsel relied on several decisions, to which we would refer to at a later stage.
6. On the other hand, learned counsel Shri K.M. Parikh for the department opposed the petition contending that the conversion of shares from stockintrade to investment was not disclosed in the returns filed or during the original assessment. Reopening beyond a period of four years was therefore permissible. The petitioner adopted the cost price for such conversion instead of the market value which would be the correct method. This would result into income chargeable to tax escaping assessment. This issue was never examined by the Assessing Officer during the original assessment.
7. Before proceeding further, we may record that though broadly counsel for the petitioner, as noted above, had Page 7 of 17 HC-NIC Page 7 of 17 Created On Sat Aug 13 02:34:39 IST 2016 C/SCA/10217/2011 JUDGMENT raised three separate contentions, he focused solely on the last of these contentions while elaborating such contentions. In other words, his main and in fact, the sole contention was that in the process of converting the shares from stock to investment, the petitioner was not liable to pay any tax and that therefore, under no circumstances can it be stated that income chargeable to tax had escaped assessment. We have therefore, focused only on this aspect of the matter.
8. In this background, if we analyse the reasons recorded by the Assessing Officer, in such reasons, he had stated that the assessee was engaged in the business of trading in shares and securities apart from having other business activities. The company had purchased shares with borrowed funds and held them as stockintrade. The company would claim interest expenditure on the borrowed funds. This pattern continued till 31.3.2004. In the meanwhile, amendment was made in the Income Tax Act through which the sale of shares held as investment through recognized stock exchange would be free from tax with effect from assessment year 20052006. The assessee thereupon transferred the shares from stockintrade to investment which was done on 1.4.2004 as per old historical purchase cost. According to the Assessing Officer, any such change or transfer of shares had to be done on market price and not at cost price, since valuation of transferred stockintrade would have direct effect on the taxable income under the Income Tax Act. The profit arising on sales of share held as stockintrade is taxable as business income whereas profit earned on sales of Page 8 of 17 HC-NIC Page 8 of 17 Created On Sat Aug 13 02:34:39 IST 2016 C/SCA/10217/2011 JUDGMENT shares held as investment is free from tax. Even the auditor in the auditor's report had not mentioned the correct fact. It was noted that the market value of shares of M/s Sun Pharmaceuticals Industries Ltd. held by the assessee on 1.4.2004 was Rs.397.66 crores (rounded off) but shown by the assessee at Rs.157.01 crores (rounded off). It was further alleged that for the assessment year 20052006, the assessee purposedly did not disallow interest component on such shares, since any such disallowance would have attracted the attention of the Assessing Officer during scrutiny assessment. He therefore, formed a belief that difference between cost of acquisition of shares of M/s Sun Pharmaceuticals Industries Ltd. and market price which was Rs.9.16 crores and Rs.397.66 crores respectively would be the profit to the company which escaped assessment. Likewise, he noted that the assessee had acquired equity shares of Zigma Software Ltd. at the cost of Rs.43.20 lacs which had a market value of Rs.97.68 lacs as on 1.4.2004 and the difference between the two i.e. Rs.54.48 lacs was the profit escaping assessment. Fundamental question is in the process of converting the shares held by the company as stockintrade into investment, was the assessee liable to pay tax on cost of acquisition of shares at its market value on the date of transfer? In the context, the question would also be, would it make any difference whether for its accounting purpose the assessee transferred such stocks at cost instead of prevailing market value? The question in other words would be by mere transfer of shares from stockintrade to investment, did any taxing event arise so as to make the petitioner liable to pay the tax on any Page 9 of 17 HC-NIC Page 9 of 17 Created On Sat Aug 13 02:34:39 IST 2016 C/SCA/10217/2011 JUDGMENT income?
9. Very similar issue arose before the Constitution Bench of Supreme Court in case of Sir Kikabhai Premchand v. Commissioner of Incometax reported in (1953) 24 ITR
506. Facts were that the appellant assessee was an individual and was dealing in silver and shares. The assessee was following the mercantile system of accounting and he was following the cost price method under which the cost price of the stock was entered at the beginning of the year and not its market value and similarly the cost price was again entered in the close of the year on any stock which was not disposed of during the year. During the course of the year under consideration, the assessee withdrew some silver bars and shares from the business and settled them on three trusts, in all of which the assessee himself was one of the beneficiaries. He had retained to himself the revisionary life interest after the death of his wife who was given the first life interest. He himself was the managing trustee in two of the trusts and virtually in the third. In the books, the assessee credited the business with cost price of bars and shares so withdrawn. This became the bone of contention before the Supreme Court. The assessee contended that the act of withdrawal of such shares and bars resulted in neither income nor profit or gain to himself or to his business, nor was it a business transaction and accordingly not taxable. The Revenue however, argued that the bars and the shares were brought into business and any withdrawal therefrom must be dealt with along ordinary and wellknown business lines, namely, that if a person withdraws an asset Page 10 of 17 HC-NIC Page 10 of 17 Created On Sat Aug 13 02:34:39 IST 2016 C/SCA/10217/2011 JUDGMENT from a business, he must account for it to the business at market rate prevailing at the date of the withdrawal. The second contention of the Revenue was that if the act of withdrawal is at a time when the market price is higher than the cost price, then the State would be deprived of a potential profit. If the market rate was lower, the assessee would be entitled to claim such loss. In this context, the majority opinion was that :
"As regards the first contention, we are of opinion that the appellant was right in entering the cost value of the silver and shares at the date of the withdrawal, because it was not a business transaction and by that act the business made no profit or gain, nor did it sustain a loss, and the appellant derived no income from it. He may have stored up a future advantage for himself but as the transactions were not business ones and as he derived no immediate pecuniary gain the State cannot tax them, for under the Incometax Act the State has no power to tax a potential future advantage. All it can tax is income, profits and gains made in the relevant accounting year.
xxx In such circumstances we are of opinion that it is wholy unreal and artificial to separate the business from its owner and treat them as if they were separate entities trading with each other and then by means of a fictional sale introduce a fictional profit which in truth and in fact is nonexistent. Cut away the fictions and you reach the position that the man is supposed to be selling to himself and thereby making a profit out of himself which on the face of it is not only absurd but against all canons of mercantile and incometax law. And worse. He may keep it and not show a profit. He may sell it to another at a loss and cannot be taxed because he cannot be compelled to sell at a profit. But in this purely fictional sale to himself he is compelled to sell at a fictional profit when the market rises in order that he may be compelled to pay to Page 11 of 17 HC-NIC Page 11 of 17 Created On Sat Aug 13 02:34:39 IST 2016 C/SCA/10217/2011 JUDGMENT Government a tax which is anything but fictional. xxx The appellant's method of bookkeeping reflects the true position. As he makes his purchases he enters his stock at the cost price on one side of the accounts. At the close of the year he enters the value of any unsold stock at cost on the other side of the accounts thus cancelling out the entries relating to the same unsold stock earlier in the accounts; and then that is carried forward as the opening balance in the next year's accounts. This cancelling out of the unsold stock from both sides of the accounts leaves only the transactions on which there have been actual sales and gives the 225 true and actual profit or loss on his year's dealings. In the same way, the appellant has reflected the true state of his finances and given a truthful picture of the profit and loss in his business by entering the bullion and silver at cost when he withdrew them for a purely nonbusiness purpose and utilised them in a transaction which brought him neither income nor profit nor gain."
1. Decision in case of Kikabhai Premchand (supra), came up for consideration before a larger Bench of nine judges in case of Commissioner of Incometax v. Bal Shirinbhai K. Kooka reported in (1962) 46 ITR 86(SC). It was a converse situation where the assessee lady held by way of investment large number of shares of different companies which were purchased before 19391940 at a cost which was much less than the market value prevailing on 1945. For the assessment year, 19461947, the Income Tax Officer found that the assessee had converted her shares into stockintrade and was trading in shares. Her income for the assessment year 19461947 was therefore, computed on the basis of profits which she made by sale of her shares as a trading activity, profit being calculated on Page 12 of 17 HC-NIC Page 12 of 17 Created On Sat Aug 13 02:34:39 IST 2016 C/SCA/10217/2011 JUDGMENT the difference between ruling market price at the beginning of the accounting year and the sale proceeds. Again the majority view was that the ratio in case of Kikabhai Premchand (supra) would not govern the case on hand and, therefore, did not require reconsideration in the said case. On the main issue on hand, the Supreme Court held and observed as under :
"In an earlier part of this judgment we have taken pains to point out the distinction between Kikabhai's case (2) and the case under our consideration. In view of that distinction, we do not think that it is really necessary in the present case to reexamine the ratio of the decision in Kikabhai's case (3). What then is the basis for computing the actual profits in the present case ? We think that the basis must be, as the High Court has put it, the ordinary commercial principles on which actual profits are computed. We think that the approach of the High Court was correct and normally the commercial profits out of the transaction of sale of an article must be the difference between what the cost the business and what it fetched on sale. So far as the business or trading activity was concerned, the market value of the shares as on April 1, 1945, was what it costs the business. We do not think that there is any question of a notional sale here. The High Court did not create any legal fiction of a sale when it took the market value as on April 1, 1945 as the proper figure for determining the actual profits made by the assessee. That the assessee later sold the shares in pursuance of a trading activity was not in dispute; that sale was an actual sale and not a notional sale; that actual sale resulted in some profits. The problem is how should those profits be computed? To adopt the language of Lord Radcliffe, the only fair measure of assessing trading profits in such circumstances is to take the market value at one end and the actual sale proceeds at the other, the difference Page 13 of 17 HC-NIC Page 13 of 17 Created On Sat Aug 13 02:34:39 IST 2016 C/SCA/10217/2011 JUDGMENT between the two being the profit or loss as the case may be. In a trading or commercial sense this seems to us to accord more with reality than with fiction."
2. Following the judgement in case of Kikabhai Premchand (supra), a Division Bench of Calcutta High Court in case of Commissioner of Incometax v. Dhanuka & sons reported in 124 ITR 24, observed that when there was a withdrawal of part of stockintrade from the assessee's business and when withdrawal was not in the course of business transaction with third party, there was no transaction at all because a person could not be said to have a transaction with one's own self. There could therefore, not be any actual profit or loss in such transfer. It was observed as under :
"On a careful consideration of the respective submissions of the parties and the decisions cited before us, it appears that the facts in the present case are more in conformity with the facts in Sir Kikabhai Premchand than with the facts in Bai Shirinbai K. Kooka . In the instant case, there has been withdrawal of a part of the stockintrade from the assessee's business. This withdrawal was not in the course of a business transaction with a third party. In fact, strictly speaking, there has been no transaction at all because a person cannot be said to have a transaction with one's own self. We do not agree with the contention of Mr. Sen that such a transfer should be reflected in the books at nil value. In our opinion, the transaction will have to be entered in the account at the value in which the item was being carried, that is, at the market value of the opening stock. Had it been a case of a sale or transfer to a third party, it is only then the question of crediting the account with the current market value would arise. If instead of the middle of the accounting year, the transfer was effected Page 14 of 17 HC-NIC Page 14 of 17 Created On Sat Aug 13 02:34:39 IST 2016 C/SCA/10217/2011 JUDGMENT either at the beginning or at the end of the year from its opening or closing stock, it would be the market value of either the opening or the closing stock with which the account would have to be credited. But a withdrawal of such stock during the accounting year would be reflected in the accounts by the value at which such stock was being carried.
Further, in our view, there cannot be any actual profit or loss in such transfers where no third party is involved and the items are kept in a different account of the assessce himself. The question of gain or loss would arise in the facts of the instant case only in future when the stocks transferred to the investment account might be dealt with by the assessee. If such shares be disposed of at a value other than the value at which it was transferred from the business stock, the question of capital loss or capital gain would arise."
1. It can thus be seen that the situation in the present case finds a direct answer in the judgement of the Constitution Bench in case of Kikabhai Premchand (supra) in which, as noted, the assessee had settled a part of his shares and silver bars held as stock into a trust of which he was prime beneficiary and was also in control of the trust. It was held that in the process, the assessee's business made no profit or gain nor did it sustain a loss. The appellant did not derive any income. He may have stored up a future advantage for himself but since transactions did not derive an immediate pecuniary gain, the State cannot tax it since under the Income Tax Act, the State had no power to tax a potential future advantage. Facts of the present case are quite similar. The Assessing Officer had referred to in detail the reasons recorded as a sequence of events under which the assessee converted its shares held as stockintrade to investment on 1.4.2004 which was done at the cost price Page 15 of 17 HC-NIC Page 15 of 17 Created On Sat Aug 13 02:34:39 IST 2016 C/SCA/10217/2011 JUDGMENT and not market value. The Assessing Officer seems to be having two objections. First, he refers to the conversion of stock at cost price and not market price and second, he refers to profit to the business which would be the difference between the cost of acquisition of the shares and their market value on the date of transfer which should be taxed. In view of the judgement in case of Kikabhai Premchand (supra), mere transfer of shares by the company from its stockintrade to investment account would result in no profit or gain to the business. The question of correct valuation at which the same should have been transferred therefore, pales into insignificance when we are concerned with a single question namely, whether on the premise suggested by the Assessing Officer it can be stated that the income of the petitioner chargeable to tax had escaped assessment.
2. A close scrutiny of the reasons recorded would find a mention of the act of assessee not disallowing the interest component on such shares for the assessment year 2005 2006 which according to the Assessing Officer was done to avoid detection. If case of the Assessing Officer was that interest on borrowed funds would be a legitimate deduction, as long as the shares were held as stock, but upon the shares being converted into investment, such interest was not allowable deduction and in that sense income chargeable to tax had escaped assessment, he has not built on such case in his reasons. We say so because in the computation of income chargeable to tax escaping assessment, he has referred to a sum of Rs.389.03 crores which, as noted earlier, is the total of the profit computed Page 16 of 17 HC-NIC Page 16 of 17 Created On Sat Aug 13 02:34:39 IST 2016 C/SCA/10217/2011 JUDGMENT by him upon transfer of shares of M/s. Sun Pharmaceuticals Industries Ltd. and transfer of shares of Zigma Software Ltd. This computation of the profit was based on the original cost of acquisition in the market value on the date of transfer. This figure of income escaping assessment does not in any manner refer to the interest expenditure. In other words, a brief reference to the assessee claiming interest expenditure for the assessment year 20052006 was confined only to suggest that the same was done to avoid detection during the scrutiny assessment and the Assessing Officer did not built his case any further in the context of income chargeable to tax having escaped the assessment.
3. Under the circumstances, impugned notice dated 11.1.2011 (wrongly typed as 11.1.2010), is quashed. Petition is allowed and disposed of.
(AKIL KURESHI, J.) (A.J. SHASTRI, J.) raghu Page 17 of 17 HC-NIC Page 17 of 17 Created On Sat Aug 13 02:34:39 IST 2016